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Leveraging Opportunities in Credit Markets

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Stockholm (HedgeNordic) – After several years of successful bond investing through a private investment company, Nicolai Wenckheim launched an alternative investment fund in March 2017 with the backing of new investors. Joined by Søren Eriksen in 2018, the two seasoned professionals with extensive careers in Nykredit Markets have been realizing their ambition of managing their own fund focused on corporate bonds. The fund, Refima Capital Partners, has delivered a total return of 49 percent since its inception, outperforming the Bloomberg EUR High Yield Index by approximately 28 percent.

Launched in March 2017, Refima Capital Partners employs a strategy focused on investing in subordinated debt, consisting of any debt subordinate to senior debt, as well as regulatory capital instruments such as AT1, RT1 and Tier II bonds, alongside lower investment-grade and high-yield senior bonds. Nicolai Wenckheim and Søren Eriksen also have the flexibility to amplify returns by increasing leverage via a so-called repurchase, or repo, agreement. The duo can leverage equity up to five times, although they have never reached this maximum level with the alternative investment fund.

“As is often the case with leverage, you learn from mistakes. Using significant leverage is like walking a minefield.”

“As is often the case with leverage, you learn from mistakes. Using significant leverage is like walking a minefield,” says Wenckheim. After a solid initial year of investing, Refima Capital Partners faced a challenge in 2018 with its largest position in a Danske Bank bond during the money laundering scandal at the Estonian branch of Danske Bank. “We chose not to sell the bond. Despite taking an initial hit, we held the bond until maturity and eventually got the money back,” recalls Wenckheim. However, the use of leverage introduced some volatility into the return stream. 

Refima Capital Partners also incurred a significant loss during Covid-induced market turmoil in February and March in 2020. “March was the worst month in our history,” says Wenckheim, as leverage magnified the downward pressure on returns. “This incident led us to structurally reduce our leverage after Covid, and we currently operate with lower leverage than before.” The use of leverage has gradually been reduced since the fund’s inception, with the team currently employing leverage of up to two times equity. “Once we started managing other people’s money, we adopted an investment framework with a more prudent use of leverage.”

The Strategy

The investment strategy has remained largely unchanged. “We are 100 percent credit investors and invest across all types of listed credit, including high yield, low investment grade, and subordinated debt such as AT1 from banks and RT1 from insurance companies,” explains Wenckheim. “We have a preference for high-rated issuers but select the subordinated bonds to collect a higher-yielding return in the capital structure.” 

“We have a preference for high-rated issuers but select the subordinated bonds to collect a higher-yielding return in the capital structure.”

The fund’s geographic scope includes Scandinavia, Northern, and Central Europe. “We do not go towards Southern Europe in Italy or Spain, there are plenty of issuers, issues, and attractive investment opportunities within our targeted regions,” notes Wenckheim. The Nordic high yield bond market, for instance, typically exhibits a spread of 100 to 150 basis points over the European high yield market.

The strategy and portfolio of Refima Capital Partners are built on three main pillars. First, the team builds a well-diversified base portfolio consisting of about 30 to 35 publicly traded corporate bonds. “This basis portfolio consists of convertible hybrids, high yield, subordinated debt, and so on,” says Wenckheim. Second, the team enhances returns by purchasing investment-grade bonds via a repurchase agreement with a bank, allowing increased leverage. “The leverage only consists of investment grade bonds, mostly financial subordinated bonds such as Bank AT1, Tier II, insurance RT1 and some senior non-preferred bonds,” explains Wenckheim. The third pillar involves using derivatives like interest rate futures to occasionally hedge or adjust interest rate risk in the portfolio.

“The construction of our base portfolio is a case-by-case process,” begins Wenckheim. The selection process starts with a credit analysis of the bonds. The selection process involves credit analysis, peer comparison, examination of documentation, and sector assessment. “We prefer companies whose equity is listed on the exchange for better access to general news flow,” elaborates Wenckheim. “We then conduct our own assessment to determine the investment’s attractiveness, considering the specific case and the broader sector outlook.” Refima Capital Partners has evenly allocated roughly half of its portfolio to financial bonds and high-yield bonds across other sectors so far. “So far, we have not had a default in the portfolio.”

“The end of each month allows us to go through all the key figures in our portfolio and reassess our leverage level.”

Nicolai Wenckheim and Søren Eriksen then determine the appropriate level of leverage every month. “The end of each month allows us to go through all the key figures in our portfolio and reassess our leverage level,” says Wenckheim. He highlights that Refima Capital Partners utilizes a rather unique repo facility for corporate bonds, specifically investment-grade bonds issued by financial institutions. “This is a unique facility that allows us to increase leverage using investment-grade bonds from financial issuers.”

The portfolio management team at Refima Capital Partners also has the flexibility to utilize derivatives for hedging interest rate risk. “We don’t usually take bets on interest rates,” says Wenckheim. “However, when interest rates were zero, we saw a huge asymmetric risk,” he elaborates. This bet paid off in 2022, as Refima Capital Partners generated a 10 percent return contribution from shorting ten-year bonds, offsetting half of the fund’s losses for the year. “We don’t know if interest rates should be three or three and a half percent. When central banks stopped hiking, we closed down all our interest rate shorts.”

“We don’t usually take bets on interest rates. However, when interest rates were zero, we saw a huge asymmetric risk.”

While Refima Capital Partners does not adhere to a specific benchmark, its strategy has demonstrated a higher correlation with the pan-European high-yield index, which reflects exposure to senior high-yield and subordinated bonds issued by banks and insurance companies. Consequently, the team aims to achieve a long-term return that surpasses this index by 300-500 basis points.

Despite experiencing a 10.2 percent loss amidst challenging market conditions in 2022, Refima Capital Partners rebounded with a 12.3 percent gain in 2023 and an additional 2 percent in the first month of 2024. “With a portfolio enjoying an approximately 11 percent yield-to-maturity, our ambition remains to outperform our peers and achieve double-digit returns per annum over the next five years.”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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