Stockholm (HedgeNordic) – Most professional investors are always seeking avenues that offer one or more of three key investment attributes: high returns, low volatility in returns, and minimal correlation with other asset classes. The Stockholm-based Ridge Capital, led by its founders Christoffer Malmström and Måns Levin, firmly believes that the Nordic high-yield market ticks all three boxes.
Christoffer Malmström, with significant credit investing expertise from his roles at UBS Investment Bank and Park Square Capital in both Stockholm and London, asserts that the expected return from Nordic high yield over the next 12 months falls within the high single-digit range. Importantly, Malmström emphasizes that “this return is contractual and not contingent on growth expectations or any other factors.” According to Malmström, “the contractual nature of these returns, coupled with their high expected return, makes it challenging to find other asset classes that can match that at this point.”
“The contractual nature of these returns, coupled with their high expected return, makes it challenging to find other asset classes that can match that at this point.”
Christoffer Malmström, Founding Partner and Lead Portfolio Manager at Ridge Capital
Måns Levin, formerly Head of the Advisory Office at UBS Wealth Management in Sweden before co-founding Ridge Capital, highlights the Nordic high-yield market’s capacity to deliver equity-like returns with lower risk. He underscores the contractual return stream inherent in high-yield bonds, a feature absent in equity markets. “In the high-yield market, investors receive a contractual return stream of, say, 10 percent if no significant events occur,” Levin explains. “In contrast, in equity markets, the return could be zero or even negative if nothing happens.” While high-yield bonds are often compared to equities in terms of risk and return, Levin emphasizes that “the contractual aspect is the big difference between the two asset classes.”
Tailor-Made Fund Structure and Investment Strategy
While the Nordic high-yield bond market represents an active hunting ground, there exists a wide range of investment structures and approaches to access this source of returns. The duo behind Ridge Capital has chosen a Luxembourg-domiciled Reserved Alternative Investment Fund (RAIF) structure, which they deem better suited for navigating what Malmström and other money managers perceive as an “inefficient and imperfect market.” This market may experience occasional patches of illiquidity, as well as a lack of credit ratings, among other imperfections. “We have a structure that is tailor-made to take advantage of these anomalies,” notes Malmström. The alternative investment fund structure with monthly liquidity enables Ridge Capital and its Northern Yield Fund to be an opportunistic player (not a forced seller) in more challenging market environments.
“We have a structure that is tailor-made to take advantage of these anomalies.”
Christoffer Malmström, Founding Partner and Lead Portfolio Manager at Ridge Capital
While the structure holds significance, the underlying strategy centered on credit selection stands as a core pillar. “Our credit selection is underpinned by a very rigorous credit analysis,” explains Malmström. “We maintain a much more focused portfolio compared to the typical bond fund,” he adds, noting that Ridge Capital Northern Yield holds approximately 40 positions. Moreover, the team’s preference leans towards investing via the secondary markets rather than the primary markets because this is where the team can effectively exploit market inefficiencies. Lastly, the ability to enhance returns through leverage and mitigate downside risk through short positions – using iTraxx Crossover Index Options rather than single-bond shorting – provides Ridge Capital with the flexibility to deliver returns across various market climates, as highlighted by Malmström.
Security Selection
Having previously worked at one of Europe’s leading private debt firms in London, Christoffer Malmström leverages his background in private debt, where he collaborated closely with sponsors for months and conducted extensive due diligence as you typically have access to much more in-depth company information in the private market relative the public market. “In private debt, the due diligence process involves a completely different set of information compared to public markets,” notes Malmström. “We try to adopt the same bottom-up investment process but in a lighter format compared to what we were able to do in private debt,” he continues. This investment process entails bottom-up analysis that focuses on understanding the company’s business model, barriers to entry, market dynamics, revenue generation centers, and, crucially, cash flow streams.
“Everything drills down to the cash flow. It all starts and ends with the cash flow,” emphasizes Malmström. Issuers of high-yield debt must be capable of generating ample cash flow “not only to service interest payments and potential amortization but also to deleverage, ensuring that their leverage ratio is at a level where they can either repay the bond solely with cash or maintain a low risk of being unable to refinance with a new bond,” according to Malmström. Given that high-yield investments entail a higher risk of default for investors, Malmström also stresses the importance of investing in issuers with robust ownership structures. “We place significant emphasis on strong owners who possess the financial strength and incentives to support the company if the need arises,” Malmström concludes.
In today’s environment of higher interest rates, the team prioritizes companies with moderate leverage levels. “We are going to live in a ‘higher-for-longer’ interest rate environment,” states Malmström. Therefore, it is imperative to target companies with more conservative leverage levels relative to their cash flow generation. “This is a key focus area for us.” The team also evaluates relative value within the company’s capital structure and in comparison to other bonds outstanding in the market. This strategic approach is why Ridge Capital predominantly concentrates on the secondary market, aiming to uncover relative value opportunities at all times.
Focus on the Secondary Market
“We engage in both secondary and primary trades, but our primary focus is on the secondary market,” explains Malmström. When it comes to primary trades, the team assesses companies based on the yield or coupon they offer relative to the risk associated with those investments. “For investments in the primary market, we tend to take a more long-term view,” he points out.
However, the secondary market presents more opportunities, particularly with bonds trading at a discount, where Ridge Capital seeks to capitalize on the “pull-to-par effect.” Malmström emphasizes that “this pull-to-par effect is not always a linear price increase, which underscores the importance of catalysts or event-driven situations such as sales of some business parts or rights issues that can positively impact prices.”
“This pull-to-par effect is not always a linear price increase, which underscores the importance of catalysts or event-driven situations such as sales of some business parts or rights issues that can positively impact prices.”
Christoffer Malmström, Founding Partner and Lead Portfolio Manager at Ridge Capital
This blend of longer-term investments with stable coupons and shorter-term catalyst-driven investments can create an attractive risk-return profile. “The first part provides a predictable income stream throughout the bond’s life, allowing us to lock in returns. The second part offers the potential for higher returns over a shorter timeframe, driven by specific triggers,” Malmström elaborates.
Concentration and Leverage
The impact of shorter-term catalyst-driven investments on returns is particularly pronounced in concentrated portfolios such as the one maintained by Ridge Capital Northern Yield. “If you consider your typical plain vanilla funds with hundreds of bonds, it becomes challenging to make these shorter-term trades in the secondary market because they are not going to make a difference,” argues Malmström. “With 200 positions in a portfolio and each accounting for half a percent of the overall exposure, even investments with returns between 10 to 20 percent are not going to make a difference, he elaborates. For that reason, most diversified funds tend to focus on the primary market and hold bonds until maturity, “but this approach does leave a lot of alpha on the table,” according to Malmström.
“If there are no price movements in the portfolio, the gross return be in the range of 14 percent. Considering we built out the portfolio at a discount and it continues to trade at a discount, the yield to maturity exceeds 18 percent.”
Christoffer Malmström, Founding Partner and Lead Portfolio Manager at Ridge Capital
Ridge Capital aims to enhance its source of returns through the strategic use of leverage, typically ranging from 1.25 to 1.75 times equity. “We utilize prime broker financing, keeping our portfolio as collateral with our bank and paying a relatively cheap spread on that financing,” explains Malmström. This additional capital, deployed in opportunities offering spreads of 600 basis points or more, presents a compelling return on investment. “This represents a pretty pick-up gap in what we are paying for that leverage and what we can redeploy that cash into.”
Despite achieving a net return of 19 percent in its first 15 months since inception, the fund’s current portfolio still offers an attractive return potential with an unlevered gross yield-to-maturity of 14 percent and a levered gross yield-to-maturity of 18.6 percent. By achieving a six percent gain in the first quarter of 2024 alone, Ridge Capital Northern Yield has already reached halfway toward its yearly target of seven percent above risk-free rate. Additionally, with a cash yield of 14 percent, Malmström affirms, “If there are no price movements in the portfolio, the gross return be in the range of 14 percent.” Furthermore, “considering we built out the portfolio at a discount and it continues to trade at a discount, the yield to maturity exceeds 18 percent.”
