Danish fixed-income boutique CABA Capital has launched the third vintage of its leveraged, closed-end fixed income strategy: CABA Flex3. The fund aims to deliver equity-like returns by capturing structural spread premiums in Scandinavian covered bonds through a three-year, maturity structure.
The launch comes as the first vintage – CABA Flex, launched in mid-December 2022 – nears the end of its three-year lifecycle with an annualized return of 13.8 percent. “The first CABA Flex fund is structured out of Denmark and expires this December,” says Mette Østerbye Vejen, Chief Executive Officer at CABA Capital. “CABA Flex3 follows the same structure and is aimed at investors who wish to join us for another three-year cycle. We’re excited to welcome both returning and new investors to the CABA Flex concept.”
CABA Capital’s “Flex” series seeks to capitalize on structural spread premiums in the Scandinavian covered bond market. The strategy involves going long non-callable five-year Danish and Scandinavian covered bonds – high-quality, AAA-rated instruments with very low default risk – while hedging interest rate exposure through short positions in government bonds and interest rate swaps. To enhance returns, the fund applies leverage of up to 15 times, amplifying the spread between the long and short legs. “At the core of our strategy is a cash flow transformation model,” explains Østerbye. “In simple terms, we purchase a predictable stream of future cash flows from covered bonds and sell a predictable stream from government bonds and swaps.”
“At the core of our strategy is a cash flow transformation model. In simple terms, we purchase a predictable stream of future cash flows from covered bonds and sell a predictable stream from government bonds and swaps.”
The value of these cash flows fluctuates over time, primarily due to changes in credit spreads. As a result, the fund’s Net Asset Value (NAV) may exhibit some volatility, explains Østerbye. However, this volatility naturally diminishes as the bonds approach maturity and their prices converge toward par, reducing mark-to-market risk and enhancing return stability. “This volatility naturally declines as the portfolio approaches maturity, because the uncertainty around the final cash flows diminishes, and the bond prices converge toward their par values,” she clarifies. Moreover, the mean-reverting nature of credit spreads introduces a self-correcting mechanism: short-term valuation losses caused by spread widening are often followed by recoveries as spreads revert to more typical levels.
By investing exclusively in bullet structures (non-callable bonds), the CABA Flex funds avoid prepayment risk, locking in spreads for the full investment horizon. The three-year maturity structure further enhances return predictability and eliminates liquidity risk and forced-selling, which are often the Achilles heel of leveraged strategies. The buy-and-hold nature of the strategy ensures the declining risk profile and minimizes trading costs, according to Østerbye. “The strategy is designed to capture long-term risk premiums in the AAA-rated Scandinavian bond markets. This strategic approach focuses on investing in high-quality fixed income instruments and holding them (almost) to maturity, thereby ensuring the declining risk profile and minimizing trading costs.”
“What truly makes these funds stand out is their unique return profile: they offer investors the stability and predictability typically associated with bonds, while also providing return potential that can, in some market conditions, resemble that of equities.”
“What truly makes these funds stand out is their unique return profile: they offer investors the stability and predictability typically associated with bonds, while also providing return potential that can, in some market conditions, resemble that of equities,” concludes Østerbye. “This is a rare and valuable combination. In essence, our approach is about combining rigorous risk management with systematic harvesting of predictable excess returns, all while delivering a level of stability that’s uncommon for strategies offering equity-like upside.” Having already validated the strategy through the first CABA Flex fund – on track to deliver a cumulative net return of 41 percent by its conclusion in mid-December – CABA Capital is continuing to build on this success with the expansion of its Flex fund series.
