Global credit funds & CLO's
February 2020
| Issue 220
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Opinion credit derivatives
2020 will be about relative value, watching for idiosyncratic risk and a good deal of running away
Welshcake
welshcake@acuris.com
February 2020
|
Issue 220
quotation mark
Investors must embrace change — it’s time for structured credit investors to look beyond vanilla CLOs
Four guards scuttle from the gate of a castle and retrieve a seeming gift.

“What happens now?” asks king Arthur, watching from his hiding place.

“Well now,” explains Bedivere, “Lancelot, Galahad and I wait until nightfall and then leap out of the rabbit, taking the French by surprise!”

“Who leaps out?”

“Lancelot, Galahad and I... leap out of the rabbit and... uh...”

Arthur holds his head and groans.

“Um, look,” offers Bedivere as they continue watching from their hiding place at some remove, “if we built this large wooden badger...”
In the Monty Python film, Bedivere is played by the late, great Terry Jones, Wales’s patron saint of comedy and naked piano playing, who sadly died last month. It’s not his most revered character — Brian’s mum in Life of Brian probably tops most people’s lists — but it is truest to his Welsh genius.
What worked in 2019 won’t work anymore
Arthur and his hapless knights’ misadventures resonate keenly with the difficulties of credit investors as they seek the ‘holy grail’ of a passable return and arrive at a few strange castles.

It’s a new year for new ideas, but also the end of an old, and investors must change the way they go about things (and maybe change their armour). In 2019, one could still just about prevail with the long carry trade, but 2019 is gone. 2020 will be much more about picking sectors and ratings bands, playing relative value and minding out for idiosyncratic risk. Also a good deal of running away and going short may be required.

These challenges feel acute in the structured credit market. CLOs face an increasing fight for loans, along with the growing likelihood of a wave of loan refinancings and repricings.

It was fondly hoped that synthetic bespoke tranches would pick up some of the slack, by offering an alternative way for investors to take a structured view on credit with a similar risk profile. But collapsing spreads brought 2019 to a close with a whimper for CSOs, making it hard to rationalise the diminished return of equity tranches against the likelihood of credit events.

Correlation has been moving around over recent weeks, so there is definitely still money to be made in the index tranche market. But it’s hard to see a decisive catalyst for prolonged spread widening or volatility that would make the bespoke portfolio compelling across the full capital structure. Managed bespoke deals remain the best bet for rejuvenating this asset class, but it’s going to take hard work and strong stomachs to get those going soon.

Early 2020 has shown that erstwhile market-moving events such as US-Iran tensions and China’s coronavirus quickly lose their potency against the weight of the meta-narrative. Even the impending US election cycle has so far prompted little expectation among investors other than for the same kind of short-lived skirmishes in credit. Of late, less discernment is happening at the single name level, when it should be more.

You’d need someone with the logic of Jones’s Bedivere to glean any sense from this picture. This comes, of course, from a bloke living in a country that has just left the European Union to great fanfare and bluster, but with little inkling of how the departure changes reality. The UK government’s attitude is like Arthur’s to Monty Python’s Camelot. In Camelot, Arthur is offered everything he could want, only to decide, following musical consideration, that it is “a silly place”.
Great things can arise from humble places
I’m not a pessimist, and believe we must set our minds to rejuvenation. The most uplifting thing to happen in Wales in January was the birth of a male black rhino at Folly Farm in Pembrokeshire. To get a sense of how rare and wonderful this is, consider that there have only been 40 black rhinos born in the entire UK in the past 20 years. Think about that when you do your next CSO.

A drop in the ocean, you might say, but Folly Farm itself is a warming lesson in how great arcs of development can arise from humble origins. At one stage you could undertake nothing more exciting at the farm than an argument with a goat, but now they have lions, giraffes and penguins. I’m pretty sure there will be velociraptors running amok by the end of this year. Or a killer rabbit.
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