Global credit funds & CLO's
March 2020
| Issue 221
Published in London & New York.
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Profiting from default-risk premiums
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Credit hedge funds with the ability to go long and short the market were the top performers last year. But dispersion made it possible for fund managers to eke out value across many sectors
The top four funds in 2019 all pursue long-short strategies, but express their views through different forms of derivatives. Cheyne Total Return Credit Fund December 2023 (38.6% return in 2019) is a long-biased fund which invests in CDS; Carmignac Portfolio Unconstrained Credit (20.9%) invests across cash and synthetic credit; and Selwood Credit Opportunity Fund II (20.6%) is known to invest in CSO tranches.
Duncan Sankey, head of credit research at Cheyne, says that the Cheyne total return fund benefited from “default-risk premiums” in investment grade credit and the roll down from relatively steep credit curves. “We were also well-positioned to take advantage of decompression between investment grade and high yield spreads,” he adds.

Despite this decompression between IG and HY, idiosyncratic risks meant that there were opportunities within high yield bonds. BlackRock USD High Yield Fund, for instance, generated 15.1% returns by favouring high quality bonds over excess spread.

“Dispersion amongst issuers was elevated in high yield in 2019,” says David Delbos, managing director and co-head of US high yield, “and this provided great opportunities to generate alpha through credit selection.”

Mitchell Garfin, co-head of leveraged finance, reiterates that credit selection was key and says that BlackRock capitalised once volatility subsided. “We were able to help structure and take advantage of the significant uptick in secured debt issuance in early 2019 to fund the backlog of M&A deals from Q4 2018.”
Dispersion was the big theme of 2019, which meant that the best credit pickers came out on top. It also meant that simply allocating to a segment of the market wasn’t enough — managers had to be mindful of tail risks.
Credit hedge funds: lowest and highest returns
2019 return of Cheyne Total Return Credit Fund Dec 2023
It was a similar story in Europe, where Capital Four managed to outperform in testing conditions. Officials at the firm say that they had allocated to senior secured positions, but that they were comfortable taking calculated risks on single names. As 2019 wore on, geopolitical risks surfaced and credit funds had to give up some of the gains they’d made in Q1. At the heart of this were trade tensions between China and the US, which escalated in May after US president Donald Trump said that the US would raise tariffs on Chinese goods. Throughout the rest of the year, credit reacted to China-US trade talks, one of the consequences of which was a flight to safety that fuelled further dispersion.
The loan market was a victim of this trend, with Creditflux highlighting that, in October, 12% of the US loan universe was trading below 90 cents. During the December 2018 sell off, the proportion trading below 90 was 8%. In all, $49.8 billion left retail US loan funds, according to a report by Evestment.

On top of this, loan downgrades were giving credit pickers a headache and causing CLO managers to pay greater attention to their triple C buckets. “Last year, a lot of bank loans were downgraded to triple-C and we were in a position to be able to act quickly when CLOs became forced sellers,” says Justin Slatky, co-chief investment officer at Shenkman.

Multi-strategy funds can produce positive returns across markets, depending on the degree of flexibility afforded to managers. Blueglen European Credit Fund I-22 has a fairly broad remit, including European structured credit, corporate debt, financials and credit derivatives. The fund’s London-based manager, Blueglen, was able to capitalise on this, gaining 19.7%.
“At the end of 2018, the fund was positioned for a rally in European corporate credit spreads and a recovery in European structured finance markets in 2019,” says portfolio manager Felix Braun.

Fund managers say that dispersion is a theme that will persist in 2020, which suggests that long-short funds could again outperform. But perhaps the most efficient way to express a view on dispersion, or credit correlation, is in the credit index tranche market or via CSO tranches.

As it did last year, dispersion this year will also benefit managers with asset picking skills. Allocating to CLOs is fair enough, but no two deals will perform the same.
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Credit long-short funds were best at navigating these challenges, ending the year as top performers, with the Creditflux long-short index up 9.48%. This was a far cry from 2018, when the index was up just 1.99%. But not all long-short credit funds outperformed. Just as managers had to be careful about selection to avoid problem credits, institutional investors had to be selective about which funds they allocated to. On average, long-short credit funds recorded higher returns in 2019 than in 2018, but there was greater dispersion in monthly returns. In late 2018, long-short credit funds were ideally placed to capitalise on credit market volatility that was punctuated by vast outflows from retail-orientated funds. Over the first two months of 2019, these funds were up 3.2%, according to the Creditflux index. In the end, they accounted for over a third of returns for the year.
“Dispersion amongst issuers was elevated in high yield in 2019”
David Delbos,
Managing Director and Co-Head | US high yield BlackRock
30 best performing hedge funds by strategy 2019
US high yield
European high yield
Structured finance
Credit multi-strategy
Senior secured pays off in Europe
“We were able to act quickly when CLOs became forced sellers”
Justin Slatky,
Co-chief Investment Officer | Shenkman
“The fund was positioned for a rally in European corporate credit”
Felix Braun,
Portfolio Manager | Blueglen
Corporate long-short
Dispersion tests hedge fund managers
March 2020 | Issue 221
Analysis credit
Michelle D’Souza
Research Robin Armitage
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