Conversely, another turbulent period provided the strategy’s best relative year: in 2020 it made 1.68%, some 2.14% ahead of the cash benchmark. “2020 was a very volatile year because of COVID – 19, which offered opportunities. We mostly took advantage through the relative value strategies,” says Zeenni. Even during the 2020 drawdown period around Covid, the fund never reached its 5% annualized volatility cap and has always been managed to a low volatility target. The strategy can also be accessed at higher risk and return targets.

Variable net exposure

“The strategy is designed to make absolute performance in all market environments and market cycles. It can be market neutral at some point if needed. It is a long/short absolute return strategy with directional biases,” explains Zeenni. Net exposure can vary between minus 50% and plus 50%, but has averaged positive for the past five years, as shown below.

The portfolio can invest in both investment grade and high yield, but high yield net exposure is capped at 20%.

There is minimal interest rate sensitivity. The risk limit for rate sensitivity is -2.5/+2.5 years of interest rate duration but it is usually and under normal market circumstances between -1 and +1.

Directional and relative value opportunity sets

The strategy uses little or no leverage. The maximum NAV allocations are 100% to the directional sub-strategy and 160% to the relative value sleeve. “The split depends on the opportunities and market conditions, which vary through credit market cycles. When the market is more directional, we allocate more to strategies around the directional bucket, and when we expect more dispersion, we allocate more to strategies on the relative value bucket,” says Zeenni. The two strategies diversify one another: there tends to be a low correlation between them as the relative value bucket is market neutral.

The relative value family of trades

In times of volatility, the relative value strategy capitalises on credit market dispersion from various opportunities such as basis and cross currency trades. “The split between capital structure, curve trades, currency basis, and cash versus CDS basis varies with the opportunities we see in the market overall and for individual issuers,” says Zeenni. For instance, Candriam sometimes find that bonds from the same issuer in different currencies can be arbitraged, even after considering currency hedging and other costs. Cash versus CDS basis on the same issuer can be traded in either direction. “It depends on the opportunity we see. After the ECB’s CSPP program was introduced in June 2016, many bonds were trading in positive basis territory, which was a good opportunity to short them,” points out Zeenni.

Investment universe

Candriam prefer the US and Europe, including the UK, for their liquidity, as well as the potential opportunities. There is also some preference for listed issuers as they offer more liquidity, though unlisted issuers of publicly traded credit are not ruled out. Most of the book is in corporate debt. Financials are limited to 15% and CoCos (contingent convertibles) are capped at 7.5% gross and 2.5% net exposure.

Upgrades, downgrades and internal ratings

Candriam trade a two-way traffic between high yield and investment grade in long and short books. “Fallen angels and rising stars are both sources of alpha as our credit rankings give us an idea of potential future upgrades and downgrades. We see compelling opportunities when an issuer has its rating changed from IG to HY or from HY to IG,” says Zeenni. “We tend to predict fallen angels and rising stars before the rating agencies, based on our internal credit ratings. We do monitor credit ratings but rather than following their recommendations we use internal ratings,” he explains.

Navigating dislocations

Candriam has been able to both sidestep dislocations and subsequently take advantage of them. “The fund was not impacted by the UK gilt crisis in September 2022. In late 2022, we took long positions on some UK issuers. Our long bank positions were a little affected by the Credit Suisse collapse in March 2023, but we had no exposure to Credit Suisse AT1 which allowed us to avoid losses. We then bought short duration bonds on banks,” recalls Zeenni.

Seasoned and synergistic team

Lead manager Zeenni, who has been with Candriam for over 20 years, manages the fund on a daily basis. Co-portfolio managers, Guillaume Benoit and Mouine Darwich, who have both been with Candriam for around 10 years, are responsible for pitching trade ideas and act as back-up fund managers. The investment management team benefit from synergies with the two fixed income team quants as well as the credit analyst who develop internal credit ratings and help in decision-making. They all also work closely with the ESG team. They all sit on the same floor and interact daily, as well as through meetings and committees.

Eclectic process

The process includes macroeconomic, fundamental, quantitative, legal and technical analysis, as well as governance and ESG.

Macroeconomic input

The Economic Outlook Committee (EOC) may encourage Candriam to take a long or short position in a particular sector. For instance, in mid-2024 banks were appealing. “Given the changes in rates and economic environment, some sectors benefit more than others when rates increase. For example, the financial sector tends to benefit from a rising rates environment,” says Zeenni.

Fundamental

The strategy does not expect to own any defaults on the long side, and it is not trading distressed debt. Potentially stressed issuers are closely monitored. If an issuer curve is inverted, it can mean there is uncertainty over refinancing. “This would normally be scrutinized by our fundamental analysis, considering the outcome of the analysis and the market, we may take a view on this event,” says Zeenni.

Technicals

Candriam are aware of market sentiment and do pay attention to technical factors. “We look closely at market technicals to inform our market decisions,” says Zeenni. Candriam uses position level stop losses and has always been able to close out CDS, where the volume of derivatives can exceed cash bonds on some names.

Quantitative

Quantitative research is carried out on all issuers, and Candriam’s CQS model has been used since 2022 for listed corporate investment grade issuers in developed markets. “CQS is specifically designed to provide a credit ranking for high investment grade names, and predict upgrades or downgrades for other names,” says Zeenni. Candriam is expanding CQS coverage of names. Other quant models include the “Stock to Spread” model, which supports fundamental analysis.

Governance and legal

Governance analysis is done at issuer level, while individual instruments are also assessed for security quality based on criteria such as covenants. In practice there is some correlation between the issue and instrument assessment. “A governance controversy may potentially have an impact on the yield, price and spread of a bond,” points out Zeenni.

ESG and sustainability

Exclusions at Candriam vary with SFDR reporting categories and asset classes. “Depending on the SFDR classification of a fund, a bigger part of the universe will be excluded to comply to our ESG criteria, which may also evolve over time. The sustainable investment policies also vary between equity and fixed income products, therefore some companies that are excluded from the fixed income investible universe may not be from the equity one,” says Zeenni.

Since March 15th 2024, Candriam Long Short Credit has reported under SFDR Article 8. This currently excludes issuers below Candriam’s ESG “6” rating or that are rated as “OUT” for governance. The exclusions apply at issuer level for both long and short positions.

Extra work is needed to assess private companies: “When we do not have enough data from a private issuer we may contact them in order to complete the analysis, or the data gaps can be considered in the final result of the issuer analysis,” says Zeenni. Candriam also has an extensive corporate engagement program engaging with both private and public companies bilaterally and collaboratively.

ESG and credit indices

ESG policies also effectively limit the quantum of exposure to traditional credit indices that are not ESG compliant.

While some asset managers do carve derivatives out of their ESG policies, Candriam’s view is that the maximum exposure to non-sustainable investments criteria should also apply to credit index derivatives. “The fund does not employ index futures however we do have positions on derivatives such as CDS and CDX. As an Article 8 fund, with a minimum percentage of sustainable investments, we cannot ensure that the index complies with our ESG criteria. Therefore, credit derivatives are limited to the non-sustainable investment percentage limit,” explains Zeenni.