Cheyne Capital was founded in 2000 and is one of Europe’s leading alternative asset managers, with firm-wide assets of $6.4 billion. It invests across five core asset classes and strategies including corporate credit, real estate debt, event driven, convertible bonds, equities and multi-strategy. The Cheyne Global Credit Fund is an actively managed, long-biased, UCITS IV-compliant fund. The fund trades investment-grade and crossover credit positions, primarily credit derivatives with a view to maintaining low interest rate duration, and employs a downside protection strategy to manage spread sensitivity. January Minutes from the Federal Reserve have heightened fears that Quantitative Easing could be coming to an end. The risk of rising interest rates reducing the value of fixed income assets is not one that Cheyne feels comfortable taking for the Cheyne Global Credit Fund. Sean Boland, lead portfolio manager on the fund, says that “the risk/reward of fixed rate debt is considerably skewed to the downside,” and predicts that interest rates will eventually normalise. He explains that the Federal Reserve in the US has set out criteria, including pre-defined targets for inflation and unemployment, which could herald the end of asset purchases. Financial markets are likely to react before this happens, and indeed 10-year treasury yields have already jumped approximately 50 basis points from an all-time low seen in the summer of 2012.
If interest rate risk is expensive, Cheyne contends that credit risk remains cheap. The fund receives current income from its net long position. Further returns can also come from credit spread compression, as the price of corporate credit risk declines. Cheyne believes that investors may be unduly concerned about investment-grade credit risk, given the strong fundamentals. Corporate leverage is the lowest since 2005 and liquidity ratios for companies are the best since the 1950s. Meanwhile credit is priced for levels of defaults far worse than those witnessed in the darkest days of the 1970s. So there would seem to be scope for further re-rating of the asset class. All else equal, some spread tightening also occurs automatically via roll down, as a five-year becomes a four-year with a slimmer yield. Finally, in the actively managed portfolio, Cheyne’s proven ability to select improving credits and cut losers can create alpha to further enhance returns.
When interest rates do rise, not only will the fund avoid losses, it will actually benefit as its income should tick up more or less in tandem. The unencumbered cash that is sitting in overnight deposits could benefit immediately, whilst its short-term government bonds would only take a short while to roll over. On top of this floating and short-term interest rate income, developed market corporate credit spreads are the major return driver; emerging markets, asset-backed and mortgage-backed securities are not part of the strategy. The fund can lever up spreads: it can own up to three times its value in terms of five-year equivalent exposure to corporate credit (but the average leverage is expected to be one to two times). Five years is the most common maturity but the credit default swaps (CDS) used let Cheyne tailor tenors down to the nearest quarter. Sometimes if near-term visibility of cashflows is clearer than the longer-term picture, Cheyne may cautiously opt for shorter-dated such as two-year CDS. A long bias is maintained but the fund can short for several reasons: hedging, outright shorting, or as one leg of a pair trade. The hedging strategy currently concentrates on reducing downside and tail risk, and owns baskets of options on credit indices which provide some protection against a sell-off in credit spreads. Tactically varying long exposure can also smooth out returns – in May 2012 Cheyne temporarily scaled back its long books, and this decision helped to limit losses in that month.
The team, who manage $1.7 billion across a range of products, have been working together for 11 years, and are most focused on bottom-up selection of corporates through in-depth fundamental analysis. This has helped to keep Cheyne’s default rate down to 0.34% over 11 years, well below the 2% level seen on a Moody’s proxy benchmark. There are three senior analysts and seven junior analysts, actively monitoring 450 companies globally. The UCITS fund that launched in April 2012 is only the latest in a suite of products managed by the team at Cheyne, with the long-only corporate credit programme compounding at 16% per annum, over 11 years.
Fund manager: Cheyne Capital
Fund management team: John Weiss and David Peacock, co-Heads of Cheyne’s corporate credit team and Sean Boland, Portfolio Manager of the Global Credit Fund