Cheyne Capital was founded in 2000 and is one of Europe’s leading alternative asset managers, with firm-wide assets of $6.7 billion. It invests across different asset classes and strategies including corporate credit, real estate debt, event driven, convertible bonds, equities and multi-strategy, and offers both offshore and UCITS funds. The Cheyne Long/Short Credit Fund invests both long and short, entirely in corporate credit, and mainly trades investment grade and crossover credits. In 2012 the fund returned 26.9% and since inception in 2004, the fund has annualised 8%.
The common theme running through multiple Cheyne funds is the core house view that investment-grade corporate credit still offers good value. For instance, the iTraxx is still priced to imply a default rate of 10% over five years, when its worst history was just 2.5% in the 1970s. The fact that yields are over-compensating for risk creates potential for capital appreciation from yield compression, and ongoing income from the asset class is also appealing. However, Cheyne does not find raw fixed income products attractive as they could be vulnerable if interest rates rise from multi-generation lows. Cheyne’s expertise in credit derivatives allows the funds to isolate the credit risk they want to own.
The Cheyne Long/Short Credit fund expressed this view in 2012 through owning junior slices of synthetic CSOs, in which the underlying portfolios are managed by Cheyne itself, permitting tight control of “jump to default risk”. Lead portfolio manager Tristram Leach commented that the deep discount of these assets at the beginning of the year, combined with the short maturity and subsequent visibility as to the creditworthiness of the constituent names, made this an attractive risk to take. These positions began 2012 below 50 cents on the dollar and appreciated sharply in value, making a substantial contribution to the fund’s returns. The manager is not, however, taking an aggressively long stance: these short-dated instruments have only moderate spread sensitivity.
The Long/Short Credit fund also has a market neutral “Credit Alpha Strategy”, which contributed positively to 2012’s return. This high-conviction long/short book rarely holds more than 10 long and 10 short names selected from thousands of issuers, and seeks to position Cheyne’s most compelling trade ideas. In terms of instruments, credit default swaps (CDS) are typically used on both sides to avoid the basis risk that can arise from instrument mismatches, but where compelling opportunities present themselves, the fund will also invest in bonds. Currently the two co-heads of the corporate credit team, John Weiss and David Peacock, see an abundance of “transition risk”: the rapid changes in individual credit quality which enable alpha generation by credit selection. Drivers of transition risk in the current environment could be another deterioration in the European sovereign crisis, the ongoing deleveraging of bank balance sheets and the potential for new technologies to render obsolete established business models.
Profitable calls made in the Credit Alpha strategy last year included a long position in RBS (Royal Bank of Scotland), which benefited from a sharp tightening in credit spreads early in the year, while on the short side US retailers Sears Roebuck and JC Penney were successful trades. Analysis across all of Cheyne’s credit funds is bottom-up, fundamental company research conducted by an experienced research team, many of whom have over 20 years' experience. Cheyne’s analysts regularly meet with management of the companies they cover, and closely monitor other parts of the capital structure, including equity prices, as potential lead indicators for changes in credit quality.
The outlook for this year is constructive overall: investment-grade credit is good value, and liquidity abundant. While risks remain, especially in peripheral Europe, the managers see a strong chance that Draghi’s ECB could contain these risks in the short term, despite the longer-term picture for Europe remaining highly challenging. Across the Atlantic, the leveraged buyouts for Dell and Heinz bear witness to the potential for credit negative releveraging transactions due to the availability of ample cheap funding. Cheyne’s base case scenario is for a sideways market offering some carry and more idiosyncratic opportunities for name selection. If 2012 was a macro and political-driven market, falling correlations mean that 2013 could be more about security selection.