Mill Hill Capital: Credit Relative Value and Volatility Trading

Glaring disconnects in credit markets

Hamlin Lovell

Average US credit market valuations in October 2019 are nowhere near the levels seen in early 2016, let alone those in 2009. But according to Mill Hill founder and chief investment officer, David Meneret – who featured in The Hedge Fund Journal’s 2016 “Tomorrow’s Titans” report – certain relative value opportunities are at extremely extended levels. His proprietary measures of valuation dispersion, dubbed “credit basis”, are around the 99th percentile since Mill Hill’s inception and were only recently close to this point for a few days in 2016. 

The term “basis” can refer to many things in credit markets – including cash versus CDS basis, or credit indices versus their constituents – but Meneret is not active in either of these areas, which tend to require substantial leverage to generate interesting returns. His concept of basis involves identifying two sets of instruments that are ultimately backed by the same, similar or reasonably overlapping assets or cashflows, but which trade at widely divergent valuations. Meneret thinks laterally among markets, trading a broadly market neutral portfolio across a wide range of instruments under four broad credit sub-asset classes: CLOs, financials, transportation & ABS, and MBS. In principle he is agnostic about whether the collateral is aircraft, company loans or residential or commercial property. The segmentation of other market participants who are unable or unwilling to cross over between credit sub-asset classes or trade all instruments within them – due to broker dealer capital constraints, investor comfort zones, narrow mandates and regulatory restrictions – results in blinkered thinking that can give rise to glaring valuation anomalies.

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