Single name alpha

“All trades are single names and are idiosyncratic, standalone profit centres; there are no pairs trades, indices, macro hedges or overlays,” says Pennings. 

Many credit names traded have a low level of sell side coverage and are misunderstood. Some may not have any coverage from big brokerage houses or credit ratings agencies. Gladwyne has populated this void by building up its own library of several hundred credit research reports. “Unrated bonds can be the most interesting and my vocation is to find mispriced risk in the crevices of the market,” says Pennings. These sometimes neglected issues are nonetheless easily priced: the book is marked to market on a daily basis. Most names are European companies but there can also be other issues listed in Europe. “One example was the busted convertible bond of South African platinum group metals and gold miner Sibanye Stillwater, which was a material contributor,” Pennings points out.

Contrarian energy plays

In 2021 and 2022, energy was among the largest performance drivers. Some positions were initiated before Covid hit because even in January 2020 the sector offered some of the best yields in European credit markets. “After March 2020, we re-underwrote every name in the portfolio and exited some, where outcomes had fundamentally changed. Where names had durable economics and a margin of safety, we averaged down. Our largest detractor in 2020, Seadrill bonds, later earned us multiples – we tripled our money from a purchase price of 52,” says Pennings. 

Even after the sector started to broadly recover, yields stayed high and deep value lurked in certain issues. Seadrill’s new secured notes lagged the rest of the sector in 2021, and piqued Pennings’ interest due to a special anomaly: “Post a prepackaged bankruptcy, unpaid accrued interest would be added to the notional claim upon emergence from bankruptcy. A major market inefficiency is that the cash bonds failed to discount this and we earned an extra 16% from a flat cash price, and also received 65% of the new equity business for free,” says Pennings.

ESG policies, cyclicality and tax risk can all help to explain why energy credits yield more. “A UK North Sea operator, EnQuest, recently paid 12% on new bonds with leverage below 1 turn of EBITDA,” says Pennings.

Energy service providers, such as Seadrill, are a larger part of the book than producers partly for regulatory reasons: “They are likely to be insulated from windfall taxes applying to producers,” he expects. 

Ukraine related panics and new issues

Another shrewd trade in 2022 was Ukraine-related “babies thrown out with bathwater”. “We saw a meltdown in names that had any exposure to Ukraine, even when they had other assets that fully covered the value of the debt. We bought April 2023 bonds of Dutch mobile holding company Veon, at 66, earned a 7.25% coupon, and they just tendered at 102,” says Pennings.

A screen of issuance was also helpful: “We homed in on recently syndicated new issues in both 2022 and March 2020 as being vulnerable because investors who typically aim for a short-term profit by flipping them were unable to,” says Pennings. 

Short alpha

High yield has been steadily displacing loans as a source of credit funding for European issuers, and that enlarges the short universe: “Loans can be amended and extended but this is more difficult for bonds, which will need a hard restructuring. Based on a multi-decade lookback, 20% of single B bonds default over a five-year period,” Pennings reflects.

Pennings likes to short cash bonds rather than derivatives as they provide more volatility and avoid CDS basis risk. “Shorting bonds at or near par is very asymmetric because the worst loss scenario is likely to be par or being called at the call price. We look to short bonds that would need to hit 10 green lights in a row to avoid problems – and will reprice if just one light turns amber.” The Pareturn platform provides total return swaps for shorting cash bonds in a UCITS.

Gladwyne has profited from shorts but there has often been huge latent potential in these trades, which would sometimes have made far more had they been held for longer. Pennings explains: “In 2011 we were short the bonds of a phone company in Ireland, when the cost of borrow went from 1% to 14%. We exited the short for a low teens gain. A month later I could have closed it out for a 90% gain. We covered a facilities services short at 90 upon a private equity offer but the bonds soon fell to 50 after it emerged that the PE firm would only invest in one segment. Similarly, we shorted Abengoa for years, closed it at par and six months later it was bust. And I exited a short in a German wind turbine maker at 88 before it dropped to single digits. The biggest challenge is having the patience for the short to finally collapse and sometimes this has been achieved. We are still short worthless shares of Thomas Cook because it would cost money to close them out”. 

Hard catalysts

Longs and shorts are mainly inspired by hard catalysts. Typical “hard catalysts” in credit include refinancing, liquidity, covenants, asset disposals, restructurings, and capital structure changes.

Timeframes and average holding periods are typically 6-24 months, though some high conviction value positions can stretch to three, four or five years. The generally short dated nature of catalysts means that interest rate duration and sensitivity of the portfolio is usually minimal. Timelines are important: “Delays to refinancing are a red flag and reveal a restructuring risk since outstanding bonds close to maturity can lead to a qualified audit opinion,” says Pennings.

Bottom-up work maps out upside and downside under different scenarios to arrive at a probabilistic blended expected value. A bond trading at 50 is binary market pricing, but Gladwyne’s analysis, based on deep experience, could take a different view on the probabilities. “We have often made great money in these situations, talking to management, broker dealers, advisers, and the press to do analysis of legals, financials, peers, the board, weave it all together and work out where it pans out. We bought bonds of a metals recycler at 75% of par, got comfort from the board on repayment, and they were retired at par,” says Pennings.

A full capital structure perspective 

Gladwyne can invest across the capital structure and views equity as a hybrid version of credit. Most equity owned is received through debt for equity swaps or issued for liquidity reasons. There are also some busted convertibles in the book, which fall between two stools. “Traditional convertible bond investors are not interested and nor are plain vanilla fixed income investors,” says Pennings. 

A full vista of the capital structure also generates ideas. Disconnects between equity and credit can throw up lucrative signals. “When the cost of borrow on a stock is elevated but bonds are at par, one price must be wrong. We shorted SolarWorld bonds at 101 when the cost of equity borrow was 36%. Similarly, Carillion was the most popular equity market short before it imploded and bonds went from 90 to zero,” explains Pennings. Conversely Tullow Oil bonds traded at 60 cents when its market capitalisation was nearly $2 billion.

Pennings has occasionally made events happen through activism. “Second lien bonds in Spanish bus company Avanza were acquired at 76, and later the notes were tendered for at 95, before a final price of 102 was obtained.” Pennings helped to orchestrate this.

Litigation and arbitration are monitored. “Currently, there is a position in a somewhat binary arbitration event, where we see a ratio of five times upside to one downside on Northern Drilling.”

Liquidity provision

True alpha is the bread-and-butter strategy, though liquidity provision for dislocated siloes is another return driver that can take advantage of abrupt re-pricings caused by investors liquidating daily dealing ETFs and mutual funds, which own a significant part of high yield bonds. This throws up regular and repeatable trading opportunities. “We bought bonds in a Spanish gaming company, twice at 83 cents, and sold them twice at 97 cents. This was not alpha but rather liquidity provision,” explains Pennings.

Financials

In addition to corporate debt, Gladwyne trades instruments issued by banks such as contingent convertibles. The March 2023 selloff related to Credit Suisse and several US banks did not surprise Pennings, who has seen similar moves before: “Deutsche Bank AT1s dropped 35 points after the firm was threatened with a behavioural fine. This led us to buy tier 2 bonds in Lloyds Bank and a German real estate lender. Similarly, the Credit Suisse panic has pulled down peers in sympathy and we find deep value in that collateral damage”.

Pennings has three decades of credit market experience, including proprietary trading as an MD at Goldman Sachs, and Gladwyne as a firm has lived through several bull and bear markets in credit. Gladwyne, which means good friend in Welsh, is named after a town in Pennsylvania where Pennings lived in his high school years and was married in 1998. “The name signals that everyone is important to culture and wellbeing, and is deliberately not a homage to me as founder,” he humbly says. Pennings works with Jan Mroczkowski, who has 15 years of mostly buy side industry experience, primarily fundamental credit at Centerbridge, Capstone and Goldman Sachs. He has been with Gladwyne for nearly five years.

Gladwyne was initially seeded in a Cayman fund in October 2009 by a foundation linked to a prominent UK investor and philanthropist. In 2015 the UCITS was co-seeded by Pennings and a German wealth manager migrating its business to UCITS. There is a high degree of overlap between the two funds, though the UCITS does not invest into less liquid areas such as trade claims, liquidations, private credit, or loans.

Distribution

Assets have been raised mainly through word of mouth and the UCITS is the priority for asset raising. The UCITS investors are mainly high net worth individuals investing via wealth management platforms, though there are also some retail investors. The UCITS is currently approved for distribution in Belgium, Finland, France, Germany, Italy, Spain, UK and Luxembourg, and assets have also been raised in Switzerland. The UCITS should soon migrate to making disclosures under SFDR category 8 and has never invested in weapons or tobacco anyway.

“Managed accounts are also operationally very easy to set up and we have run several,” explains Pennings.

Outlook 

Pennings is constructive on the opportunity set for deploying capital in both the long and short books. Longs are generating a worthwhile standstill return from yield alone even before catalysts kick into action. Meanwhile, although headline rates of outright default have been low so far, many bonds see heavy repricing upon refinancing and/or restructuring as they face the macroeconomic and market reality shocks of higher inflation, rates and spreads – as well as company specific issues.