Can you give a brief overview of your strategy in terms of what you are trying to achieve for investors, your investment process and the make-up of the investment team?
The objective of the investment team is to achieve a relatively high risk-adjusted return for investors by investing in high quality (investment grade) global financial companies.
The market makes it clear that investors have a problem. Currently there is no, or little, yield in the global fixed income market. 27% of the market is has a negative yield and more than 94% of the market is yielding less than 3%. Algebris' solution to this problem is the Financial Credit Fund, which currently yields over 3%. The investment team expects additional returns from capital appreciation of the bonds held as the spread over the risk-free rate continues to compress on positive news within the sector and as new investors increasingly move into the asset class.
The team focuses on high quality investment grade issuers such as HSBC, BNP, Santander, UBS and Barclays, essentially well-known national champions, and then look for opportunities further down the capital structure. We invest in this way for two primary reasons. Firstly, investment grade issuers rarely default. Secondly, with confidence in the credit worthiness of the issuer, we can be confident investing in the subordinated debt of these investment grade issuers and access the higher returns available.
The highly experienced team at Algebris is managed by CIO Sebastiano Pirro. They meet with the management teams of all the companies that they invest in and conduct bottom-up analysis of the respective companies' credit worthiness and importantly, also develop an understanding of their equity and balance sheets. The Fund has developed a strong track record since launch in 2012, generating a compound annual return of 7.5% in GBP.
How have you been trying to weather the storm caused by the Covid-19 pandemic and what could be the longer-term implications for your strategy?
We were cautious at the start of last year as the true potential impact of the Covid-19 pandemic started to become apparent. As long-only investors, the two main tools available to use as protection are the increasing of cash buffers and holding the best quality names. These were both used effectively in early 2020.
When the pandemic storm broke, the fund was well positioned to deploy the cash buffer that we had built up into some of the highest quality opportunities that were created by new primary issues and very attractively priced secondary issues. The Fund ended the year posting a 10% return. Interestingly, the spreads in additional tier one securities, which make up the majority of the exposure of the Fund, are wider today than they were in January/February 2020. In other words, the fundamental prospects look better today that at the start of last year.
The Fund managers have traditionally taken advantage of both primary issuance and secondary market opportunities. Cautious positioning in high quality names and a cash buffer allows the fund to take advantage of periods of market volatility and lock in robust future returns for investors. The pandemic has been a good test and demonstration of this.
Can you identify a couple of key investment opportunities for your fund you are playing at the moment in the portfolio? This could be at a stock, sector or thematic level.
The Financial Credit fund looks for opportunities globally. Currently, and it has been the case for the last three to four years, we have had a high allocation to European financial credit, specifically additional tier one securities.
Following the 2007/2008 financial crisis, European Banks were slow to increase capital ratios and reduce non-performing loans to the levels regulators were comfortable with. With a few exceptions, this was achieved three to four years ago, although Northern European countries (ie UK, France, Germany) managed it much sooner than their southern counterparts. Given this, spreads have been much wider in Europe than for comparable securities in other countries like the US, which created a comparatively better opportunity for investors once European banks had met the regulatory requirements.
Now, spreads in Europe are close to 400bps, wider than they were pre-Covid despite capital ratios being higher than they have ever been (and despite the pandemic-induced recession). With issuers having passed the depths of the Covid storm in Q2 2020, profits and capital are going up and providing comfort that the worst is behind us, especially with the successful vaccine rollout gaining pace.
Importantly, we also focus on lower duration bonds with high backend reset spreads which provide significant protection against bond yields continuing their year-to-date rise.
