Jamie Cane explains how credit investors can utilise a variety of instruments to generate returns, regardless of the direction of markets.
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?
Muzinich European Credit Alpha (ECA) is a long/short European high yield strategy designed to capture upside but with enhanced downside protection. Comprising three books – Core Long, Overlay (hedges) and Arbitrage – ECA runs a dynamic beta profile of around 0.5-1x, using a simple model: when spreads are tight, beta is low; when spreads are wide, beta is high. This straightforward approach has enabled the strategy to perform well in a wide variety of market conditions it has faced since inception in late 2017, reflected by returns which are over 20 percentage points ahead of the high yield market (ECA +36.7% vs 15.1% HY market).
The proposed Muzinich Credit Market Neutral (CMN) strategy seeks to generate consistent absolute positive returns by capitalising on mispricing and dislocation opportunities within European credit, without taking a directional view on the market. Modelled on ECA's Arbitrage book, the tools and approach have been developed over a 6-year period and proven highly effective in generating returns in excess of the high yield market despite carrying a fraction of the beta, volatility and propensity for drawdown. The investment process combines systematic relative-value elements with the bottom-up fundamental analysis that has been at the heart of the firm's approach for over 30 years.
How are you currently positioning your portfolio?
We retain a constructive bias within ECA based on i) decent valuations combining elevated yields and spreads that are better than they may first appear, once accounting for the additional convexity inherent when cash prices are below par; ii) resilient fundamentals; and iii) a firm technical picture. ECA beta is therefore towards the upper end of its usual range at around 0.9x, having been <0.6x during June as we sought to offset volatility around the French election. A key advantage of ECA's approach is the extended toolkit, including cash bonds, credit default swaps (CDS) and options, which enables the strategy to better protect on the downside and rapidly adjust the risk profile.
For CMN, we will be looking to position the portfolio to capitalise on opportunities arising from increased market dispersion. We envisage the strategy will have a beta close to zero and will look to generate returns through mispricing opportunities rather than taking a directional market view.
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 current environment offers a unique opportunity for ECA. Elevated yields, combined with low implied volatility and spreads at the tighter end of the range, means it has rarely – if ever – been cheaper as a portion of carry for ECA to hedge its Long Book (mostly bonds) using options. The last time options were this cheap in 2021, yields were less than half where they are now, meaning it now costs less than half the carry for the same amount of hedging spend. In simple terms, elevated current yields provide an attractive medium-term total return opportunity, while low option premia mean we can provide meaningful downside protection at minimal cost.
For ECA's Arbitrage Book and CMN, elevated levels of dispersion mean we see a steady source of potential pair trades where we can capitalise on mispricings in several ways, including relative value (bond vs bond), basis (bond vs CDS), intra-capital structure (eg, curve/ senior vs subordinated / € vs $) and macro (eg, iTraxx Crossover vs Main).
