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AA-rated PM: why we’re still keen on CoCos

AA-rated PM: why we’re still keen on CoCos

Keen gardener Julien de Saussure understands that fruitful returns come from good quality seeds. But as in the investment world, much depends on how well you adapt your plans to prevailing conditions.

De Saussure’s willingness to change has been a key driver of his €1.6 billion Edmond de Rothschild Financial Bonds fund’s success.

Over the last five years the fund has returned 45.75% in euro terms, close to doubling the 22.09% performance of its Citywire-assigned benchmark, the Markit IBoxx Euro Corporates Financials TR, see graph, right.

However, de Saussure has shifted his focus considerably since he started managing the portfolio in 2011. ‘The focus has shifted since we launched the fund, as the market has changed quite dramatically since then,’ he says.

A large chunk of his portfolio is allocated to contingent convertible bonds (CoCos) but this hasn’t always been the case.

‘The key focus hasn’t always been CoCos because at the time of launch they were non-existent, whereas now they represent close to 60% of the portfolio.

'Some of the biggest capital gains we have made were actually driven by liability management exercises. Basically, these were offers by issuers to buy back some bonds at a 10-15% premium above the quoted price.

‘That has been one of our most successful strategies, but it’s fair to say that it’s more limited now, given that most of the legacy instruments have been progressively replaced by new ones.’

Capturing complexity

When using new financial instruments, de Saussure says the key is to understand the complexity and to capture the premium offered on the market.

‘Even with new instruments, it is still possible to find some alpha-driven situations. One example of that was in Switzerland, where the first wave of CoCos was issued in 2012/2013. However, they were made redundant in 2015 after the publication of the Brunetti report, which forensically scrutinised the Swiss Banking industry.

‘That killed the first wave of tier-2 CoCos, at the time we had to replace them with internationally accepted high-trigger tier-1 bonds. For the issuers, this meant that these bonds were not relevant anymore – triggering some situations where we would be keen to buy these CoCos back.’

Aside from the killing of CoCos in 2012/13, where de Saussure was able to gain alpha from deteriorating markets, the Citywire AA-rated manager reveals that one of his worst performing bets occurred at a similar time.

‘The worst non-performing event in the portfolio was in 2012, with Groupama bonds’, he says.

In June 2012, the troubled French issuer had its credit rating slashed to junk territory by Standard & Poor’s. At the time, the ratings agency cut the insurer’s credit rating to BB from BBB- and kept the outlook at negative, as well as describing the business as having ‘marginal’ financial flexibility.

‘At this point, we lost one coupon on the Groupama bond. This was a big stress situation and the bond went down to 40. Potentially it was a misinterpretation of the protection mechanism around payments,’ he says.

The full version of this article originally appeared in the December issue of the Citywire Selector magazine.

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