Miami Office
150 SE 2nd Avenue, Suite 704
Miami, FL 33131
United States

Investing in the Subordinated Debt Market

  • Posted by: ASG Capital

You can find this article on Funds Society Website.

Controlling risk and opting for different coupon structures to manage monetary policy changes in the US and Europe are elements ASG Capital’s focuses on in order to successfully invest in subordinated debt. “We are experiencing unusual times: there has been a lot of intervention by the central banks, so we have to bank on a flexible strategy,” says Steven Groslin, Executive Member of the Board of Directors of this asset management company, where he also co-manages various funds.

In a webinar organized by SharingAlpha, Steven Groslin, together with Ygal Cohen, President, Executive Director and Founder of ASG Capital, delve into this instrument’s key points, and more specifically the strategy of its flagship fund: LFP ASG Dynamic Income Fund. They insist on the importance of managing risk, both general fixed income market risk, for example taking into account the recent monetary changes over the last few years in the US and Europe, and specific risks linked to this kind of instrument, the subordinated bond.

Groslin outlined how their focus is on “blue chip” corporations and on “systemic” entities. As a consequence, they invest mainly on investment grade issuers. At the same time, they are committed to maintaining a diversified portfolio with no more than 3% allocated one any one instrument. Currently, 90 positions are held in the fund.

According to him, the fund’s uniqueness comes from the different types of coupons held within their portfolio: fixed rate coupon (10,4%), floating rate coupon (22,4%) and, above all, fixed rate that become floating rate after a future call date (67,2%). The main advantage of being overweight in this last category is that it allows them to “optimize their positioning, based on the interest rates.”

Risk Control

Groslin points out that there is no additional risk over and above that which is inherent to the fixed income subordinated debt market: “there are no derivatives, there is no leverage and there are no repos.” If a currency risk appears, this is hedged so as to convert the master portfolio into a “pure USD” investment vehicle.

“Risk management is essential in order to be able to benefit from the attractiveness of this type of asset”, adds Cohen. He points to alternative investment solutions providing a similar level of returns, such as the emerging debt markets or high-yield debt market. He considers the level of risk of these two investment markets is “substantially higher” than the one proposed in their subordinated investment strategy.

He underscores the current average carried yield return of the fund at over 6%. In addition to this carried yield, there is a “capital gain component” for an additional potential return thus making the fund an attractive investment proposition.

Their investment approach is bottom-up. Issuers are selected for their strong economic fundamentals: “90% come from the investment grade space”, he states. Once a corporation has been selected as an investment target, ASG chooses the debt instrument with the best risk-reward ratio of this same issuer.

Cohen confirmed how they mainly invest in OECD market, preferring to stay away from the emerging space so as to avoid dealing “with potential geopolitical risks.” Their main geographical exposure is as follows: 37,1% of their issuers are based in Eurozone, 29,7% of them in European non-Eurozone countries, and 23,3% in North America.

According to Cohen, geographical diversification allows them to have access to a greater diversification in terms of different economic sectors. The financial sector represents (60,5%) of the fund, (banks are the main issuers of subordinated debt instruments), followed by an allocation to the asset management and insurance sector (20,2%), and the industrial sector further behind (5,8%).

As the fund is managed in USD, this allows them to have more investment opportunities than with any other competing currency. Another factor making their strategy “unique”. Few funds are specialized in this way in Europe and the US. Their investment solution meets the increasing need for yield of many investors such as: retail, family offices, private and institutional banks….

The strategic investment strengths outlined above are brought together to generate investment value over time. Their management of the Fixed Income assets follows their unique “prudent, flexible, and transatlantic” approach, concluded Ygal Cohen.

Author: ASG Capital