Andrew Main, Stratton Street Capital: “What you do not invest in defines your performance as much as what you do invest in”

Andrew Main (pictured), managing partner of fixed-income specialist Stratton Street Capital, whose products under management or advice include the New Capital Wealthy Nations Bond Fund and the Renminbi Bond Fund, says the firm’s combination of a value approach to individual securities with a top-down macro approach to indebtdness is unique in the business.

AM: Stratton Street Capital is a limited liability partnership launched in June 2005 as the successor to MSG & Partners, which had received its initial approval from IMRO (a predecessor of the FSA) in May 2001. The partnership’s activities are split into three areas of investment focus, of which the largest is international bond and currency investment.

 

Under Andy Seaman and Mark Johns, who are both partners in the LLP, this area has grown dramatically since 2008. Based on a well-developed investment process which they formed in the late 1990s before joining MSG & Partners in 2001, it was further refined as the Asian Bond & Currency Fund, which returned 59 per cent in 2008 as credit spreads widened.

 

In addition, the long-only Renminbi Bond Fund was launched in November 2007 as the first offshore fund giving international investors exposure to renminbi. It also produced a positive return of 5.6 per cent in 2008, which was a negative year for most Asian fixed-income managers.

 

Working with other investors, a version of the same investment process with a much wider investment mandate covering the world rather than just Asian creditors was developed in Ucits form. This was launched as the New Capital Wealthy Nations Bond Fund in September 2009 with EFG Asset Management in London as manager and Stratton Street Capital as advisor and joint distributor.

 

The overall investment process focus is on investing on bonds issued by creditor nations with investment-grade ratings and a strong ability to repay their debt. The net foreign asset position of a country is an essential component in the investment decision.

 

Net foreign assets may be defined as the value of assets owned abroad minus any debt owed to foreigners. This indicates whether a country’s indebtedness and/or its exposure to currency risk in its debt imply potential instability going forward.

 

At the end of March, the fixed income group managed and advised on USD1.065bn of fixed-income portfolios managed on those investment principles, including USD714m under advice in the New Capital Wealthy Nations Bond Fund and USD125m in the Renminbi Bond Fund. The balance represents managed accounts and other funds either managed or under advice utilising the same investment process.

 

Partner Dominic McEwan manages the Himeji Fund, a long-short Japan fund, supported by Adrian Edwards, who also works with partner Trevor Sliwerski on our Japan and Asian Synthetic Warrant Funds. Matt Lonergan, also a partner, also works on the Asian Fund and backs Trevor up on the Japan Fund.

 

 

AM: The Renminbi Bond Fund is a cell of a Guernsey-based protected cell company, Stratton Street PCC. The structure has three other cells, the WONDA Bond & Currency Fund (formerly the Asian Bond & Currency Fund) and the Japan Synthetic Warrant Fund and Asian Synthetic Warrant Fund. The PCC is a Guernsey class B Scheme.

 

The Renminbi Bond Fund has seven currency share classes denominated in US dollars, euro, sterling, yen, Singapore dollars, Swiss francs and CNH (offshore renminbi). All currency classes are fully hedged into the US dollar master in which the fund is denominated and managed.

 

At that level a non-deliverable forward is added the portfolio to give the fund exposure to the performance of the renminbi against the US dollar. Overall performance is then reflected back into each currency class. The fund deals on a weekly basis with an extra dealing day for month end. The currency classes are listed on The Irish Stock Exchange.

 

The New Capital Wealthy Nations Bond Fund is a daily dealing sub-fund of an Ireland-domiciled Ucits umbrella fund. It has an Ireland-based management company and eight currency classes, including US dollar linked to the renminbi, US dollar linked to the Indian rupee, euro, sterling, Swiss franc, Norwegian krone and Singapore dollar. The renminbi and Indian rupee classes give exposure to the performance of the underlying currencies, while the others are fully hedged.

 

 

AM: For Stratton Street PCC, the administrator is Northern Trust International Fund Management Services in Guernsey. The designated custodian is Northern Trust Guernsey with Newedge Group in London as sub-custodian and prime broker to the Renminbi Bond Fund. The accountants are KPMG International in Guernsey and legal counsel is Carey Olsen.

 

For the New Capital Wealthy Nations Bond Fund, the administrator is GAM Fund Management in Dublin, the custodian is HSBC Institutional Trust Services (Ireland), the accountants are PwC in Dublin and legal counsel is Dillon Eustace. There is no prime broker.

 

 

AM: Our current investor base has been built by working with a wide variety of private wealth advisory companies. The two funds particularly appeal to investors looking to achieve a higher yield to offset the lack of return on bank deposits and other parts of their portfolio. As the funds have grown in size, they have begun to appeal to a more institutional investor base. The UK and Europe have been the core of our investor base, but we are now active globally, and are seeing increased interest from Asia and the Middle East.

 

 

AM: The downturn has if anything attracted more interest as our investment process has allowed us to avoid the weaker creditor countries while maintaining a higher yield from our core wealthy countries. Our performance in both funds has been top-quartile, and our fixed income assets under management and advice have risen from USD221m at the end of 2009 to USD549m in 2010 and USD926m by December 2011. We were pointing out the weaknesses of countries like Greece and Portugal long before they went into crisis, and people are asking why they had these ‘investments’ in their portfolios.

 

 

AM: Our investment process is a marriage of top-down review of the macro picture of the world along with a bottom-up approach to individual assets, looking at which appear cheap and then analysing these in detail to see whether they still have merit under more detailed scrutiny of the borrower’s financial position and the details of the securities issued.

 

This view is driven by a series of our own proprietary models that analyse where we believe we are in the credit cycle and the likely effects on different types of creditors. This is then applied to our net foreign asset review of countries to pick out those that may be storing up problems or improving their profile for the future. This combination of a value approach to individual securities and a top-down macro approach to indebtedness is unique in the business.

 

 

AM: Using this analysis we sift daily through our database of some 5,000 bonds to establish a credit curve for each rating of bonds. Using this credit curve we then examine which ones are trading cheaply or expensively relative to their curve. If they are trading cheaply and there is sufficient size in issuance to allow us to build a position, we will then carry out an in-depth review of the borrower and prospectus to understand its investment merits.

 

On the macro side, we are looking for longer-term trends, and indicators of shifts in the cyclical and structural positions of countries. We target leading indicators, backed up with longer-term data that shows ongoing structural changes.

 

We spend as much time on negative ideas – we are aiming for absolute returns, so avoiding securities and countries that may be deteriorating or defaulting is just as important. What you do not invest in defines your performance as much as what you do invest in.

 

 

AM: Risk modelling is fine if the world continues to work along the same lines as your models, but it has a habit of not doing so. Most modelling tools used are designed for managing risk situations that are very different from those of the long-term investor. Volatility is an opportunity not a cost in the long run, as it means opportunities to buy securities cheaply. Our risk tools are built around building in enough diversification, not buying overvalued positions, and avoiding the major downside risks.

 

 

AM: Since the Renminbi Bond Fund was launched in November 2007, the US dollar A class has returned 58.1 per cent, or about 11 per cent per annum, while the sterling class returned 51.9 per cent. The largest class, however, is the Singapore dollar class, which for a sterling-based investor returned 124 per cent, or 21 per cent per annum.

 

The Wealthy Nations Bond Fund has a shorter track record, having been launched in September 2009. The US dollar A class returned 20.9 per cent up to the end of April, while the sterling hedged class returned 21.1 per cent.

 

Ongoing the funds are still yielding over 6 per cent, and there is scope for capital appreciation from undervalued bonds, as well as from continuing appreciation of the renminbi in the case of the Renminbi Bond Fund.

 

 

AM: One of the advantages of operating in the global credit market is that it is always throwing up new opportunities. Often it is not the opportunities that are purchased but those passed on that enhance portfolio performance. Situations that are cheap and have value may also reflect distress, so the review process is vitally important. We currently see value in the Middle East and Russia; you can buy the bonds of AA-rated IPIC, the Abu Dhabi sovereign wealth fund, at a spread of more than 300 over Treasuries, compared with only 131 over Treasuries for Brazil.

 

 

AM: Within the fixed income sectors we expect many more issues from many more countries. We anticipate portfolio managers diversifying their portfolios more into emerging market government assets. We anticipate investors wanting to make a currency decision on how they invest their money not just in US dollars, euro or sterling, but looking at Asian currency classes such as the renminbi and Singapore dollar.

 

 

AM: We believe that the skills required for the investment manager actually to produce returns that can be marketed to the investor are hard to acquire. This takes time to build up, and we believe we are in a good position to take advantage of our established track record.

 

 

AM: They expect performance, of course and no sudden surprises, but also process, control, and something different, because there are a lot of me-too funds. Our Renminbi Bond Fund is a great example: it was launched before the competition, performed better, and continues to perform better than the wave of new funds launched subsequently.

 

 

AM: Our investment process and analysis is unique. We do not invest on an index-weighted way, which is pretty unusual in fixed-income. We are also open and accessible to our investors, because we believe that transparency is the key to trust.

 

 

AM: We hope to maintain the trend of the past few years, but we realise that we have to develop our resources further in order to appeal to a wider range of institutional investors. Yields will remain low, so our higher-yielding but low-risk funds are appealing in that environment.

 

 

AM: We do not currently market to the US nor do we intend to in the near future. We are currently in the middle of regulatory overload with new sets of rules often put in place to paper over regulators’ past omissions. We are not sure that, if and when a full cost-benefit analysis is done, the new measures will be demonstrated actually to protect the most vulnerable, as the unscrupulous will always try to find a way around regulations.

 

It does increase the cost of managing portfolios, which is currently being absorbed by the managers. It will however stifle some from taking the plunge to set up on their own and regenerate our industry. It would be sad to think that nascent Winton Capitals, Brevan Howards or CQSs are being put off by the higher cost of entry into the fund management and advice business.

 

 

AM: The industry will likely see consolidation, with those that can streamline their processes to handle the new regulations able to take in less efficient managers that nevertheless have excellent performance. However, our current plan is to grow organically, as mergers in fund management have rarely added value.

 

 

AM: We have received requests from our clients to launch a number of new funds using our core investment process. We are reviewing these requests at the moment, including aspects such as the regulatory implications of the structure used. We do expect to launch one or two new funds this year, but do not yet have firm dates. Watch this space!