Veteran hedge fund manager finds returns in actively managed fixed income
With an annualised return since 2011 of 12.95 per cent placing it in the top decile of fixed income hedge fund performance tables, LNG Capital’s Europa Credit Fund is beginning to attract the attention of institutional investors alongside its traditional client base of funds of funds, family offices, private banks and high net worth investors. Global Fund Media’s Beverly Chandler talks tactics with managing partner and CIO Louis Gargour…
The LNG Europa Credit Fund is a USD280 million actively managed fixed income fund with a focus on European corporate debt. Gargour (pictured) describes the investment approach as adaptive and designed to produce consistent returns across all market conditions.
Formerly, Gargour was head of fixed income at USD7 billion hedge fund firm RAB Capital, which gives him a track record with this strategy back to 2001. In 2006 he set up LNG and launched it as a managed account within a family office with colleagues from his former firm.
The strategy was managed within a managed account until 2011 when it was converted to a long/short fund due to strong client demand for a fund structure. This opened the strategy to a wider investment audience.
The fund has an annualised return of 12.95 per cent since 2011, and a year to date return to end October of 9 per cent, making it top decile in fixed income hedge fund performance tables.
Gargour says: “We are able to focus on the entire fixed income universe, therefore we are able to invest in the market segments offering the best risk-adjusted returns.”
There are four principle strategies: the lowest risk is relative value and has the lowest volatility; next up is investment grade long/short; next, high yield long/short; event driven and special situations come last, where he looks for a catalyst for change.
“We can dynamically allocate between these strategies depending on where we are in the credit and default cycle,” Gargour explains.
The managed account version traded through the global financial crisis going almost entirely relative value in 2007, which meant that when the fixed income world was down 25 to 40 per cent in 2008, LNG was down just 8 per cent.
It was this sort of performance that attracted a wider range of investors, hence the launch of the fund in April 2011 and asset growth from USD 30 million to close to USD300 million now.
The principal clients are funds of funds, family offices, private banks and high net worth investors. The fund is beginning to see interest from institutional investors.
“It’s been an interesting and exciting journey,” Gargour says. These days the fund is run with a top down, bottom up approach, assessing dominant themes in the investment world in the US and Europe, looking at what interest rates are doing, what is going on with the central banks and then at the technical, of the market including retail and ETF flows.
“Looking at the credit cycle, we observe now that people are being more cautious,” Gargour says. “We look at what sectors we want to be long, short or neutral; and which companies meet our criteria for shorts or longs. Currently, we are underweight UK retail, paper and packaging, auto and auto supplies and assisted living.”
A sector that he likes is shipping, commenting that oil tanker owners can control the speed of delivery of crude oil to refineries depending on current and expected forward oil prices. Improving day rates in shipping, as well as the improvement in companies leverage and interest coverage ratios, he also mentioned improving cash flows across the sector as a positive.
“We drill down and look at the companies that benefit from higher day rates but have highly leveraged balance sheets,” Gargour explains. “We then do a ratio analysis compared with other companies to see whether they are over or under priced relative to rating and leverage and then drill down further into the company’s management team and the capital structure.”
Questions such as ‘what if the firm has to dispose of its vessels?’ are posed and then the team looks at the value of what those assets are to relative outstanding debt (asset coverage ratio) and, at the end of that process, they come up with a few companies they like.
“We have a wide mandate and most of the time we buy a bond because we can understand and analyse it and have a priority claim on the assets,” Gargour says.
“What we are good at is mid-sized companies with around USD250 million to USD750 million of debt. The big guys can’t touch these as they are restricted to investing in much bigger deals due to their size (USD1 billion plus). We have a distinct advantage for operating in the mid-tier of corporate debt in terms of size and issue and that gives us a distinctive competitive advantage and makes us dynamic and agile.”
Gargour uses principal uses individual longs and shorts to generate alpha through in the portfolio, but has access to swaps, CDS, ETF’s, and other hedging and derivative instruments.
This year has seen a sectoral shift with a move to a more defensive stance in October. “What we think is happening is that the US economy is growing and that we will shortly begin to see higher levels of inflation due to wage inflation. As the Fed combats inflation through increasing interest rates, the equity dividend yields of US stocks begin to look less attractive, and this will create downward pressure on equity market valuations with technology being most exposed.”