UCITS fund run by Lyxor Chenavari eyes alpha generation as QE creates “unhealthy” market

Bubble

Continued central bank support amid the Covid-19 pandemic is creating “bubble-style valuations” in markets, according to Chenavari Investment Managers, a London-based credit-focused hedge fund.

The prevailing backdrop is predominantly suited to long/short credit strategies in corporates and financials credit, it said.

In a note to investors, the team managing the Lyxor Chenavari UCITS fund at Chenavari observed how the first half of 2020 saw a “brutal market dip”, which was quickly mitigated by “unprecedented” central bank and government support globally, helping to strengthen markets.

But since then, the disconnect between the souring economic climate and a continued market rally has raised eyebrows.

The current “unhealthy” environment, characterised by bubble-style valuations sustained by central bank support, is leaving markets “in levitation”, the Chenavari UCITS team suggested.

“Never in the history of markets has a crisis of such magnitude been translated into such low risk premiums,” the team said of the credit rally, with investment grade debt yielding 0.65 per cent, whilst junk companies yield 3.7 per cent.

“Obviously, nothing in the ‘real economy’ justifies such euphoria, but one does not fight central banks at their QE game,” the team observed. “The QE-spurred bubble can last for years and years, until the cracks in the real economy and the social disparities it fuels finally push the system over the edge.”

As a result, the Chenavari UCITS team is now turning its focus on alpha generation in its core strategies, trading long and short in corporates and financials.

Currently, corporate trades are tending to be relative value plays, with long and short bets remaining largely idiosyncratic without any specific theme. In financials, meanwhile, the key trade theme has centred around the compression between core and peripheral European banks.

The team has also slashed allocations to convexity in the Lyxor Chenavari UCITS Fund to 5 per cent.

“Naturally, the team continues to keep the capacity to build a very convex profile on the fund, notably via options, which offer better liquidity than tranches,” they wrote.

“At current levels we do not believe it makes sense to chase market beta and as such, the fund’s market exposure will be very limited and tactical.”

The team, whose Lyxor Chenavari UCITS fund has advanced 3.5 per cent year-to-date, and 8.8 per cent over the 12-month period, added that liquidity remains key.

“New market dynamics have created an unhealthy liquidity environment with market makers having a reduced amount of inventory compared to past levels, especially compared to pre-Global Financial Crisis,” they noted.

“In the context of high volatility, we are very wary of being able to move risk very quickly without too much cost, and hence remain focused on the liquidity of the instruments we are trading.”