How pioneering hedge fund Sancus Capital has stayed at the cutting edge of credit investing

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Colateralised loan obligation

Launched in the immediate aftermath of the Global Financial Crisis, pioneering credit-focused hedge fund manager Sancus Capital Management has built a formidable decade-plus track record in the market, and more recently broadened its focus into CLO management.

Established in 2009 by former Goldman Sachs and JP Morgan credit derivatives specialist Olga Chernova, Sancus today has approximately USD550 million in assets under management in total, split between its flagship Sancus Capital Select Master Fund, managed accounts and its newly-launched CLO management business.

The flagship hedge fund strategy trades across the structured credit spectrum in a broad range of asset classes and instruments, using a mix of long/short, relative value and event driven investment approaches.

Specifically, it looks to invest nimbly across North American and European markets, taking a fundamental approach to identify inefficiencies and other asymmetric opportunities within deal structures. 

The firm – which has offices in Los Angeles and New York – has a flexible investment mandate, so “technically we can go all the way up to the top of the capital structure”, managing partner and chief investment officer Chernova tells Hedgeweek.

“When we first started, we were doing a lot of credit defaults swaps, CDS and CDX indices, bonds, and loans,” she recalls of the fund’s origins. “As some of those derivative products became less liquid, we gradually migrated to cash assets and CLOs.”

While the fund has traded higher-rated and senior tranches, its double-digit return target means it typically gravitates towards the high-yield, junior mezzanine, and equity classes further down the capital structure.

Evolution

Chernova – who has traded a range of structured credit instruments including single name CDS, CDX indices, tranches and options for both buy-side and sell-side firms – started her career as a credit derivatives trader at Goldman Sachs in 1999. She later became head of the bank’s US credit correlation business, developing its index and bespoke high yield correlation trading platform.

“The early 2000s saw a big evolution in credit products,” Chernova recalls. “There were new products, new indices, options, synthetic CDOs. While I started my career in fundamental trading very quickly took me more towards the structured side.”

Running Goldman’s correlation and index trading in the US, Chernova – who came to the US aged 16 as the Soviet Union was breaking up – saw the ease with which synthetic deals could be put together, which in turn helped the sector grow in the early 2000s.

In 2006, she moved to the buyside, becoming managing director and head of correlation and index trading at Dillon Read Capital Management, focusing predominantly on liquid credit. She later joined JP Morgan’s proprietary trading desk, where she was a managing director and head of North American credit and structured credit until 2009 when she left to set up Sancus.

“We were one of the few prop desks that made money during the crises,” she says of her time at JP Morgan. “That’s what allowed me to launch Sancus in 2009.”

‘Radical change’

Chernova says the collateralised loan obligations sector has undergone a “very radical change” in terms of investor appetite over the past decade, with a whole host of institutional investors and pension funds returning in the years since the 2008 Global Financial Crisis, when large parts of the structured credit universe – mainly mortgage-backed securities – were blamed for the turmoil.

Since launching in the latter half of 2009 in the aftermath of the crash, Sancus’s flagship strategy has built an impressive track record. In its first full year of trading, the fund was up more than 10 per cent, and while the European sovereign debt crisis of 2011 left it nursing a 5 per cent annual loss, it has since rebounded, scoring several annual double-digit gains.

More recently, structured credit has held its own during the Covid-19 pandemic, drawing further investor interest. Following an initial sell-off during the March 2020 maelstrom, CLOs quickly rebounded, and their recovery from the latter half of last year into 2021 has helped drive Sancus’s year-to-date returns towards the mid-teens territory.

“With the asset class having done so well, it’s attracting new capital,” Chernova says. “People are looking at it, new players are coming in, which has helped tighten some of the CLO equity spreads and drive prices up.”

In the prevailing investment environment, she sees recent concerns surrounding inflation as helping to further fuel allocator demand for floating-rate asset classes, such as loans and CLOs.

“CLOs are a floating rate asset class, and one of the things people are afraid the most of right now is inflation,” she observes.

“The asset class has also performed very well throughout Covid, despite the doom and gloom predictions. This is all driving interest in credit and floating rate credit, which is leveraged loans and CLOs.”

On current market opportunities, she adds: “We often go back and forth between the equity and the mezzanine. If you look historically, you probably have done better in the BB tranches. When market sells off, the BBs sell-off significantly. They also rally a lot faster. So there’s an interesting trading opportunity in BBs.

“If you look at where BBs are today – at 600-700 spread over Libor – it’s significantly wider versus corporates.  On a relative value basis, they are attractive, but at that level we start to prefer the CLO equity more. So whereas last year we were bigger fans of the mezzanine, this year we are leaning towards the bottom tranche.”

Pioneering

As a CLO equity investor, Sancus is also known for pioneering a novel feature in CLOs called an applicable margin reset (AMR). This mechanism provides a method for refinancing CLOs electronically without having to go to the new issuance market, which helps reduce costs compared to traditional refinancings.

“When we started to look at CLO equity back in 2014, we felt there had to be a better way to refinance. Why does there have to be a new issuance process if all you want to do is lower the coupons on debt?,” she says of the process, which avoids the lengthy process of engaging underwriters, legal counsel and other parties in structuring, offering and rating new issuance notes.

To date, Sancus has issued and invested more than USD200 million of CLO equity using this AMR feature.

“Originally, we were among the first ones doing it, but there have since been some transactions printed by other investors using this feature, with around USD6.5 billion issued using this online refinancing innovation,” she explains.

“It improves the returns for the equity investor significantly, and depending on the environment, you can achieve anywhere from 1.5 to 3.5 per cent IRR improvement.”

‘Natural progression’

Sancus has also expanded its focus beyond hedge funds, branching out into CLO management with the launch of its first issuance, Trysail CLO 2021-1, earlier this year – a move which Chernova sees as a “natural progression” for the firm.

“This is something we kicked around for a while,” she says of the move into the CLO management sphere, which saw the firm hire portfolio manager Andrew Maria, formerly CEO and CIO of East West Investment Management, last December.

“We’ve been investing in this space since 2013. In our hedge fund business, we spend a lot of time trying to analyse managers, manager behavior and their investment styles.

“By looking at manager styles, and meeting managers when doing our own due diligence, we have accumulated much institutional knowledge and have learned from the best.”

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