How EJF Capital is positioning for inflation as central bank moves recalibrate market dynamic

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Peter Stage, EJF Capital

EJF Capital, which invests long-only and long/short in both equities and credit across the financial services spectrum, believes it is well-placed to navigate the evolving investment landscape, as inflation looms large over markets and the European Central Bank begins winding down its emergency bond-buying pandemic support programme.

Peter Stage (pictured), EJF Capital’s co-senior managing director in Europe, said inflation continues to be a “topic du jour” across markets, with much of the investment landscape for the remainder of 2021 set to be dominated by central bank policy decisions.

But he added that the USD9.5 billion financials-focused alternative asset manager – which invests in both credit and equities across a broad spectrum of financial services spanning banks, insurance and specialty finance firms – can capitalise on the shifting market dynamic.

“As a portfolio manager, what we are trying to grapple with is how we position ourselves to seize opportunities and mitigate any risks we see down the line,” Stage told Hedgeweek.

“The policy overlay is going to be very important. When will they start to taper? How aggressively? There’s still a debate around when the US might move. So the question over whether inflation will be transitory or permanent and the implication for rates will continue to be a live debate, and people will position either for or against.”

Earlier this month, the ECB announced it will start reducing its emergency bond purchases from the fourth quarter onwards, signalling the start of a winding down of its EUR1.85 trillion (USD2.18 trillion) Pandemic Emergency Purchase Programme (PEPP) scheduled to run until March next year.

The move to unwind the stimulus – which has bolstered the bloc’s economy over the course of the Covid-19 pandemic – comes as inflation rises and markets continue to rebound.

“I think they’ve done the right thing,” says Stage, who is responsible for identifying and managing investment opportunities across European fixed income, equity and private markets at EJF with a focus on banking and specialty finance.

“I think they should taper the pandemic response element, because they need to signal that we are through the worst of the pandemic.

“Broadly, we clearly see far less inflationary impulse in Europe than we do in the US or the UK. So, I would not be surprised to see some form of replacement, called something else, when the PEPP actually rolls off, because the big question over inflation right now is whether it’s transitory or persistent – and that’s a very difficult question to answer and the ECB clearly thinks we need to generate more inflationary impulse in Europe.

“However, it doesn’t take much of a change in perception for rate markets to move dramatically. At such low levels, even a modest change is a large percentage change, so we are very conscious of that.”

In Europe, the London-based manager has a particular focus on unique, smaller, less well-known issuers where the firm looks to generate high-yields in assets which can make mark-to-market gains.

“We have a nuanced approach to credit investing in the financials space. That gives us a lower correlation to the market in general, which is part of what we’re seeking,” he added.

While credit assets may be expected to be impacted more by higher inflation than equities owing to their fixed coupon, Stage believes the higher returns offered by EJF provide a greater buffer against mark-to-market moves and any inflation risk if it materialises.

“Our assets are returning higher so on a relative basis we think they are better protected. That doesn’t mean we are complacent, but we believe they are better protected than many generic credit assets,” he added.

“The market is still very open, despite the fact there may be some inflationary discussion, and it’s very much a sellers’ market for large benchmark issuers. For our bonds, which are more off-the-run, smaller, more nuanced and more niche, the relative value that they display is even more attractive and gives them more defensibility and upside.”

Expanding on this point, Stage said: “Our approach is to forge links with small banks, insurance companies and specialty finance players and create assets that otherwise might not ordinarily exist, but which makes sense for them – whether it’s achieving their regulatory requirements, or help them achieve good funding, which means they're not forced to raise equity.

“This gives us a good returning asset that has the chance to reprice through time as the catalyst plays out.”

This, he observed, offers lower correlations to broader market assets because the returns do not simply hinge on beta. “Rather, it’s dependent on whether you’ve created an asset with catalysts that can be realised.”

In equities, meanwhile, Stage said a degree of inflation is a “positive”, but stressed the ECB’s decision will likely stave off a rise in the near-term, adding that the firm’s positioning in equities is informed more by idiosyncratic catalysts at individual companies.

“Inflation should lead to higher rates, and higher rates are generally good for banks, insurance companies and also specialty finance in many instances,” he said.

“However, we’re not relying on that in Europe – because that will need time to come through, and the ECB is really signalling ‘lower for longer’. Instead, when we buy bank equities in Europe we’re looking for catalysts other than rates.”

These include capital return, in the form of dividend payouts and buy-backs, he added.

“If you look at our portfolio, and what we’re doing, it does display an element of lower correlation to the broader market, and that is definitely attractive to allocators,” he explains.
 

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