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1 Alpha generation built to last
This document is provided for information purposes only and its contents (including any opinions) are subject to change without notice. This document has been prepared exclusively for the information of the person or persons for whom it is intended.
CONVERTIBLE BONDS IN THE UCITS CONTEXT
Zürich, September 19th 2011
2 Alpha generation built to lastARKOS CAPITAL
An independent Swiss asset management firm:
• Authorised and regulated by the Swiss Financial Market Supervisory Authority FINMA as a manager of collective investments
• Applying a solid and consistent investment approach since 2002
• Managing a range of liquid and transparent absolute return funds, both off-shore and UCITS
• With a significant portion of employees’ liquid assets invested in the funds
• Employing a core team of seven long standing investment professionals with a passion for fundamental analysis supported by a risk manager and eleven further specialists
• Managing EUR 594m of AUM as of August 31, 2011
The Company
Our Mission is to provide excellent performance and service to our clients through low volatility, liquid and transparent absolute return investment products
3 Alpha generation built to lastARKOS CAPITAL
Developed Europe
• World Invest Absolute Return, L/S equity UCITS fund, beta mandate between 0 and 0.5 (average 0.15) and max vol of 10%
Emerging Markets
• World Invest Absolute Emerging, L/S equity UCITS fund, beta between 0 and 0.5 and maxvol of 18%
Financials
• World Invest Absolute Financials, L/S equity UCITS fund, beta mandate between 0 and 0.5, max vol of 10%
Convertible Bonds
• World Invest Absolute Strategy, Convertible Bonds UCITS fund
Our UCITS Offering
4 Alpha generation built to last
Fixed Income Product
Convertible Bonds are first of all BONDS. Corporate Bonds. What do they offer:
•Fixed maturity redemption•Coupon cash flow•Bond Floor protection
Equity Characteristics
Convertible Bonds also offer equity characteristics:
•Fixed conversion ratio at the option of the holder•Dividend protection•M&A Protection•Optionality upside
Convertible Bond Essentials
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CBs - Long-term Asset Class
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CBs steadily outperform over the long-term
Fixed Income CharacteristicsCBs offer redemption at maturity. Corporate credit risk, not equity risk.
Bond FloorsBefore maturity, CB prices are sustained by the bond value. As new issuance gets rolled-out, bond floors are higher and higher.
Soft/Hard Call FeaturesMost CBs are callable. This forces a kind of “take profit” situation when in-the-money CBs get forced into conversion. New issuance also creates higher call levels.
Dividend and M&A protectionCoupons AND full dividend protection helps keep up with the equity market. M&A protection keeps premiums safe in corporate action.
Where does the outperformance come from?
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New Investor Base
From Hedge Fund dominance to broader investment basePre-Lehman the CB market was dominated by leveraged Hedge Funds (CB Arb).“Non-traditional Investors” were attracted by excess yield and negative basis.Market now 60/40 between outright and HFs
Prospectus Changes
Full dividend protectionAfter the crisis, and indeed again today, dividend yields were historically high. In order to place new issuance, full dividend protection became “standard”.
Change of Control (CoC) protectionPremium protection through CoC ratchets has become common. Mostly linear ratchets.
Convertibles after 2008…
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M&A Protection
Change of control “ratchet”:
100%
80%
Prezzo
Bond Floor
Increase in conversion ratio in
case of M&A “ratchet”
Or 100% Put + accrued?
?
Initial premium
protection
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M&A Protection
In real money… Bulgari 5.375% 2014
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Moments of distressed valuations!
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Negative basis is back in the CB market!
Not only yield pick-up… but also free equity options!!
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SpreadYTMMaturityAskBidSecurity Name15.09.2011
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Convertible Bond main strategies
There are/were two main lines in CB management:
Outright Investors
Long Only dedicated mutual funds – Traditional CB SICAVs, Units Trusts
Fixed Income Funds – Use CBs as a means to gain equity exposure
Pension Funds – Long term “buy and hold” investors
Private Banking – Wealth Management and retail banking
Arbitrage Investors
Hedge Funds / Bank Prop Books – Relative value, Gamma trading, M&A, Carry trades
Market Makers – Gamma trading, Carry trades
13 Alpha generation built to lastARKOS CAPITAL
LiquidityIndependent custodian, administrator and manager
No strategy deviationEU Passport
Delivery channel to broad investor baseRecognised brand
Fundamental OutrightInvestment
UCITS AI
Arbitrage Opportunities
Under UCITS you can combine both
Regulated Environment
14 Alpha generation built to lastARKOS CAPITAL
Lower average deltaCapital Protection
Delta upside opportunity miss is substituted by Alpha generating arbitrage trades
Equity fundamental analysisleads to outright investment
in Convertible Bonds
Equity upside + Bond Protection
Under UCITS you can combine both
Reduced delta portfolio
Arbitrage opportunities such as M&A ratchets, Carry,
and relative value
Zero delta alpha generation
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Similar performance… less delta
You can manage a slight over performance with lower volatility (180d 5.8% vs. 6.15%)
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Key Regulatory Limitations
Global ExposureVaR approach UCITS vs. commitment approach UCITS
OTC counterparty exposureMargins, synthetic shorts, credit exposure
Concentration Limits10/20/40% rules
Liquidity ObligationsMinimum bi-monthly NAV
…how does this affect our Convertible Bond management?
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Key Regulatory Limitations
Global Exposure - VaR UCITS vs. commitment UCITS
Commitment UCITS VaR UCITS
Limited use of derivatives for hedging only
Total Commitment Max. 100% of NAV
Extensive use of derivatives for investment
purposes
Relative VaR2x benchmark VaR
Absolute VaRMax. 20% - 99% conf
Fits comfortably for our CB strategyOur average VaR has been 3-4% in 2010, while maintaining 140% gross exposure and fully invested – (Was close to 6-7% in Nov08)
Not ideal for CBsCould manage long-only, but would be limited in absolute return trades.
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Key Regulatory Limitations
OTC Counterparty Exposure
Problem1. Limited ISDA agreements2. Lending source3. Margins and unrealised P&L
add up as exposure
As you cannot short stock physically, you end up with large OTC counterparty exposure. Max limit 10% with credit institution.
•Synthetic Shorts (CFD, Equity Swaps)•CDS•ETD & OTC derivatives•FX forwards
Fix1. Open multiple ISDA counterparties2. Lending via give-up3. Resetting of open P&L reduces
exposure
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Key Regulatory Limitations
Liquidity Obligations - Coverage Rule
The fund must be able to meet delivery and payment obligations involving derivatives.1. Hold deliverable securities or enough liquidity to acquire assets needed2. Hold enough liquidity to allow required payments
Minimum NAV requirement is twice monthly
Liquidity is a MAJOR concern
We launched in January 2008 and have maintained daily NAV Careful liquidity management needed – No illiquid trades (ASWs or other lockups) Only classic long bond – short CFD – long CDS
Twice-monthly NAV is easily achievableNo ASWs with long make-whole provisions
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Current Portfolio Structure
ARKOS CAPITAL
Delta Exposure
Conservative Delta: Average delta is 0.20
Convertible Arbitrage Trades:Over 10% of portfolio is delta neutral and represent relative value trades.
Long Only Trades:The outright trades are based on sound bottom-up fundamental research.
Interest Rate ExposureHedged duration: The gross duration is -2.00 (Rho)Over 50% of the risk is hedged via short interest rate futures cross currency and curves.
Net duration is -0.95 (Rho)
Credit and Liquidity
Credit Exposure: Despite issuers in the CB space are generally high-yield credits, we maintain a relatively conservative credit exposure. Average credit spread is +400bp (iTrax Xover +750bp)
Liquidity: Liquidity is monitored constantly via market-maker runs in order to ensure ample flexibility inline with our daily NAV requirements.
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Performance – World Invest AbsoluteStrategy
World Invest Absolute Strategy DJ Euro Stoxx 600 DJ Euro Stoxx 50 iTrax Europe Main
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC TOTAL2007 0.83% 0.27% 0.51% -0.10% -0.54% 0.97%2008 -0.55% -1.03% -1.44% 0.57% 1.03% -2.75% -1.10% 0.02% -7.25% -10.07% 3.19% 1.99% -16.57%2009 2.31% 0.98% 0.45% 3.06% 3.81% 0.78% 3.71% 3.20% 2.25% 0.02% 0.55% 1.78% 25.25%2010 -0.18% -0.19% 2.93% -0.71% -4.63% -0.45% 2.45% -0.27% 2.46% 1.52% -1.00% 1.83% 3.58%2011 1.53% 1.03% 0.80% 0.47% -0.25% -1.16% -1.90% -4.80% -4.34%
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World Invest Absolute Strategy
ARKOS CAPITAL
As of End of Aug, 2011 World Invest Absolute Strategy
StrategyLong-biased Convertible Bonds with partially hedged risks (main strategy)
DescriptionPrimarily invests in Convertible Bonds, while partially hedging some of the consequent exposures. Geographic focus: Global Beta mandate between 0 and 0.5
Type of Fund / Domicile UCITS Sicav - Luxembourg
ISIN LU0333971942
Other Characteristics Diversified portfolio with over 50 positions
Inception January 2008
AUMs EUR 124.34 m
Liquidity Daily1.5% management fee,
10% performance fee, HWM
Minimum Investment EUR 5,000
Annualised Return 0.98%
Return Since Inception 3.62%
Max Target Volatility n.a.
Historical Volatility (s.i.) 7.09% p.a.
Fees
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Arkos Capital SAVia Marconi 16900 LuganoSwitzerland
www.arkoscapital.com
Contact Information
ARKOS CAPITAL
Christina Howardchristina.howard@arkoscapital.com
Tel. +4191 260 7805Fax +4191 260 7811
Marco Baldassinimarco.baldassini@arkoscapital.com
Tel. +4191 260 7827Fax +4191 260 7811
SpeakerJonathan StanfordFund Manager – World Invest Absolute StrategyConvertible Bond UCITS
jonathan.stanford@arkoscapital.comwww.arkoscapital.com
24 Alpha generation built to lastARKOS CAPITAL
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Disclaimer
This document is provided for information purposes only and its contents (including any opinions) are subject to change without notice. This document has been prepared exclusively for the information of the person or persons for whom it is intended and therefore may not be suitable for all investors. Nothing contained in this document constitutes or forms part of any offer to sell or buy an investment, or any solicitation of such an offer, by Arkos Capital, or any of its affiliates, in any jurisdiction where such activity is prohibited (including, without limitation, the United States of America) or to any person to whom it is unlawful to make any such offer or solicitation. Nothing contained in this document constitutes investment, legal, tax or other advice, nor is it to be relied upon when making investment or other decisions.
The information set out in this document in relation to the funds is for general guidance only and potential investors must obtain further information from the prospectus, offering circular or other offering document for the relevant fund. Any investment in the funds described in this document may involve significant financial risks. The price of investments and any income from them may fluctuate and may fall as well as rise. Past performance is not necessarily a guide to future results and there is a significant risk that investors will lose all of the money or other property invested. When an investment involves a foreign exchange transaction (i.e. an investment denominated in a currency other than the investor's base currency), it may be subject to fluctuations in currency values and the value of such investment and the income on them may go down as well as up. Units in a fund may not be readily realisable and there may be no recognised market in any such units in the event of an investor wishing to sell. There is no assurance that a fund's investment objectives will be achieved and investment results may vary substantially over time. Investment in any fund or in the funds generally is not intended to be a complete investment programme for any investor.
This document has been prepared, approved and issued by Arkos Capital. The information and opinions contained in this document have been compiled, or arrived at, in good faith and on the basis of publicly available information, internally developed data and sources believed to be reliable as at the date of publication. However, no representation or warranty, express or implied, is made by Arkos Capital or any other person as to their reliability, accuracy, completeness or correctness. Neither Arkos Capital nor any of its directors or other employees accepts any liability for any loss or damage of any kind, including any loss of profit, whether direct or indirect in respect of the use of this document or reliance on the information and opinions contained in it from time to time. However, Arkos Capital does not exclude or restrict any liability it may have under applicable laws and regulations.
All material copyright Arkos Capital 2011. All rights reserved. None of the contents of this document, either in whole or in part, may be reproduced, stored in a data retrieval system, or transmitted, in any form or by any means - electronic, mechanical, photocopying, recording or otherwise - without the prior written permission of Arkos Capital. However, reasonable extracts may be made for the purposes of comment or review, provided that the source is acknowledged.
ARKOS CAPITAL
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