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Going north

19 July 2017

Sandro Näf of Capital Four Management discusses why his bond portfolio is weighted towards northern Europe – including the UK.

“If you get into trouble in Italy, it takes a long time to get your money back,” says Sandro Näf of Capital Four. “Our portfolio is more exposed to northern Europe – we have been negative on the periphery.”

Näf and his team at Capital Four were appointed last year to manage the European half of the International Corporate Bond fund. Their focus is therefore high-yield, senior secured European credit. Capital Four is based in Copenhagen, and Näf’s approach is cautious and questioning.

“When we invest in a high-yield company, we always go through a possible scenario of a default,” he says. “It is important to be prepared for all types of future outcomes and we, therefore, look at the corporate practices and legal backdrop. As a result, we have had significantly fewer defaults than the universe; and when things go wrong, our recoveries tend to be much better than the average in the market, which results in better risk-adjusted returns for our clients.”

The last 12 months have been challenging in European corporate credit, and Capital Four’s bottom-up process has proved apt. Indeed, the portfolio has achieved a higher rate of return than the benchmark.

Näf believes the European high-yield market is currently experiencing a relatively disciplined phase; debt leverage is significantly below the peaks of the last cycle. Although some companies that have come to market might have struggled in more challenging times, his broader diagnosis is that restraint is largely bettering valour – for the moment, at least.

“Between 2005 and 2007 there was a rapid increase in leverage and there is nothing like that just now,” he says. “Leverage is surprisingly moderate and the cost of debt is substantially lower, which translates into significant financial flexibility for the average high-yield corporate.”

Capital Four anticipates only very gradual interest rate increases at the European Central Bank and Bank of England – and certainly nothing like the highs of the 1990s and 2000s. Näf believes the greater worry is the potential for structurally lower growth in Europe, given the continent’s challenging demographic profile.

Rising tide

For the moment, of course, the eurozone economy is enjoying an upswing in growth. That upswing both reflects improved corporate performance and helps to perpetuate it. Since rates remain low, companies have been borrowing in order increase return on equity for their owners. Yet what has been efficient for the equity owner may turn out to be less beneficial for the lenders, if the credit work is not done carefully by the investor.

Näf points out that, in the UK, the sectors that have been struggling most in the wake of the referendum vote have been property and financial services. Although the portfolio includes some local financial services companies operating in the retail sector, it has only very limited exposure to the sector.

In fact, the portfolio’s allocation to retail names tends towards niche businesses and smaller players, rather than headline names. One example is SMCP Group, a French apparel and accessories company that operates in the mid-tier, avoiding competition with the big names. All the same, Näf prefers the beauty sector to retail apparel, in part for its non-cyclicality – lipstick demand doesn’t tend to rise and fall too dramatically with the broader economy.

The portfolio also has significant allocations to a range of support services. For example, its largest exposure to the capital goods sector is in packaging for consumer staples – not for consumer discretionary products.

A similar desire to avoid cyclically oversensitive companies is evident in Näf’s preference for parts suppliers rather than manufacturers in the automotive sector. One such company is Alliance Automotive, a major supplier of parts and technical support to more than 30,000 repairers and automotive centres across the UK, France and Germany.

Fallen angels

Yet that does not mean he is averse to high-end companies. One of the UK-headquartered companies in the portfolio is Cognita, a service company that owns and operates private schools around the world. Although the company is a relatively recent entrant to the high yield market, Näf likes its pricing power, as well as its global diversification. Moreover, the fact that the company’s debt is classed as high yield means that it offers an attractive yield for investors.

“Currently most of the high yield bonds we own are ‘born’ as high yield securities [i.e. below investment grade, which means they are rated BB or below],” says Näf. “During recessionary times, our portfolios can contain a lot of ‘fallen angels’.” A ‘fallen angel’ is a company whose debt was rated ‘investment grade’ but has since been downgraded to ‘high yield’.

Some investors have begun to be more concerned about the UK markets, assuming that the EU referendum vote – and the recent spate of negative indicators – means it is quickly falling from grace itself. But Näf doesn’t agree. Instead, he still sees a robust market with plenty of opportunities. He also likes the strong legal framework in place for senior secured lenders; indeed, that framework ensured a 100% recovery in their last restructuring – a UK insurance broker.

“There is headline volatility but we aren’t concerned – we are confident that the companies we have invested in will be able to withstand the economic shocks,” he says. “Technical negative developments can always have short-term negative impact on the portfolio, as happened after the surprise referendum outcome last summer. But then there was a 2-3-month convalescence period, in which prices recovered nicely. As an investor, you have a choice in these circumstances. Either you rebalance or you have companies you trust which can withstand short-term negative impact.”

Capital Four is a fund manager for St. James’s Place.


Past performance refers to the past and is not a reliable indicator of future results.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up.  You may get back less than you invested.
The opinions expressed are those of Sandro Naf of Capital Four Asset Management and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.


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