PICTON HEDGE FUND BETTING ON CREDIT SELL-OFF
Most defensive in a decade amid ‘pain trade’
• Picton Mahoney Asset Management is the “most defensive” in a decade as the Us$5.5-billion Canadian hedge fund bets on a looming sell-off in credit.
Trade tensions and a slowing global economy at a time when “complacency” in the bond market is running high are prompting the 15-year-old fund to hold its fire power in the fixed-income space.
“We are not buying anything, we are just being patient trading in the secondary market,” said Phil Mesman, partner and head of fixed income at the Toronto-based fund. About 50 per cent of the bond portfolio was bought in 2016 and another 25 per cent in the selloff last autumn.
If you combine “risk off and volatility, suddenly the market plunges, and that plunge is getting into liquidity- driven volatility,” Mesman said in an interview at Bloomberg’s Toronto offices. “That’s when we are most active.”
With more than US$16.3 trillion of bonds trading with a negative yield while stocks remain fairly lofty, investors face the dilemma of assessing which market is correctly reflecting the economic and geopolitical developments. Inverted government yield curves may suggest chances of recession are increasing, yet investors keep bidding for new corporate bonds at historically low coupons. Mesman, 48, isn’t tempted. Picton’s fixed-income assets are organized around three strategies. The patient capital portfolio, or investments focused on preserving capital and limiting volatility, is at about 40 per cent, or the low end of a range usually going as high as 60 per cent. Bonds of record storage Iron Mountain Inc. and telecom and media firm Quebecor Inc. are among the eligible securities for this pocket of Mesman’s strategy.
Another 30 per cent is devoted to what Mesman calls yield with upside, or events that could trigger a boost in the securities such as ratings upgrades, or potential early repayment of bonds. Debt issued by Air Canada — whose rating may be lifted to investment grade as the company reduces its leverage ratio — is one example of the kind of trades included in this segment of Picton’s strategy.
The remaining 25 per cent is focused on single-name short bets to gain alpha or excess returns over the indexes, while 5 per cent is left for rates, credit and liquidity hedging. These strategies include longshort trades using instruments such as credit default swaps, he said.
While the volatility in the credit market is at the lowest since 2009, the dispersion of performance within the different segments of the market have increased so there are opportunities by mining into the secondary market, said Mesman, who was a proprietary analyst at Merrill Lynch & Co. For instance, the performance gap between the ICE BOFAML U. S. High Yield and the U. S. High Yield Energy indexes is the biggest since a record gap in early 2016.
The lower overall volatility of the main index may prompt some investors to overlook that the socalled pain ratio, a metric of the magnitude of losses in a bearish market, is about 1.5 times higher than levels seen before 2008, he said. The high level of complacency is reflected in the corporate bond market, with yields at record lows adjusted for the duration of the underlying securities, said Mesman.
The yield on the Bloomberg Barclays U. S. corporate bond index is at 2.87 per cent, less than 30 basis points above record low reached in May 2013, before the Federal Reserve started tapering its bond purchase programs. The gauge’s duration has lengthened to about 7.8 years, from about 7.2 years in 2013.
“I think the bond market is at a pain trade,” said Mesman.
BEING PATIENT TRADING IN THE SECONDARY MARKET.