Cheyne Capital’s hedge funds, with a total of $6.6 billion under management, mostly returned double digit positive performance in 2013, according to an investor letter reviewed by ValueWalk.
Analysis of Cheyne Capital letter
The letter noted that as the equity markets rallied to all time highs – and long underperformer Japan delivering its largest annual gain in 40 years – the year was “less auspicious” for emerging markets as they prepared for the Federal Reserve to scale back its quantitative easing program. “The abundance of central bank liquidity – not just the Fed’s $85-billion monthly asset purchases but also the Bank of Japan’s decision to almost double its monetary supply over two years – precipitated a 30% tightening in the iTraxx index of European investment-grade credit and a 26% tightening in its US equivalent over the course of the year,” the letter noted. “Easy liquidity, coupled with low-to-modest economic growth, gave rise to idiosyncratic releveraging and M&A during 2013, as corporate management sought alternatives to earnings growth to enhance shareholder value.”
50% return in 2013
In the real estate debt silo, the Cheyne Real Estate Debt Fund returned 10.9% from investments in EU bonds backed by real estate while the Credit Holdings Fund delivered 12.7% from investments in loans and real estate-backed bonds. The share value of the London Stock Exchange listed Real Estate Credit Investments (RECI) rose 50.1% in 2013. “European real estate debt markets remain structurally dislocated, with a persistent supply/demand imbalance,” the letter said. “European banks are continuing to retreat from real estate lending as they focus on asset disposals and recapitalisation. New regulatory regimes for banks and insurance groups largely restrict lending to low-LTV senior loans. Yet demand for real estate finance is growing, due to refinancing needs and new transactions.”
In corporate credit, the Total Return Credit Fund USD class delivered 49.2%, the top performer in this segment. “Even with the tightening of the iTraxx Main index over 2013, spreads on investment-grade credit remain over three times pre-crisis levels and are still factoring in excessive compensation for default risk, which we believe will remain subdued in 2014,” the letter said, touching on a primary concern of credit investors and hitting a hot topic. The letter also noted the fund is migrating from cash markets to derivatives markets due to better liquidity. “2014. However, for cash investors, the benefit is likely to be more than outweighed by the value-destructive impact of rising rates. We believe investors would be well served to switch from bonds into derivatives-based credit instruments which isolate the excess return in investment-grade credit spreads from the impact of rising rates.”
In the event driven silo, the European Event Driven Fund delivered +12.0% to investors and the European High Yield Fund returned +12.9%. “Large-cap M&A activity is showing strong signs of picking up in Europe following the recovering trend we have already seen in North America,” the letter said. “Mid-cap activity continues to be solid as boardroom confidence increases and companies look to spend a portion of their high cash balances on strategic deals. Arbitrage spreads in Europe are attractive as the competitive landscape has changed dramatically over the last few years, with the Eurozone crisis leading to a significant amount of capital retreating from the region.” The fund considers how crowded the trade is and how “unloved” an investment might be due to a specific issue all while remaining product agnostic.
Convertible bonds remain steady
In the equity / equity-linked securities silo, the Convertibles Absolute Return Fund returned +13.2% in 2013 and “highlighted the attractions of the convertible bond asset class, delivering strong relative performance, high historical issuance levels and impressive risk-adjusted returns. “ Looking to 2014 the fund expects a positive market environment in this asset class. “A supportive credit environment should further aid convertible returns while the equity optionality embedded in the asset class has it well placed to benefit from strengthening economic growth, offsetting the detrimental effects of rising rates.”
The Equity Fund returned +16.0% while the S&P 500, by contrast, returned nearly 30% in 2013.
“With tapering coming to an end, we expect rising equity markets and interest rates, albeit accompanied by increasing volatility. We believe valuations within the equity markets will be driven more by fundamental differentiation than by macro themes, leading to a particularly favourable environment for long/short equity investing.”