SGAM seizes opportunity from subprime turmoil

Strategies seeking opportunities from the mêlée have been cropping up across the US over the past month, but most have focused directly on US mortgages and asset-backed securities (ABSs).

However, credit fears have reached far beyond the US subprime and ABS markets. Between June 1 and July 30, for instance, the on-the-run iTraxx Crossover Index of sub-investment-grade European credit default swaps shot up 59.8% to 471 basis points.

The worries have caused a dearth of liquidity as investors withdraw from what are perceived to be risky credit assets, pushing down valuations for investments that are thought to be otherwise fundamentally sound.

Gregoire Pesques, Paris-based head of SGAM’s corporate credit team and co-manager of its new fund, said the fund was designed to capture this liquidity premium. It only plans to invest in assets rated AAA or AA.

“In the US market there is a huge amount of funds being set up to invest in distressed assets. In Europe we don’t have distressed assets,” he remarked.

SGAM Invest Bonds Recovery is a French-registered mutual fund that is planning an 80% weighting in European prime ABSs and 20% in highly rated European corporate credit. Pesques said he hoped to attract approximately €500 million to the fund, which is aiming for a return of 200bp over Libor.

The strategy is predicated on a view that market values of European prime ABS and highly rated corporate credit will recover within a year. But, due to current mark-to-market volatility, investors in the strategy have been warned the fund’s net asset value (NAV) is expected to drop before it rises.

“We expect the NAV to decrease at the very beginning because of the fair value method and, when the liquidity premium begins to decrease, the NAV of the fund will rise,” said Pesques.

Other fund managers have sought to profit from dislocations in valuation closer to the epicentre of recent market turmoil. California-based asset manager Trust Company of the West, for instance, recently raised $1.56 billion to set up a fund investing in US mortgage credit. Meanwhile, at JP Morgan in New York, special situations partner Jonathan Katz has left the firm to set up a fund that will invest in distressed assets.

California-based investment management firm Dalton Investments is taking a subtly different approach. The company, which is active in the underlying real estate market, is trying to attract $1 billion into a new fund that will directly purchase distressed US mortgage loan portfolios. Steven Persky, the company’s California-based chief executive, likened low asset values in underlying loan and derivatives markets with the downturn in Asian stocks after the financial crisis of 1997.

“You had everybody lending money to Indonesian and Thai corporates at 100 to 200 basis points over Libor in the early 1990s. Then the crash happened and nobody wanted to talk about Asia – so debt was very cheap and Asian equities were very cheap,” he said.

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