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Credit Long Short: a diversified alternative strategy targeting moderate volatility

Patrick Zeenni
CFA, Head of Investment Grade & Credit Arbitrage
Guillaume Benoit
Senior Investment Grade Fund Manager / Credit Analyst
Mouine Darwich
Fund manager/ Quantitative credit Analyst

What is a Credit Long Short strategy?

A Credit Long Short strategy aims to capitalize on inefficiencies in the credit market, while seeking to limit exposure to market risks (credit and interest rates) and/or volatility peaks.

At Candriam, our approach integrates ESG criteria[1] and aims for long-term absolute returns and low correlation with other asset classes.

Our strategy is based on a broad investment universe, in terms of geography (selection of issuers from all regions - with a preference for Europe and the USA), type of issuer (financial and non-financial companies), market segment (investment grade[2] or high yield[3] ), and, last but not least, instruments involving bonds or the use of credit derivatives such as Credit Default Swaps[4] and Total Return Swaps[5] (i.e. all instruments that are directly or indirectly linked to an issuer's ability to repay its debt, thus offering a diversity of investment options for managers).

What is the favorable economic and financial context for long-short strategies?

Long-short strategies have the advantage of adapting to changing economic and financial cycles. They can adjust to a volatile market context, influenced by central bank decisions, economic indicators that don't match expectations, or geopolitical tensions. They may also be capable of performing in a relatively stable environment.

In turbulent times, investors are seeking strategies that provide performance, stability and diversification in their portfolios.

Our Credit Long Short strategy aims to be a wise choice to meet these expectations by investing in the credit market.

What are the special features of your Credit Long Short strategy and how does it stand out in the market?

Our Credit Long Short strategy boasts several key features that make it an attractive solution for investors.

Firstly, it is a low-volatility strategy, aiming to offer an optimized balance between return and risk. When markets are marked by heightened volatility, our strategy has historically stood out for its ability to keep volatility low, thanks to robust position diversification, disciplined and rigorous risk management, and the use of strict stop-loss [6] selling.

Another distinctive feature of our strategy lies in our investment process, which relies on two complementary performance drivers - relative value arbitrage and directional strategy[7] - and our flexible approach, which have enabled us to achieve our performance objective throughout credit cycles since its inception in 2009. Our fundamental and extra-financial (ESG) analyses, as well as our legal expertise and quantitative research, are the cornerstones of our approach.

Finally, the strategy benefits from the support of an experienced team of 11 credit analysts/managers dedicated to the analysis and identification of opportunities, and 20 ESG analysts whose analysis enables us to better understand the risks and opportunities that could impact the solvency of issuers over the long term.

How do you select your investments?

Our aim is to capture the best investment opportunities in the credit market. This selection is based on a fundamental financial and extra-financial (ESG) analysis of issuers, an in-depth legal assessment, and a quantitative analysis of issues. Our ambition is to select issuers we consider undervalued for long positions[8], and those we consider overvalued for short positions[9].

These investment opportunities are structured around two distinct pockets within the portfolio:

  • Relative value arbitrage: this strategy aims to exploit observed or anticipated differences in returns between different geographical zones, business sectors, currencies or financial instruments. To identify these arbitrage opportunities, we use fundamental and/or quantitative analysis.
  • Directional strategies: we implement long or short positions based on strong convictions about the outlook for issuers. This approach allows us to take advantage of market trends and price movements.

We apply dynamic global management of credit and interest-rate risks to limit volatility, with the aim of generating performance in all market conditions. This proactive risk management enables us to maintain an optimal balance between return and risk for our customers.

To what extent does a flexible approach enhance performance?

The fundamental and ESG analyses we apply to each issuer, which have been tried and tested for over 25 years, enable us to go beyond traditional boundaries and position ourselves between investment grade and high yield segments. This agility enables us to navigate through credit cycles by exploiting the "cross-over" zone between these two market segments, where the difference in market perception between the "rising stars" and the "fallen angels" can be significant. The "fallen angels" are companies whose rating is "downgraded" from investment grade to high yield, and vice versa for the "rising stars". In recent years, high-yield issuers have strengthened their balance sheets in order to reduce their cost of debt and regain investment grade status. De facto, "fallen angels" have seen their credit rating improve and are now "rising stars" likely to enter the investment grade category.

This diversification between the two segments offers attractive performance potential, reinforced by current market dispersion and volatility. We manage the overall[10] duration (credit and fixed income) in a flexible way, to adapt the portfolio to changes in the market environment.

Flexibility is the key to our Credit Long Short strategy, enabling us to seize a wide range of opportunities while seeking to maximize returns and reduce the risks associated with market fluctuations. In an uncertain geopolitical and economic context, this flexible approach can be particularly relevant and advantageous when seeking to diversify a portfolio or achieve performance.

Credit Long Short: a diversified alternative strategy targeting moderate volatility

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[1] Environmental, social & governance
[2] Investment-grade issuers are those with a high credit quality (i.e. low probability of default) assigned by a rating agency. For example, an issuer with a minimum rating of BBB-.
[3]  high yield " issuers have a lower credit quality than " investment grade " issuers (i.e. with a higher probability of default). For example, an issuer with a rating below BBB-.
[4] Credit Default Swaps (CDS) are derivatives used to hedge against the risk of default.
[5] Transaction in which two players exchange revenues and the risk of changes in the value of two different assets over a given period.
[6] The stop-loss can be defined as an advance order to sell an asset when it reaches a certain price level.
[7] Explanation in the next question
[8] To be long, to hold a long position, means to have anticipated an upward trend for a financial asset.
[9] A short position consists of being short because you expect the price to fall in the future.
[10] Duration measures the sensitivity of the price (principal value) of a bond investment to changes in interest rates.

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