To receive a presentation from CQS, the Fund’s Multi-Asset Credit (MAC) manager.
Minutes:
The Committee received a presentation from Soraya Chabarek and Craig Scordellis,
CQS, the Fund’s Multi Asset Credit (MAC) manager. The presentation covered the
performance and outlook for Dorset County Pension Fund’s investment in the CQS
Multi Asset Credit Fund.
CQS were a credit specialist and didn’t do anything else. Their fund was positioned defensively, and looked to lend to good businesses and to avoid defaults. Over the last six years there had been three defaults, but with very high recovery rates.
The objective of the CQS fund was to return cash plus 4-5% over a business cycle. Since inception in December 2017, Dorset’s investment had performed below this target, but it had performed well against the market.
It was a very challenging environment for credit markets, as economies moved from a sustained period of Quantitative Easing (QE) to Quantitative Tightening (QT). CQS did not believe there was a systemic banking or default crisis as there had been in 2008, when many companies only just covered their interest costs with ‘free cash’. This left them exposed to the risk of being unable to service their debt should interest rates increase and/or earnings growth decrease.
Whilst the level of defaults was expected to increase, CQS believed their process was designed to avoid lending to businesses that would default. Their fund was positioned to minimise the exposure to interest rate rises and to take advantage of opportunities in floating rate debt. It was a diversified fund with a maximum 1.2% exposure to any one company.
The CQS fund’s highest exposure was to Senior Secured Loans, near the top of their allowable maximum exposure of 60%. These were loans to companies with credit ratings below BBB-. Such loans were higher up the capital repayment structure than other debt, so therefore had higher recovery rates in the event of default. They had floating rates of interest, so were less exposed to the risk of increases in interest rates.
The CQS fund’s second highest exposure was to Asset Backed Securities (ABS), near the top of the allowable maximum exposure of 25%. This was lending to a securitised structure, where the investment was secured against physical assets such as property. Exposure to corporate bonds was relatively low, with the exposure to High Yield Bonds at an all-time low, as the presence of many retail investors in these markets had added volatility.
The Independent Advisor noted that the defensive positioning of the fund was one of the reasons for the selection of the manager in this asset class.
The Vice-Chairman asked how CQS could achieve their target over the longer term. CQS had been able to invest at low prices, therefore the cash returns from their holdings should be sufficient to meet their target, if markets stabilised. Capital preservation was the priority in current market conditions, and the key to long term performance was to avoid defaults. Since inception CQS had not met the target but they had made a positive return unlike most index tracker funds in credit markets.
In response to questions from members, it was confirmed that all debt was bought through banks not directly from companies, and that the allocation to Europe was higher than to the Americas because borrowing in Europe had been more conservative than in the US.
The Independent Advisor asked if the Committee should be concerned about the fall in lender protections from the rise of ‘convenant-lite’ and ‘side-car’ debt arrangements. CQS replied that loan market documentation had moved towards that for bonds, and this emphasised the need for detailed analysis of default risk and recovery rates. Awareness of how loan defaults in different jurisdictions could be treated was also a very important consideration.
Noted