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High-performing credit specialist PVE keeps a wary eye on European tail risks
P
lenty of European-based credit and structured credit managers racked up very impressive performance in last year’s generally
buoyant market conditions, with more than a
few making returns of 50% or more in a banner
year for the credit asset class as a whole.
But not many of them also managed to post
outsized gains in 2007 and 2008 during the credit market meltdown – when several credit-focused specialists suffered some huge drawdowns.
One of the few that can claim to have done so
is Gennaro Pucci, the founder and chief investment officer of London-based global and European credit hedge fund PVE Capital.
Pucci, a long-time trader and fund manager in
the credit space, was formerly the head of trading
at $1.3 billion credit asset manager Credaris before setting up his own firm in July 2009 – having previously held senior credit trading positions in the banking world at Commerzbank,
MPS Finance Banca Mobiliare and Cofiri.
At Credaris, he was also a portfolio manager on
the group’s $130 million Credaris Credit Correlation Fund and its $900 million multi-strategy
credit fund, as well as running a $140 million
Structured Credit fund for the firm.
In an 18-year career in the credit markets –
ranging across fund management, trading and
structuring – Pucci has exhibited a proven and
rare track record of strong performance in both
bull and bear markets, with a particular history
of thriving in difficult market conditions.
This was best shown in 2007 and 2008, when
he returned more than 50% in each of those two
tumultuous years for the credit markets – mainly by shorting CDOs as a result of being one of the
first managers to spot the impending collapse of
the US sub-prime sector. He then made 20% returns in both 2009 and 2010 with PVE, before
dropping almost 25% in 2011.
But an early decision to reverse the short trade
that had served him and his investors so well in
the earlier years – by going long of structured
credit in late 2011 – paid off handsomely last
year, with PVE’s main structured credit investing
vehicle up by 67% on the year.
Over the eight years that he has been running
credit hedge funds – a period that spans the
most turbulent and fast-changing credit market
conditions in recent history – Pucci has generated a cumulative return of more than 300%, a
record that few peers can match.
At PVE Capital, which runs about $300 million
in assets under management, he heads a ninestrong team that collectively boasts some 70
years of credit experience – with each individual having been active in the markets for at least
10 years.
On the front-line investment team are four
other professionals led by portfolio managers
Derrick Herndon, a key recent hire who has been
with PVE since July last year, and Loren Remetta,
who joined the firm in June 2010 – with the in-
Gennaro Pucci’s experienced credit trading team
produced another stunning showing in last year’s
buoyant credit market conditions, but he cautions
that 2013 could be a very different kind of year
vestment team being supported by a four-strong
operational and risk team under the leadership
of COO Mike Geaghan, who operate from London and the firm’s secondary office in Malta.
Herndon, a 26-year veteran of fixed-income
markets, was formerly head of European credit
trading at both UBS and Credit Suisse – while
Remetta, who focuses on liquid macro credit
product trading, has 13 years of credit trading experience as a market-maker and risk-taker at UBS
and Bank of America, specialising in index products and CDS trading.
Credit research analyst Galina Goryacheva,
who has been with PVE since September 2011,
previously five years as a senior credit analyst at
London-based credit hedge fund Elgin Capital –
where she specialised in leveraged loans and
high-yield debt.
And quantitative research analyst/risk manager
David Yuen has been with the firm since March
2010 – having formerly worked with Pucci at
Credaris, where he analysed and developed pricing models for a variety of structured credit and
ABS products.
Pucci believes the investment team’s complementary mix of fundamental and quantitative
approaches – and the balance of skills-sets
across different sectors of the credit space – is a
major factor in the ability to source alpha across
the whole spectrum of the credit market.
A dynamic investment process blending a topdown perspective with fundamental bottom-up
analysis – across the global credit landscape, but
with a particular focus on Europe – enables the
team to cover all areas of the asset class as well as
more complex credit opportunities.
Technical issues such as price, timing, size and
liquidity are then factored into investment decision-making – with any macro or underlying
volatility risks being hedged with liquid credit
instruments, underpinned by a risk management system and framework that PVE says is
typically used by larger-sized credit and multistrategy hedge funds as well as banks.
Despite the increasingly bullish sentiment in
equity markets over the past few months and the
increasing evidence of economic recovery in the
US, PVE believes that low and slow growth will
continue to be a major theme in Europe throughout 2013 – and that the ‘Japanisation’ of European economies will continue to favour credit
and fixed-income.
However, Pucci predicts that this year will be a
very different one for credit managers from
2012, when liquidity injections by fiscal and
monetary policies helped riskier assets to outperform and created a relatively easy environment
in which to make money.
In particular, PVE believes that serious problems in the European peripheral economies are
likely to arise as resistance to austerity intensifies
in countries like Italy and Spain – and that significant tail risks remain, in terms of deep-seated
political and banking sector issues.
“Now is the time to add shorts in peripheral
markets after the substantial rally in credit in the
last three months,” the firm wrote in a note to
clients in early February, even before the results
of the recent Italian election.
In an update sent after the election, the firm
went even further in its bearish assessment, saying: “For the bravest it is also time to short the
short-term peripheral bonds which have felt the
most positive effect of the OMT programme and
present little upside at this stage.”
PVE’s view is that the combination of the Monte dei Paschi derivatives scandal in Italy – which
occurred under the watch of ECB chief Mario
Draghi (who was then head of the Italian central
bank), thus conceivably weakening his credibility in the now crucial area of EU-wide banking
supervision – and the extent of the social/political antipathy to German-led austerity in Italy and
other European countries that the Italian elections have revealed have brought to the market
“a very fat tail risk event” in Europe.
Ominously, the firm added in its update: “The
worst-case scenario should bring markets back to
November 2011 levels, with a correction from
here in the order of over 35%.”
PVE dates back to 2009, when Pucci left Credaris to set up his own firm. Having initially used
the regulatory/FSA authorisation umbrella of
Matrix to get up and running, PVE went solo as
fully-fledged independent firm in 2010.
Since then assets have grown from around $50
million to $300 million – with the lion’s share
of the firm’s current AUM (more than $200 million) being run in a managed account portfolio
called PVE Special Credit Situation that invests in
structured credit opportunities. Last year, the
managed account was up by almost 70% –
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Gennaro Pucci
“
Investors are being sucked into equities, which is what the policymakers are trying to achieve through the extraordinary policy
responses that we saw in 2012, but there is still a great opportunity
in credit for investors to get high returns with no leverage
mainly thanks to long unlevered positions in a
red-hot structured credit market that was a oneway street for most of 2012, with correlation
trades proving much of the stellar performance.
There is also a less high-octane and more balanced long/short credit fund called PVE Credit
Value – a total return strategy that looks for
value opportunities across Europe on both the
long and short sides of the book, using a macro
overlay strategy to manage volatility through liquid hedging instruments.
That fund – which is currently a closed fund
on the Goldman Sachs managed account platform, and is also (since December last year)
available in a UCITS-compliant format as well
– was up by around 10% in 2012, reflecting its
less directional and lower-vol approach to credit
investing.
“Last year was an incredible year in structured
credit – and it was a pretty easy market,” says
Pucci. “We went long before the tide turned –
and you could make great returns without needing any kind of leverage. We hadn’t seen those
kinds of opportunities in European credit for
years. In the past you would have needed four
times leverage to get the same returns.”
He adds: “But 2012 was all about buying assets
and being long. 2013 will be a very different kind
of year – and people will need to be running
much more balanced portfolios. There is no
shortage of opportunity in European credit, but
the volatility has not gone away and there are
some very big potential event risks – particularly in terms of political risk.”
With increased firepower on the five-strong
investment team thanks to the addition of Hern-
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don last year, PVE spans the breadth of the credit markets – concentrating on the corporate
credit, high-yield and structured credit sectors –
with Pucci acting as CIO and head of quantitative/risk analysis.
Although the firm’s remit is global, the focus is
predominantly on Europe – especially on the
peripheral countries in the case of the structured
credit investing side, but with a greater focus on
the core, supposedly ‘safer’, northern European
countries for the long/short credit fund.
“We’ll look at any opportunity that comes on
the market,” says Pucci. “In terms of risk management and the operational infrastructure, we
have a very sophisticated institutional set-up. In
the credit space, the risk and analysis tools and
systems that you use are very important – and
we were the pilot for rebuilding a bank-style trading system that I was using at Credaris and which
is now used by a lot of funds that are much bigger than us.”
The investment strategy starts with a topdown, macro-style view across sectors, regions
and asset classes – but then drills down into
bottom-up analysis to select the best instruments
for expressing the team’s views and desired risk/
reward exposures.
Although the wave of money being allocated
to European credit by many big US funds is having a big overall impact in terms of market liquidity and the general supply/demand dynamics of the credit space, Pucci believes it is also
skewing the capital structure – creating opportunities and dislocations for more specialist, research-driven players.
“This is a very research-driven business these
days,” he says. “You need to be doing very intensive analysis about what you are buying – and
you need to have the best people and analytical
tools to do that.”
On the sell side, he believes that many European banks that have so far been reluctant to sell
assets are now increasingly willing and prepared
to do so – as a result of new regulatory and capital requirement measures, and under mounting
pressure to delever.
On the buy side, meanwhile, natural buyers
like insurance companies are also hampered by
new regulatory and solvency requirements that
are restricting their ability to take up the increased supply – creating huge opportunities
for hedge funds in the distressed and structured
credit areas.
With bank prop trading having dwindled dramatically in recent years, the opportunity set for
hedge funds has become much richer and less
competitive – with fund managers are also in a
much stronger position as suppliers of market
liquidity and flows.
“The bank proprietary function has largely
been disabled,” says Remetta. “The amount of
risk that a dealing desk can hold has gone down
by 50-60% in the last three years – certainly on
the European side – and some banks are now
brokerage operations rather than flow shops. In
many ways it is a return to the early 2000s, before
the European banks started to try and emulate
what the US investment banks were doing.”
Pucci believes this pullback has fundamentally
altered the way the credit markets operate. “Before the crisis banks were operating on a basis of
about 5:1 in terms of CDS trading versus cash
trading. Now they are doing more cash than
CDS,” he says.
“And there has also been a big change in the
balance between real money investors and hedge
funds. There are a lot of real money investors
these days – from retail, institutional, ETFs, corporate bond funds and so on. There is no leverage, so there is not so much risk of a bubble
building, and the risk of a liquidity crisis is much
less than when people are using leverage.”
Despite evidence of a ‘great rotation’ from investors back into equities, Pucci is confident that
there will not be any sudden reversal of the massive inflows into corporate credit in the last few
years from institutional and retail investors.
“Investors are being sucked into equities,
which is what the policy-makers are trying to
achieve through the extraordinary policy responses that we saw in 2012, but there is still a
great opportunity in credit for investors to get
high returns with no leverage,” he says.
“At the moment there is no reason for corporate bond retail investors who are getting 8% a
year to go into equities. If you own equity, you
are going to get lots of volatility. There are still
big tail risks out there and, if you choose to
ignore them, you’re taking a big gamble.”
March 2013