- Structured credit is considered as an attractive investment vehicle due to the good risk adjusted performance and low market correlation compared to traditional fixed income products. Please share with our readers some information on HSBC’s structured credit business, as well as the key personnel in the team.
As of the 30th June 2017, HSBC Global Asset Management had approximately $10bn of Structured Credit / ABS under management. The team is one of the largest in the industry, with 14 dedicated specialists whose sole focus is structured credit research and client investment. The 3 senior team members each have over 25 years experiences and have worked together at HSBC for over 13 years. The team is organised with Sector specialisation with a focus on credit research. We compliment this credit research with intensive asset monitoring from our monitoring and analytics team. We believe our focus on credit helps to unlock the complexity premium associated with Structured Credit. The organisation along specialist lines for both Credit research and portfolio management / trading allows us to manage the liquidity of the product and to source attractive opportunities. The team invests in Structured Credit Globally and regularly amends its allocations to different countries and sectors to focus on the best risk/return opportunities in the Global Structured Credit universe. The key members of our Investment Committee who take all investment decisions are Andrew Jackson and Nick Ventham, who have 27 and 25 years of structured credit experience respectively. Andrew is the Head of Portfolio Management and Trading; Nick Ventham is Head of Credit Research and Analytics and is responsible for structured credit research. The Investment team is complimented by Dominic Swan, Senior Advisor to the Global CIO and Head of ABS Investments.
- HSBC began to offer structured credit in 2010 and has exhibited good performance across the structured credit strategies over the past 7 years, even though the market of structured credit was shrinking. What initially motivated HSBC to enter this market, and how has the business developed since then?
The team formed to invest in Structured Credit for HSBC Bank Plc and its clients in 2002. The team transferred to HSBC Global Asset Management in 2009 to bring their experience of investing in this asset class to clients of the Asset Management business. We set up three strategies in 2010 to offer to clients: an Investment Grade Global ABS strategy, a Crossover Global ABS strategy and a high Yield Global Abs strategy. All 3 strategies now have a 7 year track record.
- What is the current level of interest around structured credit in the market, and how does it fit in an institutional investor’s portfolio relative to other investment vehicles? In particular, what kind of investors are HSBC’s structured credit strategies geared toward?
There is significant interest from Institution investors around Structured Credit today. We believe Structured Credit is the largest floating rate securities segment of Fixed Income. Structure Credit typically provides a higher return than corporate Fixed Income Bonds for all rating categories. Structured Credit also has a low correlation to the wider fixed Income market. By investing in Structured Credit, Institutional investors with a Fixed Income portfolio are therefore able to enhance their yield, benefit from rising interest rates and protect their portfolio from capital erosion due to rising interest rates and also dampen the volatility of their returns. These features apply at all rating categories and hence we are seeing interest from many types of investors with varying risk appetites.
- Please walk us through the various structured credit investment strategies offered by HSBC including their exposure to various asset backed securities, as well as geographic regions. What makes these strategies different from other products offered by your peers in the structured credit market?
The picture shows our three strategies. The key differentiating feature of these strategies, we believe is our truly global approach resulting in a Global fulfilment of the asset class.
- Since the inception of HSBC’s structured credit strategies in 2010, what would you consider as the most challenging periods of time for the business, and how did they help the team to reposition itself to better prepare for something similar in the future?
There have been two challenging periods since 2010 in the Structured Credit Space. The first was during the Eurozone crisis, where Structured Credit underperformed against wider Fixed Income. The shock of the Eurozone caused credit spreads on all assets to widen considerably and hence Structured credit instruments took their fair share of this. Fixed Income, however was stimulated by significant rapid interest rate cuts that lead to a significant price boost. Given the shock was outside of the Structured Credit Market and was broad based, there was little change to our approach other than to reiterate the importance of fundamental credit research. The second period was a shock to the CLO sector in early 2016. This was caused by oil prices falling rapidly and the knock on effect to any sectors exposed to the US oil producers. We took time to analyse the cause and likely impact of this effect and found that the Leveraged loan market had only a 4% exposure to oil producers, which was typically easily absorbable by the credit enhancement in the deals we invest in. We therefore used this as an opportunity to find increase our allocation to CLOs. However, the experience has underlined our approach in CLOs to concentrate only on the broadly syndicated loan market and avoid CLOs with loans to middle market and SMEs.
- Risk management is a very important aspect in investment strategies. Please walk us through the HSBC structured credit team’s risk management process so that our readers can understand better how the team copes with various risk events to prevent losses?
Risk management is very important to our investment process at HSBC. The ABS team fits into the risk control framework in HSBC Asset Management and there is regular interaction between the team and control groups such as Risk and Compliance. Investment risk related to day to day bond selection is also carried out on the desk. Here there are 2 main strands – Credit risk and top down sector/country selection. All of our Credit Analysts are specialists in their sector and follow a well-documented and formal process in how they underwrite the credit risk for each investment. The final decision to make an investment is undertaken by the Investment Committee comprising the senior members of the team. The specialist approach using experienced credit analysts and the oversight of the Investment Committee is designed to ensure that a deep consideration of all of the risks is undertaken prior to investment. In addition to the regular Investment Committee decisions, the Investment Committee meets monthly with credit analysts and portfolio managers to consider the risks and returns of each sector and country we invest in so that we can move each strategy to the most efficient risk return part of the market. For example, we deliberately have no Subprime Auto loan deals or Subprime US RMBS in our strategies today.
- The structured credit strategies under HSBC’s management have some exposure toward CLO and CDO, which featured extensively during the US subprime mortgage crisis back in 2007-2008. With regards to the underlying fundamentals, how different is the current marketplace for such securities compared to the crisis days?
Following on from our monthly allocation committees we currently favour the CLO market in all our strategies. We particularly favour US CLOs. The performance of CLOs secured on broadly syndicated leveraged loans through the crisis was good with typically no losses incurred to senior tranches of CLOs as a result of collateral losses. The CLO market where the collateral is Corporate loans is a mainstream market and provides significant finance to corporations in the US and Europe. CDOs of ABS, where subordinated tranches of ABS (often Subprime US RMBS) were used as collateral had the highest losses of any Structured Credit sector during the financial crisis. We have no CDOs of ABS in any of our strategies. Since the crisis we are not aware of any significant new issuance of CDOs of ABS. The sector has broadly disappeared as the losses have been crystallised and the structures collapsed.
- Leading from the above, how hard is it to convince prospective investors to venture into this space again? What could help turn the tide against the negative publicity this sector received to better help position its growing value proposition?
Some investors have reservations about the sector because of its role in the Global Financial Crisis. We are happy to show that losses were concentrated in Subprime US RMBS and the derivative of that, CDOs of ABS. However losses to Prime RMBS, European RMBS, CLOs and other sectors such as CMBS and Consumer ABS were much lower and show the resilience of ABS as an asset class. A clear explanation of this effect can help investors overcome their fears of Structured Credit. Today there are several initiatives to promote Structured Credit. The European Union is agreeing definitions of good ABS in the form of Simple Transparent Securitisation (STS). The ECB is buying STS ABS in its ABS purchase programme and bank and other regulators are loosening the capital requirements for these good ABS. A key example of ABS that is penalised is resecuritisation, which is CDO of ABS.
- Some of the key opportunities for structured credit lie in misunderstood or mispriced risks caused by inefficiencies in the market. Considering the enormous range of instruments involved in HSBC’s structured credit strategies, can you share with us how your internal research personnel monitor these instruments for mispricing and plan for the best course of action?
Finding the best opportunities and ensuring the opportunities are regularly assessed is a key consideration for us. Structured Credit is an Over the Counter (OTC) market. We are able to source the right opportunities as we have the experience of doing this over many years in all the markets we operate in. The team is organised along specialist lines, so portfolio managers have access to the relevant dealers and the track record and knowledge to execute efficiently. They are backed up by Specialist credit analysts. Our formal appraisal every month of the sectors and countries that offer best value feeds into this approach and allows us to apply a top down rigour to the selection of best ideas to complement our bottom up credit approach. A key part of the credit analysis undertaken is to perform scenario analysis looking at how a bond will perform. These scenarios are crystallised around an expected result, upside and downside. The Credit analyst also prepares triggers on a deals performance that will allow us to be aware of collateral deterioration. Our monitoring analyst runs the Credit analysts’ assumptions every month on every bond and also monitors the deal against the analysts performance triggers. Issues are raised by the Credit analyst to the Investment Committee to make the investment decision. This allows us to refresh the case for investment monthly on a current and forward looking basis.
- Lastly, what are the major challenges faced by the structured credit industry, and how do you think the industry would evolve in response to those challenges? How well is HSBC positioned to maintain an advantageous position over its peers in the market and where do you feel the opportunity lies?
There are a number of challenges to the industry. Since 2007, the amount of bonds outstanding has halved as new issuance fails to keep up with repayments. The current promotion of Structured Credit should see this stabilise if not increase. Further, new issuance is likely to be of a better quality given the regulation of the market.
Securitisation is a funding technique of assets from the real economy. To the extent that issues arise in the finance markets around the world, some of those issue will be passed onto the ABS bonds that securitise those. Regulation has encouraged better practices, but areas of risk will arise such as in the retail CMBS market or in certain RMBs markets where housing bubbles are evident. The best protection here is sold Credit analysis to step around unrewarded risks.
All of Capital markets face to risk of reducing liquidity as market makers face increased regulation. Structured credit will bear its share of that increased liquidity risk.
At HSBC we have a scalable model that allows to undertake the deep dive credit analysis to grapple with the risks involved. The experience of the team should allow us to continue to have a strong credit process. Our structure allows us to manage the liquidity of Structured credit to both source the right bonds and to sell at appropriate prices. Our top down approach provides a means to see the wood for the trees and to move each strategy to the best parts of the market to optimise returns for the risk.
HSBC Global Asset Management