Charlotte Valeur Adu, chair of Brevan Howard Credit Catalysts Limited, answers SCI's questions

Q: When and why did Brevan Howard launch a listed credit fund?
A: The Brevan Howard Credit Catalysts listed fund began trading on the London Stock Exchange on 14 December 2010 and now has US$172m assets under management. The listed fund, in turn, invests all of its assets in the US$2.5bn Brevan Howard Credit Catalysts Master Fund that commenced trading on 1 June 2009, managed by David Warren of DWIM, a boutique that spun out of Brevan Howard.

Brevan Howard recognised that it was difficult for investors with smaller balances or tighter liquidity requirements to access the opportunities being seen with the Credit Catalysts Master Fund, which is a long/short credit hedge fund. So Brevan decided to launch a listed fund that would diversify the owner base in that fund, as well as provide longer duration and a stable base of capital for the manager.

The Master Fund focuses on European and US corporate credit, ABS and MBS. Its aim is to generate high absolute returns by investing in a diversified manner.

Q: How do you differentiate yourself from your competitors?
A: The connection with both DWIM and Brevan Howard is a significant differentiator. It's rare to have the involvement of such a strong credit manager in a listed fund together with a macro manager known for disciplined risk management. The listed fund has benefited from the incorporation of Brevan Howard's risk management and macro research into DWIM's micro, catalyst-driven credit shop - a particular advantage, given that the world has become so macro and risk on / risk off.

Q: What are your key areas of focus today?
A: The interest for the fund has been good from a range of different investors and we are monitoring the market to ascertain the potential for further issuing of shares, to give the fund more liquidity and to meet investor demand - the listed fund traded at a premium to NAV for most of last year.

It has since slipped into a small discount, which is also being monitored closely. The board discusses what measures to have in place to control a potential discount and what to do to avoid a discount arising in the first place.

In terms of the investment proposition - investing in the underlying BHCC Master Fund - the investment manager tries to identify catalysts that could generate value, from both fundamental and technical perspectives. These can range from a company filing for bankruptcy or an earnings surprise, to an MBS experiencing higher prepayments than expected. The definition of what constitutes a 'catalyst' is broad - there aren't enough hard events to be otherwise - but they typically have a 12-month horizon.

In practise, the BHCC Master Fund's portfolio construction is very flexible. For example, at the peak of the 2009 default cycle, about a quarter of the assets and under half the risk were in distressed corporates. But now distressed corporates account for less than 5% of its assets and 10% of the risk because the opportunity set has dwindled for the moment. If there is a surge in bankruptcies, however, those figures could change again. For now though, corporate default rates are expected to remain low.

Similarly, when index tranches became interesting earlier this year, the fund grew its exposure to that sector. But when it started normalising in April and May, David Warren reduced the exposure significantly.

The listed fund's performance is up by 6% year to date, and it will be similar for the Credit Catalysts Master Fund, largely because of the shift in risk to structured securities in 3Q11 in anticipation of the opportunities that 2012 would bring in this sector. This year, the Master Fund made money in index and bespoke tranches, as well as its MBS holdings, based on careful portfolio construction. The strategy has generated returns in both the 'risk on' and 'risk off' months - the listed fund has never had a down year - indicating that the strategy is truly long/short.

Q: What major development do you need/expect from the market in the future?
A: The investment manager views much of the developed world as being in a prolonged deleveraging cycle, encompassing governments, businesses, and individuals. Most market participants are used to positive short-term interest rates, allowing central banks the option to cut rates. With rates cut to zero or nearly so, central banks are left with 'non-standard' monetary measures, which have been very difficult for the market to appreciate as the effects of quantitative easing work their way through the economy. Fiscal policy could possibly help, but many governments are frozen due to already high debt loads, or political differences preventing action.

The investment manager continues to focus research efforts on individual security selection within the fund's macro framework. As markets could tip one way or the other based on strong macro forces, Warren is aiming to find securities (and related hedges) that can provide absolute returns with appropriate downside protection through most outcomes.

CS