Renaud Champion, head of credit strategies for La Française Global Investment Solutions, answers SCI's questions

Q: How and when did La Française Global Investment Solutions (LFGIS) become involved in the securitisation market?
A: LFGIS is the solutions business line of the La Française Group. LFGIS was established in late 2012 and is 35% owned by its founders - Sofiene Haj Taieb and Arnaud Sarfati - and key personnel; La Française is the majority shareholder. The aim was to leverage the founders' investment bank expertise: other banks were exiting the structured products business and La Française saw this as an opportunity to step in and replicate what Sofiène and Arnaud were previously doing at SG - structuring products and distributing them to clients.

LFGIS' asset management business has three parts: a cross-asset absolute return unit, focused on arbitrage strategies within an enhanced risk premia framework and with around €190m AUM; a dedicated funds/solutions unit, where we try to resolve various client issues, which has €1.2bn AUM; and a credit opportunity strategy, which I run. The credit strategy started in June 2013 and has grown from €50m seed capital to €260m AUM.

The main conviction of our credit approach is that credit markets are undergoing a normalisation process and since July 2012 have been transitioning from a systemic regime to an idiosyncratic regime. This normalisation has seen many big players disappear from the market and regulations become increasingly stringent.

Consequently, we're seeing dislocations between investment grade and high yield and within high yield between loans and bonds. Credit curves and capital structures have also become too steep - implying that there is too much value in the senior and mezzanine tranches, whereas the first-loss piece is overcrowded, and that the long end of credit is cheap relative to the short end.

We view everything in terms of tranches and like to move up and down the capital structure to create value.

Q: What are your key areas of focus today?
A: To express our convictions, we tend to build major investment themes around our main bets. One of these bets is that leveraged loans are better than bonds and CDS in the high yield arena.

Given that we're transitioning towards an idiosyncratic regime, we like both US and European mezzanine CLO tranches because they provide protection against idiosyncratic risk. Buying mezz CLO tranches at a discount means that with higher prepayment rates, there is a quicker pull to par.

At the same time, we're short the Markit Crossover index. From a technicals perspective, the index is tight to its CDS constituents and the cash market.

We're confident that where we are in the cycle resembles the 2005-2007 cycle, so we're overall net long. But being long loans through CLOs and short CDS means we're protected against shocks while being positively convex to loan prepayments.

We've had this conviction for two years and initially purchased CLO 1.0 paper, but a clear divergence between the 1.0 and 2.0 segments emerged last year. The former lost most of its convexity and the latter became more attractive, yielding a 250bp pick-up at the double-B level, for instance.

The cheapening was driven by fundamental concerns about the energy sector: the US high yield bond market has 15%-20% exposure to energy names. For CLO collateral, the exposure is more like 4% and the fear appears to be overdone here. We're comfortable at the mezz level that shocks can be absorbed over time.

The market has also been subjected to technical pressure from risk retention rules, with US CLO managers frontloading issuance in 2014, which weighed on spreads. By end-2014, we felt comfortable that the widening would stop.

IRRs dropped because liabilities had widened too much and with arbitrage disappearing, this would constrain supply and thus spreads would rally again. Hence we moved our portfolio to CLO 2.0 bonds. Spreads in Europe followed those of the US, so we bought across both markets.

We also love financials, which suffered significantly in 2008-2009. But banks have become much safer since then: they have better quality own funds and are more tightly regulated, yet still trade much wider than non-financials. This dislocation is slowly normalising at the same pace that banks delever.

Our view on financials has changed over the last two years. Initially we saw value higher up in the capital stack and bought long-dated covered bonds from peripheral issuers.

We viewed them as homogenous to Spanish RMBS front-pay tranches, but with greater convexity. Covered bonds had 15- to 20-year durations and mid-70s cash prices, and have since traded up by 50 points due to improvements in Spain's residential market, banks and government bonds. The ECB's CBPP3 triggered the last leg of the rally and covered bonds began trading inside Spanish government bonds, which prompted us to sell the whole bucket.

Meanwhile, hybrid financials dropped by 10-15 points and were cheap by end-2014. The risk of noise from the ECB's AQR and stress tests was behind us, so we moved into hybrid financials instead and the carry remains - they still trade in the high-90s with a 7% or 8% coupon.

Our third big bet is around default correlation, which increased significantly during 2008-2009 and is yet to normalise. The upper part of the capital stack remains very attractive as there is no natural buyer of super senior risk.

We like taking risk in mezz and senior index tranches and buying protection on the underlying names. This trade should make money if idiosyncratic shocks rise - and they are finally emerging.

The preponderance of hedge funds in equity tranches has caused correlation to remain high, but they will begin unwinding their positions soon to avoid defaults popping up and losses crystallising. We also expect more buyers of super senior risk to emerge over time, as the cost of leverage cheapens.

Our fourth and final bet is more plain vanilla: given steep credit curves, five-year forwards are attractive, so flatteners make sense and allow us to be jump-to-default positive. Usually when there is a big shock in credit, curves invert and the five-year blows out. But because we're buying more protection than we're selling, the position should make money if there are defaults.

This strategy means that we're neutral to curve shifts, which mitigates the potential pain of being long-biased. It's essentially a zero-cost hedge for the entire portfolio, albeit we lose some money if spreads leak out slowly.

Q: How do you differentiate yourself from your competitors?
A: We tend to be driven by macro investment themes and favour big convictions, which can then be refined to allow us to drill down to individual security selection. For example, with CLOs, we tend to pick collateral managers that are debt-friendly, then look at structural features and choose deals that have shorter reinvestment periods.

We're more fundamental credit-driven and asset agnostic than pure structured credit shops. We screen the entire credit market, which allows the portfolio to be repositioned to find value. Whereas specialists concentrate on a single area, we offer cross-asset expertise and can allocate risk efficiently, which is where we add value.

To achieve this, our portfolio managers have complementary skills. Stéphanie Ferrieu has expertise in financials, ABS and leveraged loans; Michael Hattab-Maruani has a quant and credit derivatives background; and I have a broad credit background.

Obviously there are areas that we don't cover, such as emerging markets, so we don't trade EM. But we could recruit someone with EM experience, if we were convinced that the sector was worth moving into. The plan is to broaden our reach, but we're not in any hurry to do so.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The third quarter was turbulent, even though the CLO market tends to be more resilient than the broader credit market as there is less trading on sentiment. The US is ahead of Europe in the cycle, but this summer Europe finally imported idiosyncratic risk.

It began with energy and emerging market names and morphed into pure idiosyncratic risk with VW. Consequently, we decided to increase our bet on correlation, as dispersion is finally materialising - although prices are yet to catch up fully.

Q: What are your plans for the future?
A: We're currently looking at whether to allocate more to Trups CDOs. We like the convexity they offer, as well as the fact that they're de-correlated from the rest of the market and have their own dynamic. But the sector is less liquid, so it is unlikely to form a major investment theme.

We're also looking at hybrid corporates, which have seen 10- to 30-point price drops over the last 2-3 months. Previously they were too expensive in terms of spread differential.

Finally, we're planning to launch a UCITS fund this quarter, with €50m in seed capital plus additional subscriptions expected from early-bird investors. It will have a similar strategy to our credit opportunity programme, but will offer weekly liquidity and focus on relative value rather than long-biased investments. With a target return of 6%-8%, the aim is to broaden our investor base - there is tremendous demand for such offerings.

CS

Note: All figures are as of 31 August 2015.