David Hinman, cio, and Raymond Zucaro, managing principal at SW Asset Management, answer SCI's questions

Q: How and when did your company become involved in structured finance?
DH: We were involved in structured credit at Drake, but now the firm has gone away, so these days we have our own firm and our mandate is pretty broad. We have a small and focused firm, which is essentially a long-short credit hedge fund.

We can do pretty much anything in this format. We could buy structured credit assets, we could short structured credit assets and we could do them synthetically. To date we have not done much in that space because we have found better value in straight bonds and single-name CDS.

We would like to get more involved, but it depends on what is going on in the market. Our focus is more on corporate bonds outside of the G7 - we think that is a David Hinman                                              big growth area.

Eventually the structured credit innovations that you have seen in the US and Western Europe will be taken up in the emerging market credit space. This will not be to the same extent as when the structured credit market was on steroids between 2003 and 2006, but there will be elements of structured finance being incorporated.

That has already started to happen. There have been a couple of bespoke CDOs done on a cash basis and we think there will be more in the future. We are interested in those mandates, perhaps structuring one and managing one. At the moment the space is fairly small and illiquid, but we want to entertain any and all options.

Q: In your view, what has been the most significant development in the credit markets in recent years?
DH: The synthesising and indexation of credit was huge. We run a long-short credit hedge fund and it really was not possible 10 or 15 years ago to run the kind of fund we do now.

To get short a decade ago primarily required waiting to borrow and short single-name cash bonds. There were not indices, there was not much synthetic credit, there were not many options or swaptions, but now those innovations allow for a much broader mandate.

To manage credit assets 10 years ago, the investor had to make the decision to be long cash bonds, long interest rate risk and long credit spread duration. But now you do not necessarily have to assume those risks.

That was then. The most significant development going on right now in the credit markets that people will be talking about in three years is emerging market corporate bonds. People talk about sovereigns, which gets all the press, but corporate bonds in emerging markets are growing very rapidly, are underrated relative to their developed market counterparts and are under-researched and under-followed.

In 2013 people will be talking about this rapid growth. The emerging market corporate market is very fragmented; there are not many indices, there are not many dedicated mandates. Yet emerging market corporate performance trounced emerging market equities over any meaningful time period.

Q: What are your key areas of focus today?
DH: We tend to be long on the emerging corporate world and short the developed world. We use warrants, convertibles, CDS, indices and cash bonds. We would certainly look at bespoke CDOs and trading tranches on Raymond Zucaro                                         indices.

In 2008 we hedged our emerging market corporate credit risk by shorting mezzanine indices in US high yield, which worked out quite well. The convergence of non-credit participants getting involved in the credit space in 2006/2007, with the correlation desks and all these techniques for modelling credit away from individual credit research, just set up for a fantastic short.

Emerging market corporates are simpler. The world is going back to simple.

Companies do not have complex capital structures, private equity is not involved much and bonds tend to be issued out of an operating company. Hold your hat and get ready for this, but the proceeds from emerging market corporates actually go to the companies themselves.

It reminds me of credit in the early 1990s or late 1980s. I think we will see more CDS and more CDOs going forward in the emerging credit space and we are certainly set up to capitalise on those.

Q: What major developments do you need/expect from the market in the future?
RZ: For the area we focus on, we think there will be more products on the structured products side, where we could do a long-short emerging markets fund. In the future we think there will be more of a selection of securities on the structured side. The best thing you see in a structured product today is sovereign CDS, but that does not quite capture the risk in our view.

DH: The market ebbs and flows. Sometimes it is a tidal wave, as we saw in 2008. Participants were getting yield in 2006/2007 by leverage - whether it was via a principal protected note or mezzanine, all the different terms were still leverage - and now the market seems comfortable getting yield by taking duration risk.

Rates are very low and investors are taking a lot of risk. Looking beyond leverage risk or US credit risk, there is a healthy income out there in the emerging market credit space. We can combine some of the elements of the past and do a longer-life vehicle with a greater duration, use some leverage through tranching technology in the form of a CDO and put our emerging market corporate credit research hats on and put something together.

We know of two emerging market corporate CDOs that have been done. There have been plenty of sovereign ones. We think this could be something we are doing in the next couple of years as the market prints emerging market corporate CDOs.

JL