Olga Chernova, is founder and CIO of Sancus Capital, a long short credit manager and one of the leading female figures in the credit space. Raised in the former Soviet Union, she moved to the United States when she was 16 and had a distinguished career at Goldman Sachs and JP Morgan trading credit derivatives before founding Sancus in 2009.
Chernova says: “We are a credit fund focused on arbitraging inefficiencies in the credit markets using derivatives and structured products.”
The fund has USD150 million under management from insurance companies, a fund of funds and family offices. It has annualised at 9 per cent since inception, and was up 50.83 per cent in 2016 and 18.09 per cent in 2017.
“We do take directional exposure,” Chernova says. “It’s not a strategy that is hedged all the time - we take views. We are basically opportunistic credit and investors who invest with us know that we can evolve as credit markets evolve and move into areas that provide the best opportunities. They invest with us for nimbleness and expertise in multiple aspects of credit.”
Chernova explains that in the credit markets, most of the return is supposed to come from credit premia. Through the use of structured products and derivatives, Sancus can isolate the credit component and not bundle it in with interest rate risk.
“With more sophisticated strategies and slightly more complicated products you can create exposure that avoids interest rate risk completely,” she says. “CLOs are floating rate products and very attractive right now in the rising interest rate environment. This is why you are seeing a lot of investor flows into CLOs.”
The firm recently pioneered an innovative development in the Collateralised Loan Obligations (CLO) market called the Applicable Margin Reset (AMR). This feature uses auction mechanism to refinance CLO liabilities and skips the traditional underwriting process and costs of issuing a new set of notes with lower coupons.
The ability to refinance CLOs is a very important component of the CLO market since the underlying pool of assets is callable and spreads can tighten during the life of the transaction making it uneconomical.
“We first came up with the concept and then submitted a letter to the SEC asking their opinion whether this process would constitute a new issue. Originally the product development was targeted to circumvent the risk retention process. Now risk retention has come and gone but the advantages of the AMR are still there. There are a lot of fees that are not necessary at all. Our development relied on the concept that you can embed refinancing via an auction into the original documentation. Securities are moved from current holders to the auction winners by the broker/dealer AMR agent. So, there is no new issue during the refinancing. This avoids costs which can be in the high six figures for a CLO, so not a small fee.”
Chernova explains that very few CLOs get refinanced more than once in their life via the traditional underwriting process so it’s important to optimise a refinance for all CLO liabilities.
AMR allows you to refinance one class of notes at a time. Since the marginal cost of holding an auction is very small, it allows CLO equity investors and the manager to realign assets and liabilities in the deal more frequently and easily.
“You get increased flexibility of being able to refinance one tranche at a time and optimised timing and pricing. No longer does the manager need to get in line for a refi and find a place in the busy pipeline of dealers. This can improve CLO returns significantly.”
The mechanism is now a ‘public good’ as Chernova puts it.
“We think it’s a great feature and we wanted it for our CLO equity investments but other investors would want it for their transactions as well,” she says.
CLO market experienced strong growth in 2018 driven by large issuance and repeal of the risk retention. As investors are flocking to this part of the credit markets, the path is not without pitfalls. “We do think there are some pitfalls developing in documentation standards of the leveraged loans. Loan documents are a lot looser in terms of what investors are requiring and covenants do not offer much protection.
“Looser standards are creeping back in. It gives more flexibility to the companies to pursue riskier strategies and incur more debt. More flexibility is a double-edged sword. It gives companies more room to manoeuvre without hitting triggers which is good but can be bad for investors in the market downturn as they have a lot less protection Should the market turn, these transactions will not perform as strongly as loans in the earlier CLO vintages.”
As far as current opportunities in credit, Chernova believes that CLOs still offer attractive risk-adjusted returns. She explains that it’s been a long credit cycle and while it’s tough to predict when there will be another recession, we are at the later stages of the cycle.
“Despite looser underwriting standards, senior secured loans are at the top of the capital structure. It allows you more protection against a downturn,” she says.
Chernova believes CLOs compare favourably to the stock market as well. “A lot of investors in stocks expect high single digit returns. They are not going for double digit returns given where we are in the economic cycle. CLOs can provide similar returns with less risk. CLO equity on average performed better than the stock market in 2008-2009 crisis.”
With an attractive area of specialisation, a proven investment process and a strong track record, Sancus Capital believes it is now well-positioned for further growth and innovation.
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