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  • 1. Has your view on the fundamentals of the financials sector changed following the release of Q3 2020 results?

    Fundamentals of European banks and insurers continue to be very strong and resilient, despite Covid-19 uncertainty. Q3 bank results have surprised positively and were ahead of expectations and positive from a credit perspective as banks continue to accumulate excess capital and loan loss provisions declined close to preCovid-19 levels.
    There are three main trends that stand out:
    • Loan loss provisions have declined materially as banks have front-loaded in the first half.
    • Capital ratios continue to rise and excess capital positions are now well above pre-Covid-19 levels.
    • Profitability momentum has started to improve and, on aggregate, pre-provision profits of the sector have been more than sufficient to absorb higher credit losses. On capital, banks continue to manage their balance sheets conservatively and accumulate capital to protect bondholders from uncertainty. Combined with regulatory easing, this has led to excess capital positions reaching all-time highs. Taking HSBC as an example, excess capital rose from USD 29 billion in FY 2019 to USD 40 billion in Q3 2020, reflecting strong capital accumulation as the group’s common equity tier one ratio (CET1) now stands at 15.6%, compared to 14.7% in FY 2019.

  • 2. Why are the USD fund’s holdings mostly concentrated in EU and UK entities instead of US-based companies?

    The currency of the holdings in the USD fund are predominantly in USD, although the exposure to US banks remains relatively limited.
    • We have a focus on European / UK financials given our expertise in this area, and we see regulation as a stronger catalyst in Europe which is positive for bondholders.
    • In terms of valuations, subordinated debt of European financials offer more attractive spreads / yields than US financials.
    * The full legal name of the funds are GAM Star Fund plc. – GAM Star Credit Opportunities (USD), GAM Star Fund plc. – GAM Star Credit Opportunities (GBP) and GAM Star Fund plc. – GAM Star Credit Opportunities (EUR).
    The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Allocations and holdings are subject to change. Past performance is not an indicator of future performance and current or future trends.
    The gross performance does not include the effect of commissions, fees and other charges, which may
    have a negative effect on the net performance. The views expressed herein are those of the manager at the time and are subject to change.
    Furthermore, the historical circa 30% exposure to UK financial institutions is reflected by:
    • Banks in the UK, such as HSBC and Standard Chartered, are extremely well diversified geographically and are therefore not UK-focused banks, per se.
    • National champions like Lloyds and RBS have strong fundamentals and are focused on domestic retail banking.

  • 3. The GAM Star Credit Opportunities funds (EUR, GBP, USD) have outperformed Additional Tier 1 (AT1) and high yield (HY) securities since September – what are the key performance drivers?

    Two of the largest contributors during October were certificates from Rabobank and our legacy holdings.

    Firstly, Rabobank announced that it will pay a scrip dividend on certificates we own, which will fully compensate investors for the 6.5% of coupon which was not paid this year after a request from the European Central Bank (ECB). Following this announcement, the price of the certificates increased noticeably and drove the performance of the funds significantly.

    Secondly, we saw strong momentum among our legacy holdings following an opinion by the European Banking Authority (EBA) on the prudential treatment of legacy bonds for banks. This was an additional catalyst for the legacy space after NatWest tendered some of their legacy bonds at 3-4 percentage points above market levels in September.

    Subsequently, discounted perpetual floating rate notes (FRNs) performed well – with Aegon’s perpetual FRNs (coupons of USD swap rate + 10 bps) up around 3% on the month and legacy FRNs broadly moving up a few points on the month. At 77%, the bonds remain very cheap, in our view, with a yield to call in December 2025 of 6% at which point the bonds lose all capital value and will need to be bought back or tendered.

    Furthermore, HSBC’s 10.176% perpetual securities (callable in 2030) benefitted from the NatWest story due to the structural similarities of the instruments. The bonds are up more than 6% since September and HSBC can only redeem the bonds at a very favourable price of around 172% or an 8% yield to call.

    Overall, we believe Rabobank’s 6.5% certificates have scope to increase further. As well as seeing strong value in the legacy space, we believe this asset class exhibits significant potential upside for investors as issuers continue to clean-up old bonds.

  • 4. We have been asked to provide an update on legacy instruments and current momentum.

    We have been asked to provide an update on legacy instruments and current momentum. NatWest Group (previously RBS) has announced a tender on several legacy Tier 1 and Tier 2 bonds (total USD 4.4 billion). While this is in-line with our view of a gradual take-out of these legacy bonds, the timing sends a positive signal.

    Despite heightened uncertainty due to Brexit and Covid-19, regulators allowed the bank to optimise its capital stack by taking-out several increasingly inefficient capital securities, due to lose all capital value by December 2021. The group’s strong capital position – 17.2% common equity tier one (CET1) ratio and GBP 15 billion worth of excess capital – and excess of subordinated debt compared to requirements helped obtain approval.

    Nevertheless, we continue to see the catalyst for these old-style bonds to be taken-out until the end of the grandfathering period as intact, irrespective of macroeconomic developments.

    In detail, the main focus is the tender of two legacy Tier 1 bonds with around 4 percentage points of upside compared previous trading levels. For example, the USD-denominated 7.648% perpetual legacy Tier 1s (callable in 2031) are tendered around 154% (fixed spread of 140 bps over the treasury yield) compared to previous levels of around 150%, see Chart 1.

    We see this as generous and, in our view, it reflects NatWest’s track record as a debtholder friendly issuer.

    Both legacy Tier 1s have make-whole clauses, where upon full loss of capital eligibility (ie in December 2021) these can be repaid at favourable levels. In this case, NatWest is paying investors close to the favourable make-whole levels, sending a strong signal. As the future makewhole price is based on market conditions at the time (make-whole price is calculated based on a fixed spread over US treasury rates), there is no certainty that the future make-whole price will be as attractive, and therefore this provides a strong exit opportunity for bondholders.

  • 5. We have been asked if the GAM Star Credit Opportunities funds are investing more in legacy bonds from UK banks, compared to AT1 CoCos from UK banks (given the coupon risk on AT1 CoCos).

    We do own both legacy and new-style bonds from the UK banks. In our view, there is significant value in both, for example:

    HSBC 6.375% USD AT1s callable in 2024 (coupon reset to the 5-year swap rate + 3.705% if not called) currently trades at 550 bps of spread, or 5.8% yield in USD. The bonds are rated Baa3 by Moody’s and BBB by Fitch, and therefore we are capturing high spreads for investment grade paper and see significant value

    NatWest (RBS) Legacy Perpetual floating rate notes (FRNs) (floating coupon of Libor +232 bps) in USD currently trade well below par at 95%. NatWest (RBS) can redeem those at par from December 2021 at which point the bonds will no longer count as capital. This is equivalent to a 7% yield to call (or circa 650 bps of spread)

  • 6. Performance differences between EUR and USD fund

    The key difference between the EUR and USD fund performance is that EUR-denominated subordinated debt has underperformed USD-denominated subordinated debt, even for the same issuers. Taking AT1 CoCos as an example, you can see below that EUR AT1 CoCos are down 5% year-to-date, compared to USD AT1 CoCos that are up around 2% year-to-date (7% differential).

    Obviously, the decline in rates in USD has helped USD bonds perform better, but spreads have also recovered to a larger extent in USD. Spreads on EUR AT1 CoCos are still 230 bps wider year-to-date, while only 160 bps wider on USD AT1 CoCos. In short, USD AT1s have recovered more rapidly and benefitted from the rates tailwind. Forward-looking, it means that EUR AT1s have scope to outperform USD AT1s, as it is fair to expect that over time, this spread differential should normalize.

  • 7. BBVA’s Mexican business

    BBVA has high exposure to lending in Mexico, especially in consumer lending which has been deteriorating lately due to Covid-19. We have been asked about the potential impact to our portfolios given the worsening outlook for consumer loans in Mexico.

    BBVA has significant exposure to Mexico (12% of the group’s loans), and the situation there is challenging. However, we think it is important to take into account 1) the group’s diversification and long-term track record, where the group has not made a loss (even during the global financial crisis and Eurozone crisis) and 2) the Mexican entity is highly profitable (around 900 bps margin) and therefore has the capacity to absorb potentially higher credit losses.

    With the group’s 304 bps buffer to MDA (EUR 11 billion) as well as its significant earnings buffer (EUR 13 billion pre-provision profits per annum) the group has significant capacity to absorb potential higher credit losses. Year-to-date, the group has set aside EUR 4.1 billion for loan losses, due to very harsh macro assumptions taken (Mexican GDP drop of 9% to 12% in 2020, Eurozone GDP drop of 7% to 11%).

    For BBVA, we see Covid-19 as an earnings story and not a balance sheet story as higher loan loss provisions will be absorbed by earnings, while excess capital has increased due to regulatory easing. We therefore remain very well protected and are capturing spreads of around 700bps on BBVA’s AT1 instruments.

  • 8. Investing in subordinated financials debt versus corporate hybrids

    In general, we find both subordinated financials and corporate hybrids attractive. Corporate hybrids are a good tool for us to diversify our exposures.

    Nevertheless, we find the best value in financials (European banks and insurers) given:

    • – More attractive spreads, with around 500 bps on financials versus 200-300bps on corporate hybrids. We therefore see more upside on financials where spreads are extremely wide
    • – Legacy bonds with significant optionality in subordinated financials that does not exist in corporate hybrids

    In terms of earnings, click here to read a recent article on Q2 results of banks and insurers.

    In short, fundamentals of the sector remain strong, as the Covid-19 impact is absorbed by earnings and excess capital has increased year-to-date – providing a very strong buffer for banks to protect bondholders.

  • 9. Barclays Q2 results

    Regarding Barclays, the bank reported results that were solid. Revenues benefitted from strong trading results that helped to offset the group’s GBP 1.6 billion loan loss provisions for the quarter, therefore remaining profitable despite GBP 3.7 billion of loan loss provisions for the first half of the year. Capital was the big positive surprise, with CET1 coming at 14.2% (+110 bps quarter-on-quarter) which brings excess capital to GBP 10 billion, top-tier.

  • 10. We have been asked for our view on HSBC’s Q2 results, which we regard as strong from a fixed income perspective.

    Profits were under pressure, but the group remained profitable despite a 7x surge in loan loss provisions (compared to Q2 2019) to USD 3.8 billion for the quarter. The group expects to take provisions of USD 8-13 billion, so a large portion has already been booked in the first half of the year (USD 7 billion), and this compares to pre-provision profits of above USD 20 billion for the year – very manageable, in our view. The group actually improved its capital position, with its common equity tier one (CET1) ratio up 40 bps on the quarter to 15%, which represents a USD 35 billion buffer (excess capital) to requirements. Clearly there are headwinds for the group (US-China tensions, Brexit, Covid-19), but given the group’s strong excess capital position and ability to absorb potential loan loss provisions through earnings, we see the risk as very remote from a credit perspective, and in our view HSBC remains one of the strongest European banks.

    Regarding HSBC’s bonds, the group’s AT1 CoCos remain attractive, in our view. For example the 6.375% USD AT1s callable in 2024 (coupon reset to the 5-year swap rate + 3.705% if not called) currently trades at 550 bps of spread, or 5.8% yield in USD. The bonds are rated Baa3 by Moody’s and BBB by Fitch, and therefore we are capturing high spreads for investment grade paper and see significant value.

  • 11. Regarding the funds’ exposure to UK banks, we have been asked for an assessment of these bonds against the backdrop of forthcoming Brexit negotiations with the European Union and potential ramifications on the financial marketplace?

    In terms of UK banks, our focus for us is on:

    Banks domiciled in the UK, such as HSBC and Standard Chartered, but that are extremely well diversified geographically and therefore less exposed to Brexit

    National champions like Lloyds and NatWest (previously RBS), where fundamentals are extremely strong and focused on domestic retail banking

    In both cases, these are banks with significant excess capital positions, for example NatWest (RBS) has a CET1 ratio of 17.2% which represents GBP 15 billion of headroom to maximum distributable amount (MDA).

    Although Brexit is a risk, we believe that given the very robust fundamentals of the sector and as banks have been preparing for Brexit for the past three / four years, the UK banks we own are very well positioned no matter the outcome. UK banks are subject to very stringent stress tests from regulators every year, and based on the last set of results, UK banks are able to withstand an extreme macro shock with the average CET1 ratio of the sector falling from 15% to 10%, which is more than 2x the amount of capital pre-global financial crisis.

  • 12. We have been asked for our top down view on the month of July’s performances and valuations.

    Context:

    During the month of July, markets were strong due to:

    • – An agreement on the EUR 750 billion European recovery fund that removes a big tail risk, and allows significant firepower to jumpstart the European economy
    • – Anticipation of strong results; for example, we have seen UBS performing extremely well, and Barclays pre-announced strong results (excess capital increasing to GBP 9 billion

     

    Impact for the fund: Positive sentiment in the market resulted in positive price momentum across the board

     

    European Recovery Fund

    • – EUR 750 billion to address the consequences of Covid-19, of which EUR 360 billion is in loans and EUR 390 billion is in grants
    • – EUR 750 billion to be funded by EU borrowings (European Commissions will borrow funds on behalf of the EU on the capital markets)
    • – EUR 750 billion will be distributed based on countries that need it the most – with the goal of boosting economies of countries facing the most difficulties (mainly Italy, Greece, etc)
    • – Overall, this is very positive given (1) large scale coordinated action by the EU (2) it will boost the EU economy and help recover from the Covid-19 induced macro headwinds and (3) it removes tail risk

     

    European Banks Results

    • – Still early stage, but from what we have seen so far, very strong results – excess capital positions are very supportive for bondholders and earnings are sufficient to absorb higher loan loss provisions
    • – UBS reported a very strong set of results. While profitability was impacted by higher credit losses, very strong operating performance (especially CIB) led to a very strong 13.2% return on capital. The group’s capital metrics improved quarter on quarter to 13.3% (from 12.8% in Q1 20) and excess capital increased to USD 10 billion, which is very positive from a bondholders’ perspective
    • – Barclays pre-released part of its Q2 20 results, with the group’s capital ratios increasing significantly to 14% (CET1 ratio) and excess capital set to rise by GBP 3 billion to GBP 9 billion
    • – Positive-read across from US banks: As expected, loan losses provisions continue to be elevated as banks brace for sharp recession, and revenues from retail and commercial banking activities continue to be under pressure from low interest rates and lower activity from lockdowns. The bright spot of earnings was extremely strong capital markets revenues, which has more than offset additional reserve build-up. For example, JP Morgan reported its highest quarterly revenue ever. Furthermore, the bank increased its CET1 capital ratio by 90 bps over the quarter, which is obviously very supportive to subordinated debt holders. We expect to see similar trends for European banks, on top of which capital positions are likely to surprise to the upside
    • – Overall – European banks’ earnings should be a positive driver for the market, as we expect capital positions to remain rock solid and high loan loss provisions to be absorbed by earningsValuations
    • – Market sentiment has been positive in July, given positive news around the European Recovery Fund as well as bank earnings that reflect very resilient fundamentals
    • – Spreads have tightened – for example AT1 CoCos in USD, where spreads were around 50 bps to 450 bps tighter. As markets remained mostly priced to maturity (63% priced to maturity), there remains significant upside on a re-pricing to call (spreads to call above 600 bps)
    • – Legacy bonds continue to perform on a case-by-case basis. For example, RBS’s old USD perpetual FRNs paying the Libor +232 bps went up from 92% to 95% on the month. They are still attractive, in our view, with a yield to call of 6% to a call in January 22. Others have continued to lag, and we continue to see this as one of the most attractive areas in our markets
    • – Overall, we see subordinated financials debt as well-positioned to perform strongly given (1) strong fundamentals (2) attractive valuations with upside on a re-pricing to call (3) significant upside in legacy bonds with a very strong investment case
  • 13. We have been asked a view concerning the way our securities are performing since the drawdown experienced in February and March
    • Context: What we saw in the past months in reaction to the shock created by the COVID-19 is a gradual tightening of spreads, but when looking across the capital structure we are experiencing different short term price patterns along the different securities.

      Impact for the fund: Positive, good timing to capture the rally from other subordinated instrument

      What we saw in the past months in reaction to the shock created by the COVID-19 is a gradual tightening of spreads thanks to extraordinary support by central banks/monetary policy and governments/fiscal policy in addition to positive headlines on the gradual reopening of the economies.
      Interesting is the fact that when looking at the capital structure the spread tightening is happening showing different short term price patterns across the different securities.

      Spread tightening is disproportionate across the different sub debt instruments

      • – AT1 Cocos recovered almost 80% of the drawdown (looking at the coco index) – Especially the one issued by periphery countries which are benefit the most from the strong support policies of regulators and central banks
      • – Legacy and RT1 from insurers “lagged” more than AT1 cocos and we started to see a spread tightening on such asset classes since the beginning of June
      • – Different short-term price patterns across the capital structure still shows significant upside potential
      • – Good timing to capture the rally from other subordinated instrument

      What this is telling us:

      • – Valuation are indeed very attractive but some of the asset classes rallied more than the others (which means investors are still in time to capture the upside)
      • – Spreads remain 290bps wide of Feb-20 levels
      • – Since beginning of June also the insurance sector and legacy bonds started their rally
      • – We haven’t changed anything in the structure of the fund where we hold c.a. 20% in legacy securities & 9% in RT1
      • – Eur fund is up more than 2% MTD, this is as we start seeing, T2, RT1s from insurances and Legacy bonds repricing, following the AT1 Cocos trend
      • – As the NAV historically tends to fully recover within a period of 6-9 months, meaning another +11% until year end (EUR fund, +8% for GBP and +7% USD fund)
  • 14. We have been asked our view on the sharper cuts announced by HSBC consequent to the COVID-19, the risk for HSBC AT1 cocos not being called at the next date and what could be the impact for our funds.

    Context: HSBC has announced additional cuts in response to the impact of the COVID-19.
    Retain earnings and capital preservation policies could force the bank to not call the outstanding AT1 Cocos at the next call date, as already announced from Lloyds  

    Impact for the fund: Positive, from a bondholders’ perspective the capital positions remains strong and the extension risk arising from the non-call is already priced in as the majority of the AT1 cocos are already trading at maturity.

    Considering the time being, an issuer not calling a AT1 coco is not much of a surprise as it would technically translate in refinancing an existing bond at a worst condition than when it was originally issued and would go against the policy imposed by the regulator to retain capital and increase capital buffers, despite this as shown by the bond of Lloyds the risk of extension is fundamentally already priced in, so we should not expect big changes in the prices of the underlying in case of bonds not being further called

    Looking at HSBC, for example taking the 5.25% AT1 Coco in EUR
    YTC increased from 1.1% to currently 5.03% in the event that HSBC will call this bond in 2022.
    In the event of a non call, this bond to maturity (perpetuity) gives a yield of 4.4% which for a IG rated bond looks very attractive, especially considering that this bond has still 10% of capital gains upside potential vs fair value

    To sum up, as bonds currently price in significant extension risk in and considering current valuations, even pricing the securities to maturity offers a very attractive opportunity to capture high coupons and therefore limited risk of large price drops in case of non-call.

    Level of coco priced to perp is currently 86%

     

  • 15. We have been asked about the proposal from the European Parliament to extend the stop on banking sector dividend payments for 2021, which could potentially involve At1 coupons.

    Context:

    Can the stop of dividend extend to coupons on AT1s? what are the valuation on the asset class? How is the outlook for At1/Coco and subordinated financial bonds in general?

    Impact for the fund: Limited thanks to our strong issuer selection and exposure to the best issuers

    First of all, these are proposals from the European Parliament to amend CRR (Capital Regulatory Requirement), and as such it needs to be formalized and agreed with the European Council and Commission before being voted until mid-June. Furthermore, it is highly likely that as part of the discussions and review the advice of the ECB will be taken into account. So from a process perspective, this should be seen as an early draft that will evolve until agreed upon and voted.

    Secondly, on the potential suspension of AT1 coupons and dividends until October 2021. While on dividends this is a possibility, we view a “hard” date as less likely, as regulators and supervisors already have the ability to force banks to shut dividends off (as is currently the case) and payments of dividends will in any case depend on (1) visibility on the Covid-19 impact on the economy and (2) banks’ capital buffers and own fundamentals. Moreover, dividends being shut off is an equity story and not a credit story. For AT1 CoCo coupons, we view this as extremely unlikely given:

    • Banks have been very recently allowed to use more AT1 and Tier 2 to fill capital requirements, if AT1 coupons are shut off, issuers will not be able to issue.
    • Shutting off AT1 CoCo coupons has a very marginal impact on banks’ capital positions compared to dividends
    • The ECB has been very vocal that there is no willingness to shut off AT1 coupons, unless there is a breach of MDA

    So all-in-all, we see the risk of a ban of AT1 coupons until Oct-21 as very unlikely as (1) the CRR amendment text will evolve before being voted and (2) shutting off AT1 coupons would be counterproductive and contrary to the regulators/supervisors’ view.

    For the moment there has been very limited impact on AT1 CoCo valuations, and actually the market has been fairly strong in the first three days of June, with the EUR AT1 CoCo index up 2%. Our view remains that coupons risk is bank-specific (upon breach of capital requirements), and therefore being involved in the strongest names is the best way to mitigate this risk.

    We continue to see strong upside in the sector given very attractive valuations and very strong fundamentals of the banking sector. Q1 2020 results has shown the resilience of the sector and capacity to absorb higher credit losses as well as to support the real economy during this time of uncertainty. Spreads are currently around 600bps on EUR AT1 CoCos, and as a large portion of the market remains priced to maturity (extension risk priced in) there is strong upside on a re-pricing to call.

    We have started to see issuance normalize and more subordinated debt deals have come through in the past weeks, mainly Tier 2 of high quality banks. There has only been one AT1 CoCo deal, which reflects very wide spreads in the market. We expect to see more issuance over the coming weeks and months, depending on market conditions, as banks are now allowed to fill a larger portion of their capital requirements with Tier 2 and AT1 CoCos.

  • 16. We have been asked our view on the potential downgrade of some European countries on the NPL of banks (above all peripheral countries)? Do we see a potential side effects on banks of other countries? Did the market price this in?

    Context:Fitch downgraded Italy to BBB-, should the situation get worse, this leaves the country one notch from a HY rating

    Impact for the fund: Neutral, only exposure to strongest issuers not from peripheric countries.

    First of all the funds have no exposure to Italian banks.

    In case of downgrade (as it happened for Italy from Fitch), we have first of all to consider if this would leave the county with an investment grade rating or downgrade it beyond that.

    In the first case that would have a very marginal impact. On the other hand a potential downgrade below investment grade would potentially have a larger impact, increasing funding costs and weakening access to debt markets. Looking at the EU area, Italy is most probably the most exposed country to this risk. Nevertheless, the ECB has taken preventive steps to limit the impact of a ratings downgrade of Italy by allowing non-IG issuers as part of the PSPP (Public Sector Purchase Programme), therefore the impact is likely to be more limited, albeit the sentiment towards Italian assets would be weakened.

    What we have seen from the recent results is that, despite the limited visibility on the full impact of the Covid-19 on the economy,  the whole banking sector is frontloading loan loss provisions in order to cover potential future losses. Despite the surge in loan loss provisions, banks remain profitable with the capacity to absorb a further rise in loan loss provisions on aggregate (on average the European banking sector could still absorb twice the impairments in the following quarters without impacting the excess capital).

    On NPLs, while there is no direct link between a downgrade and NPLs, ratings downgrade do reflect a deteriorating macro outlook which can lead to higher impairments as borrowers’ ability to repay date is reduced. Historically, correlation between rising unemployment has been the key driver of NPLs for European Banks. While we expect some uptick in NPLs as the Covid-19 impacts the economy, given very expansive fiscal easing measures aimed at mitigating the Covid-19 impact, new NPL formations are likely to be significantly lower than in previous cycles.

    We don’t see risk of contagion for the banking sector arising from potential downgrade of some European countries, even in the case of a potential downgrade to sub-investment grade of a country like Italy.

    Considering current valuation we feel the prices are not reflecting the strong credit quality of the European banking sector, especially considering the support shown by government and central banks which will use the banks as bridge to support the economy.

    For this reason and considering the strength of the fundamentals of our issuers we see current valuations as extremely attractive

  • 17. We have been asked where is the investment team standing in relation to ESG?

    Context: As we previously mentioned we are in the process of fully integrating e ESG analysis in our credit analysis, where do we stand on the development of the project?

    Impact for the fund: In the process of implementing full cover for all our issuers

    ESG is an important topic and this has always been the case for Atlanticomnium.
    We have  put in place a  process of formalizing the integration of ESG into our investment process, We expect  bythe end of the year to show that the majority of the issuers in the portfolio have internal research covering ESG. As part of this project, an  ESG policy document is available on the GAM website and will be updated as our program progresses.In addition we are  due to become UN PRI signatories this year as our  application form has already been sent  in. ).  . Also note that as UN PRI signatories we will have annual reporting requirements, which will highlight our ESG efforts for the Credit Opps strategy.

    Historically, the “G” in ESG has been a large area of focus, as very topical during the reconstruction of the European financials sector. Improving Governance of banks has led to stronger risk management, improved oversight, lower litigation – overall reducing operational risk. In tandem with regulation that has boosted capital and reduced credit and market risk – this has led very strong returns for subordinated debt holders that have benefitted from improved fundamentals of the sector.

    Nevertheless, we do not ignore the “E” and “S” that are important aspects as credit investors and can positively or negatively impact banks’ credit profiles. Environmental policies of banks (in lending books) and insurers (in investment portfolios) are becoming increasingly important – for example Oil & Gas exposures, as we are living unprecedented shocks in the commodities markets. We closely monitor banks’ and insurers’ exposures to these sectors to assess potential risks. On the positive side, financials have gradually reduced their exposures to high carbon industries (such as Oil & Gas, Shipping, etc.) and increased exposures to environmentally-positive industries, reducing credit risk over time. Last but not least, the “Social” component is an important aspect, especially in current times. In the past, this has mostly been a detractor to banks’ ESG profiles (lay-offs due to restructurings – necessary to the survival of the industry due to revenue headwinds). Today, banks are very well positioned to support the real economy and their clients through this time of uncertainty therefore fulfilling their social duty.

  • 18. Why entering now in the GAM Star Credit Opportunities strategy?

    Context:

    Considering current prices, we have been asked our view on the current valuations and the opportunities we see on the subordinated bond space

    Impact for the fund: We value current valuations as an extremely attractive entry point for the funds

    • Why bonds: Second quarter 2020 will most likely be remembered as one of the worst quarters for global GDP growth since World War II. In time of uncertainty, investors are better off owning bonds than equity.
    • Why the financial sector: this is the most regulated market and has been stress-tested by regulators, so we know that the sector can absorb external shocks such as Covid-19. Covid-19 is an earnings story for sure, but not a balance sheet story.
    • Why sub-debt for financial sector: investors benefit from the strong credit quality of these issuers & benefit from a significant higher income.
    • The power of pull-to-par: while income is steady, price of a bond fluctuates but, as long as default risk doesn’t increase, it always converges toward par value. So if price of the bond declines, but default risk doesn’t change, this creates an unique opportunity to invest.
    • Extension risk as a buying opportunity: when callable perps priced to perp, because of weak market conditions, these tend to gradually reprice to next call date as soon as situation stabilizes. Which means potential for high capital gains.
    • Legacy bonds: while price of bonds have declined, regulatory framework has not changed, meaning that free option in terms of capital gains just increased as issuers will need to take these bonds out.
    • Historic record of bounce back: We just experienced one of the biggest monthly drawdowns since 1985, with no change in the credit fundamentals, each time this happened, prices of our bond recovered within 6-9 months.Risk: while fundamental are strong and valuation levels are extraordinary cheap, there will likely remain volatility in the markets. Therefore, we see price volatility as the key risk for subordinated bondholders.

     

  • 19. We have been asked about our view on the current NPLs of European Banks.

    Context: The impact of the Covid-19 outbreak will most probably create an uptick in Banks NPL in the coming quarters

    Impact for the fund: Positive thanks to our strong issuer selection and exposure to the best issuers

    Historic and up-to-date NPL of the European banks

    European Banks’ NPL ratios have declined by more than 50% since Dec-14, from around 6.5% to below 3% (2.7% as of FY19). During banks’ 1Q20 earnings releases, the Covid-19 situation has not yet led to any increase in NPLs yet and we have seen NPL levels stable to still declining. Also note that the 2.7% is an average number at the aggregate level, and therefore includes countries such as Italy, Portugal or Greece where NPLs are significantly higher. As you can see, for the Core European countries (where the fund is exposed), the average NPL ratio are lower than average, and the outliers remain countries like Portugal, Italy or Greece where we are not exposed. For the banks were hold, the starting position in terms of NPLs is very strong and reflects de-risking of balance sheets since the GFC.

    In 1Q20, we have not yet seen any significant impact of Covid-19 on bank’s NPL ratios. This is due to extraordinary support measures taken by governments and central banks, with payments holidays and moratoriums on repayments as well as extraordinary measures to provide support to retail (unemployment benefits, etc.) and corporates (liquidity lines, guaranteed loans). We do expect some NPL increase in the coming quarters (likely to start in the last two quarters of the month), however with the impact being more limited than in previous cycles. Note that in the chart above, the 6.5% starting NPL point was post the GFC and Eurozone crisis, which were more significant economic shocks and with less fiscal and monetary response.

    Banks have already started provisioning for potential future uptick in NPLs, with Barclays for example recording a 5x increase in loan loss provisions to £2.1bn, which is equivalent to 2.2% of the group’s total loans on an annualized basis. This is based on the assumption that US GDP will decline by 45% in 2Q20 and unemployment will spike to 17% in 2Q20, clearly very harsh assumptions. Away from the technical details, the key point is that despite a very large surge in loan loss provisions, banks remained profitable – therefore without touching excess capital positions.

    • – Latest capital ratio of the European banks

    The average CET1 ratio of the sector is around 14.8% as of FY19, and as of 1Q20 this number slightly declined due to RWA inflation (banks supporting their clients and the real economy by increasing their lending), while excess capital positions were higher due to regulatory easing. From a credit perspective bank’s excess capital to protect bondholders is at record highs, very supportive for our markets.

    • – Current ECB Policies

    In tandem with global coordinated fiscal easing in the European Union and worldwide, the ECB has launched an unprecedented monetary stimulus program which has been recently upsized to a total amount of €1.35tn. This will be split between purchases of government bonds and corporate bonds (investment grade bonds, commercial paper, and others) which is a very strong technical for the market. As yields and spreads on mainstream government and IG credit products will decline with ECB purchases, we expect subordinated debt from corporates and financials to benefit significantly as investors seek high income from strong companies that can absorb the Covid-19 shock. In our view technicals in general, with very limited supply expected in the second half of the year plus strong ECB buying is a very strong catalyst for the market in the near-term.

  • 20. We have been asked our view on potential and timing for CET1 easing going towards 2020 and if yes what might be the implication for the funds
  • 21. GAM Star Credit Opportunities EUR (IE00B50JD354)

    Performance:

    • Share class for the month was up 1.47%, driven by the steady income of 0.32% and complemented by the positive price movement of 1.15%. While NAV of the fund recovered by 18.9% since mid-March, performance YTD remains negative at -10.31%. Our base case is for the NAV of the fund to fully recover within a period of 6-9 months, meaning another 12.% until year end.

    The below is ex-management fees, hence slightly different from numbers mentioned above. Furthermore, breakdowns can be found on page 17, 18, 19 of the investment report:

    • Sector analysis: both financials and corporates contributed to the fund’s performance by 0.29% and 1.39% respectively.
    • Within the capital structure, main contributors were AT1 cocos with 0.64%, RT1 bonds (i.e. Tier 1 from insurers under Solvency 2) with 0.28% and Tier 2 bonds with 0.23%.
    • In terms of single positions, top 10 contributors contributed to 0.54% of the performance vs. -0.23% for the top 10 detractors.
    • Top 10 Contributors: main contributors have been a mix of AT1 cocos from banks, RT1 bonds from insurance companies, legacy Tier 1 as well as senior/hybrids from corporates. Although legacy bonds have broadly lagged the recovery seen in AT1 cocos and other new-style capital securities – several legacy bonds have started to recover, such as the BNP Fortis perpetual FRNs. These are old Perpetual FRNs (floating coupon of Euribor+200bps) in EUR that currently trade well below par at 73%. These will lose their capital value in DEC21 and yield more than 20% to that date. We continue to see significant upside in legacy bonds and expect to see bonds being gradually taken-out as we progress through the grandfathering period.
    • Bottom 10 Detractors: main detractors were mainly legacy capital securities that lagged the move higher in new-style Tier 1 bonds.
  • 22. GAM Star Credit Opportunities USD (IE00B5769310)

    Performance:

    • Share class for the month was up 1.85%, driven by the steady income of 0.38% and complemented by positive price movement of 1.47%. Performance YTD remains negative at -6.94%, despite the first leg of price recovery of 19% that occurred since mid-March. Our base case is for the NAV of the fund to fully recover within a period of 6.9 months, meaning another 10% until year end.
    • The tone in subordinated financial markets remained firm in May, despite a mixed start to the month. The USD AT1 CoCo index was up around 3.5% and spreads have tightened by ca. 40bps to 510bps, as prices continue to recover. Spreads on subordinated financials debt remains highly attractive and we continue to see upside on prices as well as continued high return contributions from income collected. Nevertheless, the 500bps captured does not fully reflect the upside potential, as a large portion of the market is still priced to maturity (around 80% of the AT1 CoCo market is priced to a non-call) and therefore the spread to call is significantly higher. What does this mean? As the market continues to recover and spreads tighten, investors will have an additional upside as bonds re-pricing back to call.

    The below is ex-management fees, hence slightly different from numbers mentioned above. Furthermore, breakdowns can be found on page 17, 18, 19 of the investment report:

    • Sector analysis: both financials and corporates contributed to the fund’s performance by 0.16% and 1.76% respectively.
    • Within the capital structure, strongest contributors were AT1 cocos with 0.91%, Tier 1 bonds with 0.39% and Tier 2 bonds with 0.29%.
    • In terms of single positions, top 10 contributors contributed to 0.91% of the performance vs. -0.16% for the top 10 detractors.
    • Top 10 Contributors: the main contributors of the funds have been AT1 cocos of strong names such as HSBC, Banco Santander and Credit Agricole as well as high income Tier 1 bonds. As market sentiment has remained strong, new-style instruments such as AT1 cocos have benefitted with prices recovering 60% from the lows of March. Although legacy bonds have broadly lagged the recovery seen in AT1 cocos and other new-style capital securities, several legacy bonds have started to recover, such as the RBS perpetual FRNs. These are old perpetual FRNs (floating coupon of Libor+232bps) in USD that currently trade well below par at 92%. RBS can redeem those at par from DEC21 at which point the bonds will no longer count as capital. This is equivalent to a 8% yield to call (or spread to call of 800bps) – extremely attractive.
    • Bottom 10 Detractors: main detractors were mainly legacy capital securities that lagged the move higher in new-style Tier 1 bonds, or senior unsecured bonds.
  • 23. MDA

    Maximum amount that a bank can distribute to its investors for equity dividends, AT1 CoCo coupons and management bonuses.

  • 24. AT1 Coco

    Additional Tier 1 instruments are junior subordinated debt securities issued by banks to fulfill regulatory capital requirements (Basel III). To qualify as Tier 1 capital, the instruments need to be perpetual with a minimum five-year non-call, have non-cumulative fully discretionary coupons and a contractual trigger to principal write-down or equity conversion.

  • 25. Tier 2

    Tier 2 instruments are junior subordinated debt securities issued by banks and insurances to fulfill regulatory capital requirements (Basel III & Solvency II). To qualify as Tier 2 capital, for banks the instruments needed to be dated (maturity of at least 5 years) and have mandatory coupons on the other hand for insurances instruments need to be dated (maturity of at least 10 years) and discretionary but cumulative coupons

  • 26. Lower Tier 2

    Lower Tier 2 instruments are junior subordinated debt securities issued by banks to fulfill regulatory capital requirements under old European banking regulation (Basel II). To qualify as Upper Tier 2 capital, the instruments needed to be dated, have non discretionary coupons.

  • 27. Tier 1

    Tier 1 instruments are junior subordinated debt securities issued by banks and insurances to fulfill regulatory capital requirements under old European banking regulation (Basel II), Tier 1 bonds were typically perpetual with non-cumulative coupons.

  • 28. Legacy bonds

    Legacy/grandfathered bonds are bonds issued by banks and insurances under previous regulatory regimes that do not fully comply with new requirements set by Basel III or Solvency II.

  • 29. Who is responsible for risk oversight?

    The roles and responsibilities of the teams responsible for the various aspects of risk monitoring and
    management within GAM’s enterprise risk management framework are summarised in the table overleaf.

     

    Department Activities Monitoring frequency
    Investment Teams Monitoring and management of market, sector
    and instrument-specific risk, using GAM’s
    portfolio construction and modelling systems,
    statistical analysis systems and internal reports.
    Daily/Weekly
    Settlements
    Departments/ Dealers
    Responsible for daily trading error monitoring. Daily
    Investment risk
    analysis/analytics
    teams
    Monitoring and management of market, sector
    and instrument-specific risk, using GAM’s
    portfolio construction and modelling systems,
    Risk Metrics, statistical analysis systems and
    internal reports.
    Weekly/Monthly and ad hoc
    Investment
    Controlling teams
    These teams monitor our investment teams’
    adherence to applicable legal and regulatory,
    prospectus, contractual and internal investment
    restrictions. They escalate established
    investment restriction breaches, enforce and
    control the timely remedy of such breaches and
    report relevant breaches to applicable external
    auditors and regulators, if required
    Daily
    Legal and
    Compliance
    These teams monitor best execution, fair
    allocation, interact with investment controlling
    teams in case of investment restriction breaches
    and oversee and monitor other legal and
    regulatory risks.
    Ongoing
    Operational risk
    teams
    Responsible for monitoring of processes
    susceptible to risk using key risk indicators,
    aiming to identify deterioration in the quality of
    critical business processes at an early stage, so
    that corrective measures can be taken within a
    short timeframe
    Ongoing
    Local risk teams Monitor financial and non-financial agency and
    proprietary risks, identifying key risks within
    business units and designing solutions to
    mitigate sensitivities.
    Ongoing
    Group M Ultimate responsibility for ensuring that all forms
    of risk are appropriately monitored and managed.
    Ongoing
    Board of Directors of
    parent company
    (GAM Holding AG)
    Oversight and governance of risk issues as part
    of Board meetings.
    Bi-annually
    Group Internal Audit
    Department
    Reviews controls to assess their adequacy and
    compliance with Group control requirements.
    Formal audit every 1-4 years
    or ad hoc based on audit
    outcomes or specific
    requests by management

    Atlanticomnium operates its own independent oversight of its business environment with additional
    controls as it relates to interfacing with the GAM teams:

    Department Activities Monitoring Frequency
    Investment Team The investment team is responsible for monitoring
    and managing all investment risk at the first level
    (Liquidity, credit, market). The Risk Management
    Process (RMP) tool covers pre-trade, post trade
    and hedging of UCITS and prospectus restrictions.
    All investment restrictions are monitored twice a
    day.
    Daily
    Operations Team Responsible for daily trade monitoring
    reconciliation of the custodian platform Vs
    Atlanticomnium PMS, and ultimately interface
    with GAM middle office.
    Daily
    Risk and Compliance
    Team (internal &
    outsource)
    The second level control is Responsible for
    monitoring the good execution of the first level risk
    control and the adherence to regulatory standards
    and investment restrictions. The team is also
    responsible for reporting its findings to relevant
    senior management and the Board. The analysis
    on the investment restrictions is done weekly
    whereas the reporting to GAM of the regulatory
    standards through the KPI is done on a monthly
    basis
    Daily monitoring,
    weekly reporting,
    monthly
    reporting
    Risk Manager Within the Risk & Compliance team, the Risk
    manager is responsible for the oversight of all key
    processes including the development,
    implementation and embedding of processes
    whereby management identifies assesses,
    monitors, controls and mitigates the risks in their
    areas.
    Provides weekly key management reporting to the
    Management Committee and liaises with Legal
    and Compliance as to relates to external audit
    requests
    Ongoing
    Management Committee Ultimate responsibility for ensuring that all forms of
    risk are appropriately monitored and managed.
    Ongoing
    Board of Directors of
    Atlanticomnium SA
    Oversight and governance of risk issues as part of
    Board meetings.
    Quarterly
  • 30. What systems do you use in risk oversight?

    The investment team at Atlanticomnium use The Risk Management Process (RMP), fully automated
    process to monitor and manage UCITS/Prospectus limits.

    The operation team at Atlanticomnium uses Computer Performance Services Ltd, fully automated process
    to monitor and reconcile daily trading and positions.

    Various GAM systems enable management to continually monitor the performance and individual
    components of GAM products to be continually monitored for adherence to style, process and guidelines.

    The table overleaf lists key investment management, analysis, trading and risk management systems
    employed at GAM.

    Investment management, analysis, trading and risk management systems

    Name Internal/External Description
    AIS Tools / AIS Modelling Internal Fund of funds modelling and simulation system
    Bloomberg AIM External Fund modelling, investment restrictions, order
    execution and compliance system (Bloomberg)
    Derivation External Convertible bond modelling, market making, risk
    management (live risk sensitivities, calculating
    the Greeks, coupled with risk simulation to stress
    test portfolios and funds alike) and live P&L
    calculation tool
    Eze OMS External Order management and Compliance system
    (EzeSoft)
    Fund Set-up & Maintenance
    (FSM)
    Internal Fund information system
    GAM FundView Internal Fund performance analysis system
    GAM PA Internal Contribution and attribution reporting system
    Portfolio Analytic System External Portfolio attribution and risk analysis system
    (PAS, from UBS)
    Portfolio Management Internal Fund of funds trading system
    RiskMetrics External VaR and scenario analysis system
    SimCorp Dimensions External Modular investment management software
    solutions
    thinkFolio (Markit) External Fixed income fund modelling, order execution
    and compliance system
    TLM External Reconciliation system for Cash, Stock and FX
    (SmartStream)
  • 31. Please list portfolios managed by the investment team
    Investment vehicles Value USD millions
    GAM Star Credit Opportunities – USD 3,340
    GAM Star Credit Opportunities – EUR 3,992
    GAM Star Credit Opportunities – GBP 1,274
    Total Size* 8,606

    Source: GAM, as at 30 April 2019. *Totals may not sum due to rounding.

    The team also manages GAM Star Interest Trend valued at 54.6 million as at 30 April 2019.

  • 32. Fund Details
    Fund Names GAM Star Credit Opportunities – EUR
    GAM Star Credit Opportunities – USD
    GAM Star Credit Opportunities – GBP
    Fund Manager(s) Anthony Smouha, Gregoire Mivelaz and Patrick Smouha
    Fund Company GAM
    Investment Management Company GAM International Management Limited
    Delegate Investment Manager Atlanticomnium
    Fund Type UCITS
    Fund Structure GAM Star Fund plc (the Company) is an open-ended
    umbrella investment company with variable capital
    incorporated with limited liability under the laws of Ireland.
    The Company is an umbrella fund with segregated liability
    between sub-funds.
    Domicile Dublin, Ireland
    Regulator Central Bank of Ireland
    Base Currency GAM Star Credit Opportunities – EUR: EUR
    GAM Star Credit Opportunities – USD: USD
    GAM Star Credit Opportunities – GBP: GBP
    Date of Inception GAM Star Credit Opportunities – EUR: 5 July 2011
    GAM Star Credit Opportunities – USD: 19 Jul 2011
    GAM Star Credit Opportunities – GBP: 12 Jul 2011
    Available Classes Ordinary shares are available in the stated base currency of
    each fund. In addition, the EUR –denominated fund also
    offers CHF and GBP share classes, and the USDdenominated fund also offers AUD classes which are
    currently funded. Other classes can be made available,
    subject to minimum funding requirements being met. Details
    of all share classes can be found in the prospectuses.
    Is the fund listed on any exchange(s)? Yes, each of the three GAM Star Credit Opportunities funds
    is listed on the Irish Stock Exchange.
    Available for sale in* GAM Star Opportunities – EUR, USD and GBP funds:
    Austria, Denmark, Finland, Germany, Ireland, Luxembourg,
    Netherlands, Norway, Spain, Sweden, Switzerland, UK.
    GAM Star Opportunities – EUR, also registered in: Belgium,
    Bulgaria, Chile, France, Israel, Italy, Liechtenstein, ,
    Singapore (restricted to institutional and accredited investors
    only).
    GAM Star Credit Opportunities – USD: also registered in
    Bahrain, Bulgaria, Chile, Israel, Italy, Singapore (restricted to institutional and accredited investors only).
  • 33. Investment / Redemption and Lock-Up Terms

  • 34. Fund Directory
    Service Provider To GAM Star Fund plc / GAM Fund
    Management Limited
    Year Relationship Began
    Fund Manager and
    Registrar
    GAM Fund Management Limited
    George’s Court
    54–62 Townsend Street
    Dublin 2
    Ireland
    Since 1990
    Delegate Fund
    Administrator
    State Street Fund Services (Ireland) Limited
    78 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 2016 for
    GAM Star Fund
    GAM’s relationship began
    2013
    Custodian State Street Custodial Services (Ireland)
    Limited
    78 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 2016 for
    GAM Star Fund
    GAM’s relationship began
    2013
    Fund Auditor PricewaterhouseCoopers
    One Spencer Dock
    North Wall Quay
    Dublin 1
    Ireland
    Since 1985
    (or its predecessors,
    Coopers & Lybrand)
    Legal Advisers Dillon Eustace
    33 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 1999

    Source: GAM

  • 35. Fees

     

    *GAM’s Total Expense Ratio (TER) calculations are based on the expense figures in the latest set of financial statements. Where
    applicable, we exclude; bank interest, incentive fees, bank charges, short dividends paid, foreign exchange losses, equalisation. The
    TER is expressed as a percentage of the average NAV for the period, and is calculated by GAM Fund Management Limited, Dublin.
    Please see prospectus for further details on fees.

  • 36. Do you use any form of quantitative analysis (e.g. screening, fundamental analysis etc.)?

    Quantitative screening is applied to the broad market to identify bonds with a minimum acceptable income
    return or potential capital gain. This helps to narrow the universe onto which the team applies their highly
    qualitative credit analysis process which encompasses understanding the overall market environme

    monitors the market backdrop and sets ranges for interest rate expectations and inflation over the medium
    term, against which they monitor developments in order to provide a general framework for investments.
    The credit and bond analysis aspects of the team’s research tend to be complementary and combine with
    quantitative and qualitative elements to provide an integrated overview of the attractiveness of potential
    investments.

     

     

    Both qualitative and quantitative factors are equally important; for example, strong cash flow generation
    impacts a company’s ability to pay whilst good governance influences the company’s willingness to pay.
    When assessing companies, the investment team applies an equity analyst mindset to determine the
    franchise value i.e. the ‘margin of safety’. They look at the balance sheet, income statement, cash flow
    statement, management, industry, competition, pricing power, cost structure, tangible assets of
    companies and then target the one with good prospects. Additional key considerations are: recovery
    value, enterprise value, risks analysis, identification of credit triggers, enterprise momentum, the
    (company’s ability to ride out weaker markets (‘e.g. not selling divisions or cutting dividend, etc.) and
    macroeconomic backdrop supportive to the issue.

  • 37. Describe your investment process

    The investment process takes a research-intensive approach to identifying quality issuers, selecting
    bonds, constructing portfolios and managing risk, which has four steps:

    The fund managers apply their investment experience and in-depth knowledge of their specialist bond
    segments to focus on the most promising pockets of the universe of predominately investment grade
    companies. Within those areas, they use detailed, bottom-up credit analysis to identify the safest issuers,
    then to analyse the risk/return of where to invest optimally within the capital structure, examining bonds
    from the senior to the most junior bonds under scenarios of both default and prosperity for the issuers.

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP

    Set against their understanding of the evolving market environment, the managers then select and size
    each issue so that it contributes appropriately to the overall portfolio in terms of credit risk, interest rate
    risk and liquidity risk. The result is a diversified portfolio of securities designed to deliver income, capital
    preservation and capital appreciation.

    Each step of the process is discussed in more detail below.

    Step 1: Issuer selection

    The fund managers’ primary aim in the first step of the process is to select companies that are profitable
    and cash generative with good growth prospects and that issue potentially interesting hybrid capital debt.
    The team believes that such companies will provide predictable and attractive bond returns, while limiting
    the risk of default.

    Given their deep familiarity with their specialised areas of the market, they take a bottom-up approach to
    research. They start similarly to traditional credit investors who, when analysing a bond issuer, typically
    ask the question: ‘If the company defaults, what do we get?’ This view naturally pushes traditional credit
    managers towards holding safer, more senior debt due to its higher recovery rate in event of a default.
    Because the Atlanticomnium team invests lower down the capital structure where upside payoffs can be
    enhanced if the company succeeds, they must go beyond the traditional credit approach by also what the
    returns are when the company survives. This requires not only fully understanding the company’s
    creditworthiness, but also its fundamentals. Therefore, they combine both quantitative and qualitative
    elements to form views on areas typically associated with equity analysis, such as balance sheet strength,
    profitability and growth, cash flows, strength of management, management ethics and end game
    probabilities, franchise value and business model sustainability.

    Once the managers have formed a clear, absolute view on the risk/return profile of each company, they
    evaluate them against peers and against the current market backdrop. Over their many years’ experience,
    they have built up strong relationships with companies, banks, brokers, analysts and industry experts.
    Combining this with a broad set of information sources, the managers continuously monitor capital
    markets dynamics. They discuss and review their current thinking in the weekly Investment Committee
    meetings, which also cover portfolio activity, research findings and direction of further research.
    The team’s research and views are documented. This body of proprietary knowledge and information
    accretes as they follow companies over years and market cycles to enrich their understanding of each
    one.

    Step 2: Bond selection

    For each issuer that has a suitably robust long-term risk/return profile, the fund managers embrace the
    fact that no subordinated bond issue is exactly like any other by conducting intensive bottom-up analysis
    of the capital structure and the subordinated debt, in particular.
    Unlike investment grade credit, where the bulk of analysis is spent on the credit risk of the issuer, to
    understand subordinated debt the fund managers must also understand the underlying reasons for
    issuing it. Broadly speaking, investment grade debt tends to be issued for funding purposes, but
    subordinated debt tends to be issued for capital purposes. As shown by the diagram below, these
    structures can be complex, and particularly so for banks, building societies, insurance companies.
    Capital structure for financials has added layers of complexity

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 13

     

    For financial institutions, issuing subordinated debt is an attractive way to meet regulatory capital
    requirements – an area that is of increasing importance in today’s markets. The managers’ detailed
    knowledge of the sector is a distinct advantage that allows them to understand both the capital structures
    in terms of margins of safety, asset quality, security and prospectus features, and the drivers behind them.
    They have cultivated the expertise in interpreting the myriad of types and variations of clauses that may
    serve to make the issue more or less attractive. For example, coupons may be discretionary, deferrable
    and cumulative, may pay, must pay and may incorporate dividend stoppers/pushers. The managers look
    at these in the context of the regulatory environment, tax environment, ratings methodologies employed,
    make-whole clauses, etc., carefully considering the risks embedded within each issue.

    Through their in-depth analysis, the managers aim to identify the instruments that they believe represent
    the best value on an absolute basis, they also consider their value relative to industry or other similar
    issues to ensure they are getting the optimal risk/return trade-off. For sub-investment grade bonds, the
    team takes an even more cautious approach, not only reviewing the credit risk but also the extent of
    potential price volatility risk.

    Typically, by the end of this step, the managers will have chosen a broad, diverse set of strong companies
    in each based currency from which identified bonds are assessed for potential inclusion in the portfolios.

    Step 3: Portfolio construction

    Using this set of investable bonds from across the whole credit spectrum, the managers select size and
    combine them so that each one contributes appropriately to the overall portfolio in terms of credit risk,
    interest rate risk and liquidity risk. Their aim is to create a portfolio that they believe will best deliver
    consistently high income, capital preservation and capital appreciation in the current macroeconomic
    environment.

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP

     

    To achieve this, portfolios are constructed with the appropriate balance of conviction – the top ten
    holdings typically comprise approximately 30% of the portfolios – and then a broad diversification across a
    large number of positions that are diversified by capital structure, security type, sub-sector and liquidity
    parameters.

    The fund managers set ranges for interest rate expectations and inflation over the medium term, against
    which they monitor developments. Interest rate risk is actively managed across the cycle by fully utilising
    the many different structures by which subordinated debt is issued. The types of instruments available for
    them to select range from traditional fixed dated bonds, fixed perpetuals, fixed to floater perpetuals, to
    floating rate notes, constant maturity swaps, steepeners/flatteners and contingent convertibles (‘cocos’).
    The managers have a ‘buy and hold’ mentality, as is to be expected from a fundamental, researchintensive approach. This long-term approach is designed to create portfolios that will withstand significant market turbulence and minimise exposure to volatile trading situations while harvesting the coupon
    premium available from investing in the subordinated debt market segment.

    Step 4: Risk control and portfolio monitoring

    Beyond initial portfolio construction, monitoring of portfolios continues on an ongoing basis. The
    investment team looks not only at each portfolio, but also at the market environment and industry
    dynamics, which set the backdrop for, and therefore influence, their credit selection, portfolio construction
    and risk control and monitoring. The key risks managed and monitored by the team include credit risk
    (incorporating potential default risk), liquidity risk and market risk. Market conditions are monitored by
    observing changes in:

    1. Spreads
    2. Yields
    3. Market inventories
    4. Impact of new supply on secondary issues.

    Credit risk

    Credit risk is a key risk that the fund managers seek to control and mitigate through the careful, bottom-up
    selection of the underlying positions in the portfolios. Credit quality is evaluated by monitoring companies’
    news flow e.g. earnings, rating changes, road shows and conference calls, enabling them to make
    decisions on both the relative and absolute value of individual companies and issues. Investment views of
    both the absolute and relative value of holdings and corporates are discussed and reviewed weekly in the
    Investment Committee meetings, which also cover portfolio activity, research findings and direction of
    further research. On an ongoing basis, using the Bloomberg platform and published data sources, the
    team monitors changes in:

    1. Average credit rating: across the portfolio
    2. Individual credit ratings: influences investor behaviour
    3. Prices: stocks and bonds
    4. Relative positions: to similar instruments and ratings

     

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 15

     

    Should they have reason to anticipate a significant decline in credit quality, their policy is to sell down the
    position ahead of waiting for further negative news flow.

    Liquidity risk

    The managers maintain a strong focus on liquidity throughout the investment process, with the majority of
    holdings within the portfolio typically classified as very liquid or liquid. Liquidity risk is further mitigated by
    diversification across a large number of positions of different types such as fixed, fixed to floating, floating
    senior, junior, higher coupon and lower coupon bonds which each behave differently from one another
    with the aim to always own some holdings that will be attractive to buyers at different times and in different
    market environments. Furthermore, the investment team monitors daily liquidity changes closely across
    the fund as a whole and of the individual underlying positions.

    The fund managers further mitigate the liquidity risk through:
    1. A high degree of portfolio diversification in terms of number of holdings, issuer size and type of bond
    (e.g. fixed vs. floating rate) each of which behaves differently in different market environments with
    the aim to always own some holdings that will be attractive to buyers at different times and in different
    market conditions.
    2. Sizing of the positions in any individual instrument: largest positions rarely more than 4% of the fund
    and are typically less than 1%
    3. Closely monitoring daily liquidity changes of the portfolio as a whole and of underlying positions

     

    Other significant potential sources of risk:

     

    Type of Risk Description Management and monitoring tool
    Concentration risk Risk from uneven distribution of
    positions across a small number of
    individual issues, companies or
    sectors
    Portfolio diversification, with individual
    positions restricted to 10% of an issue
    and 10% of the fund, daily reporting
    Counterparty risk Risk of counterparties defaulting Use of GAM-approved counterparties
    only. Transactions on a DVP basis.
    OTC derivatives in practice limited to
    currency forwards although others are
    permitted
    Foreign exchange risk Risk of the value of an asset
    denominated in a foreign currency
    depreciating against the base
    currency
    Hedging typically through the use of
    currency forwards

     

    Administrative and operational risks are also monitored by the middle office at Atlanticomnium.

     

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 16

  • 38. Do you use any models in your investment process?

    No computer models are used in the investment process.

  • 39. How many company interactions take place each year?

    The investment team conducts more than 240 company interactions annually. These vary from one-toones
    and ad-hoc meetings to scheduled investor conferences/calls, road shows, key company
    management meetings to discuss earnings results, broker presentations and conferences with equity
    strategists and economists etc. These interactions are aimed at giving the managers a well-rounded
    understanding of companies, industries and global market dynamics.

  • 40. What proportion of research is generated internally / externally?

    In the context of final investment decision making, 100% of the research is generated internally by the
    managers.
    They have access to external research from a wide range of sources including sell-side research,
    prospectuses, company releases, analyst road shows and Q&A sessions with company management
    team that provide input from top down and bottom up perspectives. In addition, their long experience in
    the industry has helped them build relationships with major investment banks, other industry analysts,
    company management, specialist brokers, industry consultants and other respected sources.
    In many instances, the investment team follows specific companies and issues for many years at a time.
    Historically, the managers have made some of their most successful trades through scaling into and out of
    such companies over multi-year periods based on their ongoing reassessment of the firms against the
    changing macroeconomic and sector backdrop.

  • 41. How is investment research organised?

    The investment team has specialist forensic research skills and depth of experience in these markets.
    Anthony Smouha has accumulated deep, extensive debt capital markets experience over 35 years’ fixed
    income investment experience as initially a prospectus writer and bond issuer, a sell side broker, a market
    maker and an investor. Gregoire Mivelaz has devoted his career to research analysis both on the sell-side
    and the buy-side primarily researching in the financial sector. In addition Patrick Smouha has been
    nominee Co-Fund Manager in January this year.That said, the managers do not divide up the world
    according to geographies or sectors, enabling them each to develop broad, global perspectives that they
    believe enhance their ability to make good decisions. They are supported by three credit analyst Edward
    McCarthy, Romain Miginiac & Lydie Favre-Felix and other team members who perform various analytical
    duties.
    Investment research influences all parts of the investment process. The managers’ research efforts
    encompass both top-down and bottom-up perspectives so that they can assemble a holistic picture of
    market dynamics. They gather ideas from all perspectives available to them to synthesise their views and
    generate investment ideas. These ideas are then channelled into their bottom-up research to uncover
    promising credit opportunities. The research process includes a large number of company management
    meetings, calls and attending investor presentations.

  • 42. What are your sources of added value?

    The primary source of added value for the portfolios is the bottom-up credit selection ability of the
    managers and their familiarity with junior debt. Specifically, their experience and expertise in the financial
    sector and specialised areas, such as undated, floating rate and fixed to floater debt instruments, allows
    them to access overlooked and often undervalued issues in the market. This enables them to obtain the
    higher yields often attached to junior or subordinated issues, or those with more complex features, as well
    as capturing the capital appreciation as the bonds realise their true value.

  • 43. In which markets do you believe your strategy performs best / worst?

    The strategy has the flexibility to search for quality issues throughout the world and different sectors,
    without style bias and regardless of index stock weightings. This should allow the strategy to outperform
    under a range of market conditions.
    It is more difficult for the strategy to perform in times of systemic crisis as prices can be marked down
    quickly. Given the high quality of issuer names in the portfolios, the strategy tends to perform very well
    once systemic fears dissipate. As these types of companies are often seen to be survivors, prices tend to
    recover quickly.

  • 44. Have the strategy or investment process changed since inception?

    No. The investment process has not fundamentally changed since the inception of the funds.

  • 45. How do you measure liquidity of positions?

    Liquidity of a security is primarily defined by the size of the issue. In addition, the number of brokers
    dealing in the security and the bid ask spread can also be taken into consideration.

  • 46. What is the liquidity of the underlying assets and what is the appropriate time period to liquidate?

    It is estimated that the majority of the portfolios could be liquidated in a few days as the majority of assets
    fall into the category of very liquid or liquid.

  • 47. Do you use currency hedging, either at portfolio or share class level?

    Yes. The base currencies of the three funds are EUR, USD and GBP but assets held by the funds may be
    denominated in other non-base currencies. A substantial part of the assets of the funds will be
    denominated in or hedged back into the relevant base currency by the fund managers using currency
    forward contracts.
    There are two CHF share classes invested in the EUR fund which are not 100% hedged at all times given
    the cost of hedging and other considerations. The CHF share classes are usually hedged back circa 90%
    – 100% to CHF by the investment managers and this can occasionally go up to a maximum of 105% in
    order to hedge future coupons. There are AUD and SGD-denominated share classes in the USD fund
    which are hedged back by the administrator.

  • 48. Discuss your leverage exposure policy and its management.
  • 49. Describe your use of derivatives.

    The funds are non-sophisticated users of derivatives and will only use a limited number of simple
    derivative instruments for efficient portfolio management purposes (being the reduction of risk, the
    reduction of cost or the generation of additional capital or income for the funds with a level which is
    consistent with their risk profiles), as mentioned in the prospectuses. The derivative instruments which
    may be held by the funds comprise contracts for difference, convertible bonds, currency forwards,
    currency swaps, futures or options. Such derivatives may be traded over-the-counter or on a recognised
    market.
    In practice, the funds enter into certain currency-related transactions in order to hedge the currency
    exposure of the classes denominated in a currency other than the base currency, but derivatives have not
    been used to hedge interest rate risk. The variety of different bonds in the fund including fixed rate and
    floating rate bonds is designed to provide a natural hedge.
    The funds use the commitment approach to calculate the global exposure generated through the use of
    financial derivative instruments as part of their risk management process. It is not expected that the
    leverage generated through the use of financial derivative instruments will exceed 20% of net asset value
    of any of the funds when calculated using the commitment approach.

  • 50. Discuss the depth of diversification. Do you have formal position limits (sector, country etc.)?

    Portfolios are highly diversified. Individual positions are restricted to 10% of an issue and 10% of the fund,
    but in practice, individual positions are much lower.
    In terms of instruments, the fund has significant holdings in discounted floating rate notes (besides fixed
    dated bonds, perpetual, and fixed to floaters). These securities benefit from higher interest rates: the
    higher the interest rate, the higher the refix rate. As they are discounted, they are intended not only to
    provide a natural hedge for the fixed-rate holdings, but can achieve capital gains in themselves. The fund
    managers also take advantage of fixed-to-floater bonds, where the coupon is fixed until the first call date
    within five to 10 years and then is refixed on a floating rate note basis. Those securities limit the fund’s
    exposure to rising interest rates.
    The funds invest predominantly in investment grade issuers, but the fund managers are prepared to go
    down a company’s capital structure to find the best combination of yield, value and capital preservation.
    One feature of the strategy is the substantial holdings in financials. While many observers associate
    financials with universal banks, there are many differences in business models and balance sheets
    among the managers’ different holdings. They clearly distinguish between universal banks, investment
    banks, asset managers, brokers, life insurance and non-life insurance companies. Their holdings in nonfinancial
    companies include a wide variety of global names.

  • 51. What is your stop-loss policy?

    Fundamental stop-losses are used as part of the ongoing review of all positions held in the portfolios.
    They can be used either when a bond has reached estimated fair value after a rise in price or as a
    protection when a negative credit event results in a change assessment and it is decided that some or all
    bonds should be sold as a protective measure.

  • 52. Describe your use of cash in the portfolio.

    It is the normal policy of the fund to be close to fully invested however it is allowed to move substantially
    into cash should the managers deem it necessary. Such circumstances include (i) the holding of cash on
    deposit pending reinvestment, (ii) the holding of cash from subscriptions pending investment (iii) in order
    to meet redemptions and payment of expenses or (iv) in any extraordinary market circumstances such as
    a market crash or major crises which in the reasonable opinion of the fund manager would be likely to
    have a significant detrimental effect on the performance of the fund.

  • 53. Does the strategy have a long or short bias?

    The strategy is long only and does not short cash bonds.

  • 54. What is your average holding period for investments?

    Assets are managed on a medium-term basis. The fund is designed to withstand significant market
    turbulence and to minimise exposure to volatile trading situations through investing in a highly diversified
    set of securities from across the credit spectrum. The managers have a buy and hold mentality and build
    core positions gradually.

  • 55. What is your sell discipline?

    Positions are typically sold when a bond price has risen beyond a level of attractive future return to the
    fund and there are similar quality bonds at a higher yield to switch into.
    The team also uses “fundamental stop-losses” (as opposed to pure price stop-losses) as part of the
    ongoing review of all positions held in the portfolio, and as protection when a negative credit event results
    in a change in investment views and it is decided that some or all bonds should be sold as a protective
    measure. The team would look to sell out of their positions primarily due to an increased risk of default i.e.
    the deterioration of company fundamentals or if default looks imminent. The team will seek to exit losing
    positions as efficiently as possible.
    If the underlying fundamentals are intact, they prefer to be patient in the face of market volatility and wait
    for prices to recover.

  • 56. What is your buy discipline?

    The fund managers look for opportunities across the whole credit spectrum and seek to hold a highly
    diversified portfolio of issues on which they have a favourable view of both the absolute and relative value
    versus the potential risk of each one. This is based on their in-depth analysis of company fundamentals.
    They size positions to suit what they believe will best deliver consistently high income, capital preservation
    and capital appreciation against the current macroeconomic backdrop, independent of index weightings.
    Such companies tend to be profitable and cash generative with good growth prospects, strengthening
    balance sheets and increasingly disciplined management, for example companies with global franchises.
    These are currently issuing a steady stream of good quality, high income providing credit. This creates
    significant opportunities for investors who diversify their fixed income portfolios into corporates.

  • 57. Describe your investment universe

    The funds have a wide universe but focus on the subordinated debt mainly of investment grade
    companies with a current focus on those issued by financial institutions. The managers also allocate to
    corporate bonds of non-financials and corporate hybrid bonds and can invest in some high yield and
    emerging markets-based issuers. Consequently, their investment universe is very broad but has no
    single, commercial index that accurately describes it.

    To give an idea of scale, the subordinated debt portion of the global bond universe is around EUR 1.1
    trillion 2 in outstanding debt, comprising circa 870 issuers and around 3,100 issues. The managers filter
    this extremely deep and diverse universe. They use their non-benchmarked, conviction-driven approach
    to instil the discipline of simplicity in the strategy: they focus only on areas of the market where they see
    the most promising opportunities and which they know best, and they avoid companies with complicated
    business models, excessive leverage and challenging macroeconomic or sector backdrops.

    At present, this has resulted in a strong bias to the structurally improving financial sector. The sector
    comprises hundreds of companies: banks (ranging from universal banks, investment banks and private
    banks) as well as non-bank financial institutions such as life and non-life insurances, asset managers,
    brokers, specialised lenders. In addition to the diversification these provide through their widely divergent
    business models and balance sheet characteristics, the sophistication and depth of the sub-ordinated
    universe means a rich and continuously refreshed opportunity set for the strategy.

  • 58. Fund Directory
    Service Provider To GAM Star Fund plc / GAM Fund
    Management Limited
    Year Relationship Began
    Fund Manager and
    Registrar
    GAM Fund Management Limited
    George’s Court
    54–62 Townsend Street
    Dublin 2
    Ireland
    Since 1990
    Delegate Fund
    Administrator
    State Street Fund Services (Ireland) Limited
    78 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 2016 for
    GAM Star Fund
    GAM’s relationship began
    2013
    Custodian State Street Custodial Services (Ireland)
    Limited
    78 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 2016 for
    GAM Star Fund
    GAM’s relationship began
    2013
    Fund Auditor PricewaterhouseCoopers
    One Spencer Dock
    North Wall Quay
    Dublin 1
    Ireland
    Since 1985
    (or its predecessors,
    Coopers & Lybrand)
    Legal Advisers Dillon Eustace
    33 Sir John Rogerson’s Quay
    Dublin 2
    Ireland
    Since 1999

    Source: GAM

  • 59. Do you believe that there are persistent structural inefficiencies in the area in which you invest?

    Yes. The areas pinpointed by the fund managers’ philosophy are permanent features of modern bond
    markets which will be perpetuated by the complexity of the markets and the variety of players in them.
    It is widely accepted and documented that bonds of investment grade issuers tend to exhibit much lower
    rates of default, compared to high yield issuers, as shown in the following chart.
    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP

    Annual global corporate default rates (1981-2015)

    Source: Standard & Poor’s Global Fixed Income Research and Standard & Poor’s CreditPro as at 30 Apr 2018. For illustrative
    purposes only.

    Just as other investment grade managers, the Atlanticomnium fund managers have chosen to focus on
    investment grade issuers precisely for the limited default risk of the asset class. However the team
    recognises that, by extension, the junior debt of these investment grade companies rarely defaults, yet it
    delivers a more attractive yield. Many other, more traditional credit managers do not replicate
    Atlanticomnium’s strategy of moving down the credit spectrum of investment grade issuers because of
    endemic barriers to entry:

    • Investment guidelines: Often institutional investors are subject to strict minimum or maximum credit
      qualities at issue level or are constrained by benchmark-relative investment approaches. For
      instance, it means that investment grade managers may not be allowed to allocate to subordinated
      debt, regardless of the strength of the corporate issuer, or conversely, high yield managers may not
      be allowed to invest in issues of investment grade companies even if the issues themselves are subinvestment grade.
    • Heterogeneity of subordinated debt: No two subordinated debt issues are the same. The
      complexity and proliferation of variants in each prospectus require time, expertise and understanding
      of regulatory, financial and tax aspects to correctly assess and value these instruments.
    • Scale efficiencies: Minimum investment sizes in junior debt issues can be relatively large therefore,
      to mitigate concentration risk, any portfolio that invests in these instruments would need to have
      sizeable assets to ensure sufficient diversification

    These limitations ensure that traditional benchmark-driven active and passive bond investors will continue
    to overlook the instruments where the GAM Star Credit Opportunities fund manager’s focus, thereby
    perpetuating mispricings, information inefficiencies and available yield pick-up for the team.

  • 60. What due diligence is conducted on the fund’s service providers?

    GAM appoints market leading service providers following initial due diligence and assessment of
    suitability, and reviews these relationships at periodic service review meetings. It invariably deals with
    entities qualified for the purpose engaged and whose activities have recognised regulatory oversight
    within their jurisdiction of operation.

  • 61. Has the auditor ever issued qualified financial statements for the fund?

    The funds’ auditor has never issued a qualified opinion on the financial statements of the fund.

  • 62. If any of the service providers has changed within the past three years, please explain why.

    GAM has long standing relationships with many of its external service providers; however the terms of
    those relationships are constantly under review as GAM seeks the most competitive terms. In particular,
    GAM has appointed State Street as the custodian and delegate administrator to the majority of its funds
    effective 7 March 2016.
    Why State Street?
    State Street is one of the leading global custodians and fund administrators with assets under custody
    and administration of USD 32 trillion, as at 31 December 2018. State Street is a strategically focused
    third-party fund administrator and custodian, is globally present, financially solid and has a large footprint
    in Europe.

    GAM already has a well-established relationship with State Street since 2013 as Custodian and
    Administrator for most Julius Baer branded funds and part of our Private Label Funds. State Street is one
    of the leading global custodians and demonstrates a high level of service excellence in managing
    migration projects, the development of IT functionality and interfaces, and their operational delivery.
    Furthermore, concentrating assets with one core provider of fund administration and custody services is
    adding considerable economies of scale to GAM’s outsourcing model, with a strong focus on risk
    management and compliance.
    The implementation of the new operating model began in the second half of 2015. GAM has successfully
    completed the transfer of the back office function to State Street, along with the middle office servicing for
    our GAM branded funds. Please refer to www.gam.com for further details.

  • 63. Is there a dilution levy?

    There is a dilution levy, in line with standard industry practice. This could be applied if considered
    necessary to reduce trading costs where they may disadvantage existing shareholders, and to preserve
    the value of the fund’s underlying assets. GAM does not apply the dilution levy systematically and we
    expect this would be infrequently applied, purely on a case-by-case basis.
    Where a fund buys or sells underlying investments in response to a request for the issue or redemption of
    Shares, it will generally incur a cost, made up of dealing costs and any spread between the bid and offer
    prices of the investments concerned, which is not reflected in the issue or redemption price paid by or to
    the Shareholder. With a view to reducing this cost (which, if it is material, disadvantages existing
    shareholders of the fund) and in order to preserve the value of the underlying assets of the relevant fund,
    where disclosed in the relevant Supplement, the Directors are entitled to require payment of a dilution
    levy, to be added to or deducted from the Net Asset Value per Share as appropriate. The Manager will
    normally charge a dilution levy of up to 1%. of the Net Asset Value per Share in the event of receipt for
    processing of net subscription or net redemption requests (including subscriptions and/or redemptions
    which would be effected as a result of conversions from one fund into another fund). The need to charge a
    dilution levy will depend on the volume of purchases, conversions or redemptions of Shares on any given
    Dealing Day, and this will be evaluated by the Manager without prior notification to the relevant
    Shareholder. Please refer to the funds’ prospectuses for further details.

  • 64. Is there a “gate” and how is it computed?

    The directors are entitled to limit the number of shares of a fund redeemed on any Dealing Day to 10% of
    the total number of shares of that fund in issue. In this event, the limitation will apply pro rata so that all
    shareholders wishing to have their shares of that fund redeemed on that Dealing Day will realise the same
    proportion of such shares for which a redemption request has been accepted by the manager and any
    shares not redeemed, but which would otherwise have been redeemed, will be carried forward to be
    redeemed on the next Dealing Day. If requests for the redemption of shares are so carried forward, the
    directors will inform the shareholders affected.

  • 65. Are there any special terms given to certain investors in relation to fees or redemption?

    GAM has not entered into any side letters which provide for preferential liquidity terms. All shareholders
    are subject to the liquidity terms applicable to the class in which they invest, as disclosed in the
    prospectus.

  • 66. What happens after capacity is reached?

    Should capacity be reached, subscriptions may still be possible for new investors, subject to restrictions
    and availability through redemptions. A list of interested parties will be established and maintained. As
    shares become available through redemptions, they will be offered to those parties whose names have
    been entered on this list.

  • 67. Are there any side letter agreements that can negatively impact the fund? If so please give details.

    From time to time GAM entities may enter into agreements that entitle certain shareholders in the funds to
    the provision of more information about the underlying investments than is disclosed to all investors, or
    providing for different fees or comfort regarding expenses. Typically, additional disclosure of underlying
    investments has been provided to substantial institutional shareholders with separate risk control
    departments for the purposes of risk management. Information issued on holdings within the funds is
    typically released with a 30-day delay. The information is provided under strict terms of confidentiality, and
    the recipient agrees not to disclose it to third parties or internally for investment decision-making
    purposes. Such agreements have been entered into on a strictly limited basis in circumstances particular
    to the shareholders concerned. We believe that any such side letter agreements would not negatively
    impact the funds.

  • 68. What is the maximum capacity of your fund?

    The team reviews capacity regularly and takes into consideration several factors to see if they still feel
    comfortable managing the funds at their current sizes.
    First they look at the size of the subordinated market in each currency to see how much market share
    they have. Then they factor in that they also invest in senior bonds and in addition that they also buy nonbase
    currency debt and hedge back, which significantly increases the depth of our universe beyond just
    the local subordinated debt market. On top of this, capacity in bonds is always a moving target as the
    market expands and new issues can have quite a big impact.
    The size of subordinated debt outstanding in each market is approximately USD 700 billion, EUR 387
    billion and GBP 71.6 billion, which adds up to about USD 1.2 trillion. The funds still have a very small
    market share of this, and the investment universe is even broader than subordinated debt.
    Given their current set up as well as opportunities, the managers are mindful of the impact of capacity as
    the strategy grows and they monitor it actively.

  • 69. What percentage of the fund assets is represented by the largest investor?

    We regret that this information is not available, as the majority of assets are held through third-party
    intermediaries.

  • 70. Please provide a summary of the controls in place to ensure accuracy.

    To ensure all month-end reporting controls are completed, State Street maintains a detailed checklist for
    each portfolio. The checklists support the daily, weekly and monthly processes, and detail all key
    reconciliations that have to be done. The daily checklist is prepared by the fund administrator and signed
    off by a senior fund administrator / assistant manager.
    Every task on the checklist is signed and dated by both the person who prepares the reporting and the
    person who reviews it. A manager also completes an overall review. The checklist is filed in a month end
    reporting file along with a copy of all supporting documentation. All accounting documentation is retained
    for seven years.
    Weekly cash, securities and income positions, reported to the department head and the Risk &
    Compliance group, ensures the necessary management time is devoted to clearing exceptions and taking
    corrective action to prevent a repeat of the issues. Exception items and balances are included on internal
    Management Information reporting, which is reviewed each week by senior management.
    As part of the overall control environment, State Street is also subject to the following reviews:
     Ernst & Young produces an annual audited Service Organisation Control (SOC) report on State
    Street’s middle office function titled Investment Manager Services – Enterprise (IMSE). E&Y also
    produces a semi-annual SOC report on State Street’s back-office function titled Global Fund
    Accounting and Custody (GFAC).
     Ernst & Young produces a semi-annual audited SOC report covering all IT systems (spanning both
    middle and back office functions and other areas of State Street) titled Information Technology
    General Controls (ITGC).
     All GAM funds are subject to an annual audit and the auditor’s testing includes re-pricing of all
    positions held at the accounting date and also confirmation of security positions with the independent
    custodians (or underlying administrators in the case of the funds of hedge funds).
     In Ireland State Street in regulated by the Central Bank of Ireland and under the Central Bank’s risk
    rating programme (PRISM) both State Street Fund Services (Ireland) Limited and State Street
    Custodial Services (Ireland) Limited have had full risk assessment reviews. No areas of concern were
    identified. In addition, the Central Bank have initiated a series of thematic reviews on outsourcing,
    regulatory reporting, AML, hard to price assets and treatment of errors which require input / review
    form State Street.

  • 71. How often are security and cash positions reconciled?

    On a daily basis, post execution trades are sent from GAM to State Street Investment Management
    Services team via a secure trade interface. These trades are then matched/reconciled to the broker’s
    confirmations. The trades are posted in to Global Horizon as part of the NAV process. Any trades which
    are not matched or have failed settlement are investigated and reported / escalated as appropriate back
    to GAM.

  • 72. How are any difficult-to-price assets or instruments priced?

    State Street is responsible for obtaining valuations. A Price Source Agreement (“PSA”) defines where
    prices will be sourced from by State Street on a market by market basis and at asset type where
    appropriate. As part of the PSA there is a price source matrix which allows for client preferences and
    flexibility while directing State Street to validate prices against specific criteria such as primary vendor
    selection by security type, pricing logic (last, bid, mean, historical), back-up vendors, spot and forward
    exchange rates sources, tolerance levels for day over day price comparisons and corresponding indices
    for each security type. All Equity prices are obtained for each exchange individually and local pricing
    conventions are followed. All Fixed income securities are provided by third party vendors who perform all
    evaluation calculations.
    State Street has a number of different options for the pricing of derivatives. These include the use of
    external market vendors such as Markit and SuperDerivatives together with internal models and systems.
    Internally, State Street has the ability to price many OTC securities including IRS, Swaptions,
    Caps/Floors, FX Options, Equity Options, credit derivatives such as CDS, CDX, ABX, MBX, Index
    Tranches, as well as more exotic products such as CMS Cap/Floors, Variance Swaps, Inflation Swaps,
    Forward Volatility Agreements, and Forward Starting Swaptions. State Street prices the interest rate
    based OTC products using a vendor product called Oberon (Lombard Risk Management). Oberon
    software allows the valuation group to input their own curves and volatility cubes daily for pricing. The
    valuation group has a daily process to analyse market data such as futures prices, deposit and swap
    rates, and to build daily discount factors and volatility cubes (using C++ and Fincad based calculators).
    Oberon employs the standard discounting cash flow model for valuation. State Street prices credit
    derivatives using an in-house developed calculator in JAVA employing the JPM model. The more exotic
    OTC products are priced using calculators that State Street has developed in-house typically in C++ and
    Fincad.
    If State Street is still unable to value the security then this will be escalated to the Price Committee within
    GAM who will review all the information / prices available from State Street, any other market information
    and in consultation with the investment manager will opine on the price to be used. All recommendations
    of the price committee for hard to value assets will be notified to the board of directors of the relevant
    fund.

  • 73. What are your pricing sources? Please give details.

    GAM has arranged a Price Source Agreement (PSA) with State Street Fund Services (Ireland) limited, the
    delegate administrator for the fund. The PSA outlines the pricing hierarchy governing the valuation of all
    instruments in the portfolio. It sets out the primary, secondary and tertiary (or more as applicable) price
    sources to be applied to each instrument;
     Listed securities primary source is Thompson Reuters
     Fixed Income securities are priced using the evaluation mean price from Bloomberg BVAL, with
    further sources available from Bloomberg BGN, IDC, Reuters and brokers where BVAL is unavailable
    or not the more accurate representation of fair value.
     Prices of unlisted securities are sourced from external sources where possible or otherwise in
    accordance with the terms of the relevant prospectus
     MARKIT is the primary source for the majority of OTC instruments
     Foreign exchange rates are sourced from Reuters
     Fund of fund holdings are priced using estimate prices received from external fund administrators and
    fund managers and are subsequently compared to the official monthly NAV produced by the external
    fund administrator for control purposes.

  • 74. What is your valuation policy?

    The net asset value of a fund is determined by deducting the total liabilities, including all accrued
    liabilities, from the total assets. Total assets are the sum of all cash, accrued interest, dividends and any
    other receivables and the market value of all investments, together with the current value of any other
    assets held.
    The net asset value is automatically calculated by State Street’s core accounting system. A price source
    agreement (PSA) is in place between State Street and GAM Fund Management Limited that defines
    where prices will be sourced from on a market by market and asset type basis where appropriate:
     Investments listed or quoted on a recognised market are valued at market price as at the close of
    business in the relevant market on the valuation day, generally using an electronic price feed from
    one or more reputable price vendors.
     Investments in listed derivatives are valued at the closing settlement price
     Investments in over the counter (“OTC”) derivatives are valued using independent pricing vendors
    such as Markit and are compared to the back office counterparty valuation
     Investments in funds, limited partnerships or similar investment vehicles are valued on the basis of
    the most recent price or valuation provided by the relevant manager or administrator
    Where possible, prices are received via multiple vendor feeds, and primary and secondary sources are
    defined where applicable. Asset prices are checked by the State Street Global Pricing Service Team to
    verify that the current prices have moved by an acceptable level from the previous price used for
    valuation.
    Any breaches to tolerance are shown as exceptions and investigated to establish the most appropriate
    price to use for valuation. Further checking results when the movement of an asset price exceeds the
    tolerance defined in the PSA.

  • 75. Who calculates the NAV and what is the frequency of calculation?

    As of 7 March 2016, State Street is the dedicated administrator for the majority of GAM’s funds including
    equities, fixed income and absolute return funds. State Street is one of the leading global custodians and
    fund administrators. State Street is a strategically focused third-party fund administrator and custodian, is
    globally present, financially solid and has a large footprint in Europe.

  • 76. How do you measure and monitor risk in the portfolios?

    There are two levels of monitoring controls within Atlanticomnium. The investment team is responsible for
    monitoring and managing all investment risk at the first level (Liquidity, credit, market). The Risk
    Management Process (RMP) tool covers pre-trade, post trade, hedging of UCITS and prospectus
    restrictions. All investment restrictions are monitored twice a day.
    The second level control is responsible for monitoring the execution of the first level risk control and the
    adherence to regulatory standards and investment restrictions. The team is also responsible for reporting
    its findings to relevant senior management and the Board. The analysis of the investment restrictions is
    processed weekly whereas reporting to GAM of the regulatory standards through the KPI is done on a
    monthly basis.
    GAM’s monitoring processes are described below:
    Investment risk analysis teams
    These teams review and analyse investment risk and performance. They produce risk reports for clients
    and regulators as required, and deliver bespoke, in-depth risk analytics to assist in the investment
    decision-making process.
    In order to support both the Group and each investment team, a suite of standardised risk reporting is
    produced using MSCI RiskMetrics by GAM’s Quantitative Analysis Team (‘QAT’) in London and by the
    Investment Analytics Risk Team (‘IART’) in Zurich. The Group provides solutions across the full breadth of
    traditional and alternative asset classes and the risk reporting output varies accordingly by asset class.
    Typical equity risk reports would usually include a breakdown of the number of holdings, key risk
    statistics, risk decomposition, VAR analysis, stress test results, correlations and portfolio liquidity. Fixed
    income risk analytics include the following metrics as standard: VAR, expected shortfall, fat tail risk, DV01,
    stress test results, correlations, portfolio liquidity and currency exposures. Market risk across all portfolios
    is monitored on a daily basis as standard. To maintain their independence, both the QAT in London and
    the IART in Zurich have separate reporting lines, away from the investment teams.
    These teams are in turn supported by an IT team which has responsibility for ongoing development of
    bespoke internal risk systems, as well as the maintenance and development of external risk systems
    used.
    Investment controlling teams
    These teams monitor our investment teams’ adherence to applicable legal and regulatory, prospectus,
    contractual and internal investment restrictions. They escalate established investment restriction
    breaches, enforce and control the timely remedy of such breaches and report relevant breaches to
    applicable external auditors and regulators, if required.

  • 77. What are your portfolio financing constraints / limits?

    Borrowing is limited to 10%, and can only be done on a temporary basis. Please refer to the fund’s
    prospectuses for further details. In practice, the funds do not borrow to invest. Any temporary overdraft is
    to address short-term mismatch due to trade settlement only.

  • 78. Describe your approach to risk management.

    The Group’s approach to risk management and control is a structured process that identifies, measures,
    reports, mitigates and controls risk. It is designed to identify potential changes in the risk profile of the
    business and is built on the three lines of defence model, supported by formal governance processes,
    individual responsibility and senior management oversight, as illustrated in the diagram below.

    Three lines of defence model

    Source: GAM

    The Group’s risk management framework defines the Group’s fundamental approach to risk and guides
    the management and control of all types of risks at different levels within the organisation. It also serves to
    ensure that the Group’s aggregate risk exposure is commensurate with its risk appetite as determined by
    the Board of Directors.

  • 79. How frequently are trades reconciled to broker / custodian confirmations?

    Post execution trades are sent from GAM to State Street Investment Management Services team via a
    secure trade interface. These trades are then matched/reconciled to the brokers’ confirmations. The
    trades are posted in to Global Horizon as part of the NAV process. Any trades which are not matched or
    have failed settlement are investigated and reported / escalated as appropriate back to GAM on a daily
    basis.

  • 80. How are executed trades allocated to accounts?

    In the GAM Star Credit Opportunities fund range, each of the three funds (in USD, EUR and GBP) has
    specific trading lines with each counterparty, so when the fund managers trade on the secondary market,
    they specifically mention during the trade for which fund the trade is going to (vs block trading with an
    allocation at a later stage). On the primary market, if they do not get the full allocation and want to invest
    the position in more than one fund, the allocation between the funds is done on a pro-rata basis.

  • 81. Describe your trading process.

    Market prices are reviewed and in most cases, competitive quotes are sought from two or more
    counterparties, agency brokers or market makers. For transactions in less liquid markets and if not
    detrimental to the funds’ interests, a single counterparty may be approached on the basis of that
    counterparty’s suitability for the transaction. Most of the transactions are traded over the counter on a net
    basis.
    The long experience of Atlanticomnium in the industry has helped them build relationships with major
    investment banks, other industry analysts, fund managers, company managements, specialist brokers,
    industry consultants and other respected sources. This enables them to have access to insightful
    information, which provides them with the best available trading prices, in accordance with the best
    execution policy.
    Then orders for GAM funds are nearly always given to the broker with a price limit. The broker confirms to
    Atlanticomnium S.A.’s back office and the custodian (State Street). Atlanticomnium verifies and
    communicates the trades to GAM, upon confirmation for independent validation upon execution. Only
    upon validation are the transactions accepted. GAM then instructs the custodian to settle the trade. There
    are two pre-trade risk and compliance checks and one post trade compliance check. These checks are
    conducted independently of the investment team, operations and risk teams in the order management
    system.
    Transactions are monitored for prices against independent data regularly as well as any limits or size to
    ensure they comply with both the stated instructions of the manager and the requirements of the funds’
    prospectuses and UCITS regulations.

  • 82. Who is authorised to place orders on behalf of the fund? Describe their function and experience?

    Anthony Smouha Gregoire Mivelaz and Patrick Smouha , the co-fund managers of the funds, are
    authorised to place orders on behalf of the funds.

  • 83. Given the latest commentaries more dovish from the ECB and now from the FED, several clients are asking the impact on the subordinated debt space (CoCos and other hybrid securities in particular).

    The main effect that this has had is a rally in subordinated financials debt in the last few days – with AT1 CoCos up close to 2% and subordinated insurance up c1%. Nevertheless spreads remain highly attractive (around 450bps on EUR AT1s CoCos for example) and wide in a historical context and hence we continue to see further price upside.

  • 84. Clients were asking how comes the capital gains showed by the funds were so low if we report a duration of almost 5 and rates are getting lower

    Context:The strategy aim to be interest rate insensitive and the modified duration reported is a limited model for the sensitivity of FRNs

    Impact for the fund: Positive as the strategy aim to reach a high and steady income from the coupon payments and not taking a view on rates to try to capture short term capital gains

    It is clear from the graph below that the fund is not reflecting his modified duration in his sensitivity to rates, and the reason for that is in the limitation of the model of Modified Duration.

    We are currently working with GAM & MSCI to be able to validate a OAS duration, but let me go more into details

     

     

    The reason for this is that modified duration is a very good indicator for classical bonds i.e. securities with a fixed coupon and fixed maturity. But the fund has only 14% of such securities (fixed-dated bond), explaining why the fund reacts differently than his modified duration to interest rates.

    For example, modified duration doesn’t know that Tier 1 securities issued under Basel II will lose their eligibility as regulatory capital by 2022 (this is why we call them grandfathered Tier 1), meaning that issuers will buy them back by latest 2022 or in less than 3.5 years. This means that grandfathered fixed perpetual (8.7% of the portfolio) should not have a modified duration higher than 3.5, if taking regulatory changes into account. With a stated modified duration of 17.2, this is the biggest contributor to the duration for the fund but in reality it is very insensitive to rates. Taking a conservative assumption of a duration of max 3.5 for fixed perpetual, one can already deduct 1.2 from the fund’s duration, or from 4.7 to 3.5. In addition, we own discounted floating rate notes (FRNs) in order to mitigate the interest rate risk on fixed-dated bond. FRNs trade at discount because of their low coupon. The coupon is a floater so that any rise in interest rates means a higher coupon and a higher price. So the capital gains that we generate on FRNs, when rates get higher, off-set capital losses that we would experience on fixed-dates bonds. By taking the OAS (option adjusted spread) duration for the FRNs, one can deduct approximately another point from the fund’s duration.

     

    Taking both elements into consideration (i.e. impact of regulatory changes as well as OAS duration), the fund’s duration can be adjusted from 4.7-1.2-1= 2.5.
    MSCI gives us a OAS duration for the USD fund as of end of August of 2.62 which confirms the above approximation
    Going forward you should see the OAS duration be added to the documentations for the funds

  • 85. Clients are buzzed about the whole low rates environment, negative yields and capacity for bond investors to capture nice income

    Context:In the prospect for rates to remain in negative space for longer, how that translate for an income strategy like the one for the credit opps

    Impact for the fund: Positive, in times of uncertainty and low rates, the subordinated debt of European financials is a liquid, heavily regulated andstrengthening sector still offering incomes above 4% in EUR

    I would point the attention on the article we have been published lately on Lower rates for longer.
    There we explain how actually for the sector of financials and in the specific, subordinated debt of best quality issuers, this challenging environment, when considered in parallel to the regulatory changes we are experiencing actually translate in a positive credit story for the GAM Star Credit Opportunities.

    To give a little of context, from the macro/political aspect we have been experiencing uncertainties, contrasted by “simultaneous” policy easing by central banks.

    This was reflected by

    • Drop in inflation expectation vs tight labor market
    • Global trade and manufacturing under pressure vs. resilient services and domestic consumption

    VS

    • Simultaneous easing by central banks should help contain potential market volatility and limit downside risk
    • A good environment for fixed income investors, especially for active managers as macro/political regain the upper hand – stay up in the credit quality

     

    Yields on sovereign debt has indeed keep getting lower and negative yielding fixed income securities are now at all time high

    • 10 years sovereign debt of Austria, France, Germany, Sweded, Netherland, Switzerland and Japan currently report negative yields
    • More than 25% of EUR IG corporate market already has negative yields and there is even a handful of HY corporates which are currently in the same situation
    • Cash is not an option as deposit rates also are in negative space
      • EU -0.4% and CH: -0.75%

     

    In such environment, in order to capture positive yields there are different options: either higher interest rate risk or higher credit risk, OR something a different like what the Credit Opps is proposing.

    • Quality beta, such as choosing the best national champions of the financial sector for then descending their capital structure in order to capture a higher income
      • This translate in IG issuers with low risk of default with a nice and steady income from descending down their capital structure, up to 4% for EUR sub debt.

     

     

    While many Investors have been pushed up the risk scale to capture some income, subordinated debt allows to reach a high income from safe and secure investment grade companies
    In particular for European Banks:

    • Banks have strengthened the quality and quantity of regulatory capital
    •  Increased capacity to absorb losses in a severely adverse scenario
    •     Banks have cleaned up their balance sheets and asset quality keeps on improving
    •  Structural reduction of risk-taking activities
    •     Strong solvency, capital and liquidity ratios
    •  Highly regulated and liquid market

     

     

    This bring us to what we believe is a very big opportunity for this asset class, stronger names which are heavily scrutinized and forced to continuously improve their balance sheets, nice capacity to generate income by the juniority of the asset class and valuation which remains still very attractive as the spreads on such securities yes tightened YTD but remains still very wide

    • Pre-GFC, it was not unusual to capture spreads of less than 100bps for high quality issuers, so ca. 4x lower than what we are capturing now
    • Spread have tightened year-to-date but still remain much wider than 18 months ago:
    • From FEB2018 to DEC2018, spreads widened by 230bps to 480bps
    • Since then, spreads have only tightened by 100bps or not even half of the widening experienced last year

     

     

    To conclude we do have a very constructive tone and while performances has been strong YTD we remain very constructive for the remaining of the year.

    While macro/political uncertainties have somewhat reduced during July, the dovish stance by central banks should help contain potential volatility that these might create over the coming months, due to the low interest rates environment, it is getting even more challenging for investors to find yielding securities, without taking excess interest rate or credit risk.

    We feel that subordinated debt from national champions remains the sweet spot as we do see strong fundamentals, attractive valuation levels and supportive technical.

  • 86. Analysis of the recent holdlings for the funds in terms of the Bloomberg BVAL Score? Each holding has usually a BVAL score (excpet ABS, CLOs, etc.).
    GAM Star CreditOpportunities EUR BVAL Score % of fund
    BOND Average:               7.493 80.56
    N/A 0.00 2.15
    PrefShares 0.00 2.11
    CASH 10 15.18
    FUND Average: 9.01 100.00
    Fund average Net of Cash 8.83

     

    Please note that using BVAL to assess the liquidity of the bonds we hold could result quite an approximation as we do hold bonds which do not report a BVAL score like pref shares which are actually quite liquid positions but score a 0 in the attached as Bloomberg considers them as Equity.

  • 87. What is the view of the investment team on the recent ECB Announcement

    Context:On the 16th of September the ECB announced a new cut on deposit rates, a new asset purchase package and a new round of TLTRO

    Impact for the fund:Positive, rally in subordinated financials debt with EUR AT1 CoCos up close to 1%

    and subordinated insurance up c0.5%.

    Overall, the ECB was slightly more dovish than expected:

    • They cut the deposit rate to -0.5% (from -0.4%)
    • Doing QE of “only” EUR 20 billion a month from November. This was a smaller number than expected, however the QE is open-ended (meaning there is no time deadline). This is dovish and plays into our theme of lower rates for longer.
    • Tiering: This is a mitigating measure, which will help banks profitability.
    • Rates seen at lower level until inflation converges on goal
    • Longer TLRO maturities

    The ECB announced pretty much what we see as a good outcome both for the macro backdrop and for banks. The rate cut which was broadly as expected (main rate cut by 10bps to -0.5%) and while the asset purchase package was slightly lower than expected at €20bn per month there is no time limit which is positive. Finally, the ECB has announced a new round of TLTRO at very favorable terms (banks can borrow at the main rate if certain lending conditions are met) and deposit tiering where part of banks’ excess liquidity reserves will be exempt from negative rates. This will alleviate some pressure around banks earnings and in tandem with further dovish monetary policy to boost the economy this is a strong positive for financials and hence our fund.
    For the moment the effect that this has had is a rally in subordinated financials debt yesterday – with EUR AT1 CoCos up close to 1% and subordinated insurance up c0.5%. Nevertheless spreads remain highly attractive (around 420bps on EUR AT1s CoCos for example) and wide in a historical context and hence we continue to see further price upside.

  • 88. Client Just reached out further to news on the Pershing SQ PP deal financed by Guggenheim

    We actually sold our holdings of Pershing Square at a profit during the 1st half of year. The main reason being that we felt the spread had tightened quite significantly and that we could find better relative value elsewhere. Looking at the Guggenheim deal, it is important to note that the Pershing Square 5.5% 2022 have a limit of indebtedness covenant.

  • 89. A client is asking about the Regulatory Par Call, example on Lloyds 12% on which can apply a regulatory par call after 12/2021 despite the first call date being 12/2024. He understands about legacy papers that the banks are incentivized to call them after 2022 (when they will be no longer part of the regulatory capital required by Basel), but these papers are obviously passed their first call right? The legacy papers we have in the Credit Opps funds are all trading with a discount?

    Yes the Lloyds 12% Perp can be called at the end of the grandfathering period (Jan-22) at par at the election of the issuer, significantly reducing the yield of the instrument from c6.9% (Dec-24) to 2.4% (Jan-22).

    This is why it is paramount to fully understand the terms of bonds and hence reading through the prospectus before investing in these instruments. We always assess the yield/spread given the issuers’ call options to have a true picture.

    Issuers are definitely incentivized to redeem these instruments as they are increasingly inefficient from a regulatory capital perspective. Some have call dates still in the future while others have indeed passed their first call date, and some are trading at discounts (especially legacy Discounter Perpetual FRNs) while some above par. For those trading above par, we focused on instruments with “make-whole” features – where the issuer can only redeem the bonds at a fixed spread above the current risk-free rate (government bond yield). For example, Commerzbank 8.151 Perps are only callable in 2029, but from Jan-22 the issuer will have the option to repay those at the US treasury rate plus 50bps, equivalent to a price of 139% (based on today’s levels) and hence a yield to make-whole in Jan-22 of 6.6% (spread of 480bps) – highly attractive.

    Overall – we are invested in different types of legacy securities where we see value and with favorable outcomes for us in case of redemptions such as discount FRNs callable at par or legacy instruments with “make-whole provisions”. In any case we incorporate the different redemption options into our assessment of each security when making investment decisions.

  • 90. Clients asking if we can provide them with a commentary or updated information about preferred securities; as they are seeing more issuance on the space than before and don’t understand the reason behind it.

    Context: LatAM clients are used to preferred securities which are bonds equivalent to AT1 Cocos but issued from US banks, these

    Impact for the fund:Pref Shares are more expensive then European AT1 cocos which is supportive for our strategy

    First of all, the preferred securities we hold in the fund are mostly legacy capital securities issued by banks and insurers under previous regulatory regimes, and hence these are not issued any more as they would not be eligible as capital.

    US banks do issue “preferred securities”, which are the equivalent of AT1 CoCos for US banks with very similar features to AT1 CoCos (fully discretionary coupons, perpetual, etc.). These instruments are fairly different from old-style prefs that we hold in the fund, that are usually fully perpetual (no call dates), can have cumulative coupons, etc.
    European banks and insurers currently only issue new-style fully eligible instruments, namely AT1 CoCos for banks and Restricted Tier 1s for insurers. We have seen c€26bn of European banks AT1 and c€2bn of European insurance RT1 being issued YTD. While the AT1 CoCo issuance figure is slightly ahead of the €20-25bn expectation we had for the year, supply has not been a headwind for the sector given very strong appetite for higher yielding paper in a negative rates environment. We have seen for example Nationwide bring a new £ AT1 CoCo this week, oversubscribed more than five times despite the overhanging Brexit uncertainty. Moreover, as issuers have front-loaded some of 2020’s issuance, technicals will remain very favorable for the sector.

    Our reasoning behind the lack of involvement in US prefs is driven by valuations, where European banks offer significantly wider spreads. For example HSBC 6.375% AT1 CoCos callable in 2024 currently offers a spread of c350bps over treasuries, compared to c220bps spread for JP Morgan 6.125 US Pref callable in 2024. This is despite similar ratings (both BBB- Bloomberg Composite) and similar bond structures

     

  • 91. What is your investment philosophy?

    The investment philosophy for the GAM Star Credit Opportunities funds (the ‘funds’) is based on the fund
    managers’ belief that attractive yield can be captured from corporate bond investing without incurring
    unnecessary default or interest rate risk. They believe that targeted, fundamental credit analysis focused
    on more complex bond issues from high quality issuers can harness strong total returns by:

    • Investing in higher yielding issues of investment grade issuers
      allows the managers to harvest yield from sub-investment grade issues, but to do so without the
      default risk associated with lower quality companies.
    • Focusing on income as well as price, instead of on price alone
      A buy and hold bias means that over the long term, incremental payments of coupons add up,
      contributing significantly to total returns – a much more reliable approach than depending on
      favourable bond price movements or trading in and out to drive performance. Using hybrids to calibrate interest rate exposures
      Hybrids, such as long-dated and undated bonds, offer a range of fixed, floating and duration
      characteristics which can be used actively to position portfolio for market conditions at all stages of
      the market cycle.
    • Invest in the best opportunities, without regard for benchmarks
      conviction-driven approach targets efforts solely on the areas of ripest opportunity; for instance, in the
      financial sector, where regulations are enforcing structural quality improvements to support a deep,
      varied range of quality bank and non-bank issuers.
      Building on these beliefs for more than 30 years, the fund managers have been developing extensive
      expertise analysing the corporate quality and capital structure of investment grade issuers. The resulting
      highly diversified, conviction-based strategy has produced strong, long-term performance with attractive
      yield and low default rates.
  • 92. Is there any limit of CoCo bond which is available to be accepted as ‘eligible capital’ under European regulation? e.g. In Korea, CoCo bond is recognized as capital up to 25% of total capital.

    Under current European regulation, the limit for AT1s is 1.5% of RWAs (for UK and Nordics this is slightly more – c2%). For example for BNP (on the right), the group’s capital requirement is 13.33%, of which 9.83% in CET1, 1.5% AT1 and 2% Tier 2 (all as a % of RWAs).

    More into details, the maximum limit of RWAs is 1.5% (anything above has limited capital efficiency – but issuers can have more than 1.5%). In terms of AT1 requirements within the capital structure, this is 18.75% of Pillar 1 requirements (8% total, of which 4.5% CET1, 1.5% AT1 and 2% Tier 2). There is no actual minimum and in theory they could fill their AT1 requirements with CET1 capital – but it is more efficient to use AT1 given the lower cost vs. the banks’ cost of equity.

     

     

  • 93. Clients were asking main difference between AT1 cocos (Tier 1 bonds under Basel III), RT1 (Tier 1 bonds under Solvency 2) and Pref Shares (Tier 1 bonds issued by US issuers)

    Context:The strategy invests in junior subordinated and many of the bonds we invest in are very technical instruments impacted by different regulatory regimes for which the market doesn’t necessarily understand the opportunities and risk.

    Fund:All

    Features of financials capital instruments

    Features of financials capital instruments
    Feature Insurance Restricted Tier 1 Bank Additional Tier 1 Bank Pref Shares
    Maturity Perpetual, minimum 5 year non-call Perpetual, minimum 5 year non-call Perpetual, non call (Legacy EU pref)                         Perpetual, callable (Current US pref)
    Coupons Fixed to floater – Fully discretionary, non-cumulative Fixed to Floater – Fully discretionary, non-cumulative Fixed or Fixed to Floating – Fully discretionary, cumulative or not depending on the instrument
    Write-down/conversion Contractual trigger level (usually 75% of requirements or lower than 100% for three months) Contractual trigger level (5.125 or 7%) or Point of non-viability (PONV) No (Legacy EU pref)     Yes (Current US pref)
    Coupon step-up after first call date No No No

     

    • AT1 cocos instrument are junior subordinated debt securities issued by banks that can qualify as capital under current European Banking Regulation (Basel III). To qualify as Tier 1 capital, the instruments need to be perpetual, have non-cumulative fully optional coupons and a contractual trigger to principal write-down or equity conversion.
    • Restricted Tier 1 instruments are junior subordinated debt securities issued by insurers that can qualify as capital under current European Insurance Regulation (Solvency II). To qualify as Tier 1 capital, the instruments need to be perpetual with a minimum five-year non-call, have non-cumulative fully optional coupons and a contractual trigger to principal write-down or equity conversion.

    Although insurance RT1s have similar feature as banks AT1 (perpetual, fully discretionary coupons and a contractual trigger) we view the risk for investors as different. Unlike banks, there is no Insurance bail-in regime where an instrument can be written down when an issuer reaches the “Point of Non Viability” (PONV) – which is at the discretion of the regulator when a bank is deemed failing or likely to fail. This reduces the risk of an early regulatory intervention to impose losses on creditors or force coupon cancellation. Secondly, there is no Minimum Distributable Amounts (MDA) trigger – which is the amount of capital required for banks to be able to make coupon payments, typically well above the trigger level. For European banks, this creates incremental coupon risk, not present in insurance RT1s. Overall, the risk from the features of the bond is lower in our view compared to bank AT1s, as for RT1s coupon skip risk arises at very remote levels and there is no bail-in regime.

    • Pref Shares in general are junior subordinated debt securities issued by US banks with very similar features as AT1 CoCos .

    To be noted that the Pref Shares we hold in the fund are mostly legacy capital securities issued by banks and insurers under previous regulatory regimes, and hence these are not issued any more as they would not be eligible as capital going forward. These old style pref were usually issued for taxation efficiency purposes as the coupon on such securities was tax deductible like a normal bond despite they were accounted as equity capital and were non callable fully perpetual non cumulative coupons kind of bonds.

    In this regard, our reasoning behind the lack of involvement in US modern prefs is driven by valuations, where European banks offer significantly wider spreads. For example HSBC 6.375% AT1 CoCos callable in 2024 currently offers a spread of c350bps over treasuries, compared to c220bps spread for JP Morgan 6.125 US Pref callable in 2024. This is despite similar ratings (both BBB- Bloomberg Composite) and similar bond structures.

  • 94. Clients were asking how the spreads level for our investment universe has been evolving in the last few years

    Context:The investment team consider the current valuation level on our securities very attractive as reflected by spreads, which are still very wide if only compared to end of year 2017, levels at which the team was considering getting closer to a fair value for our asset class.

    Impact for the fund: Positive as the markets are showing strong momentum and spreads on our asset class are still very wide. This shows a potential for high capital gains going forward as it has been

    The continuation of the multi-year process of capital strengthening for European financials makes us feel very confident in the strong and improving credit fundamentals of our issuers.
    Although prices have continued to rally, spreads has tightened only 170 bps YTD which sets us on average at 1/2way towards the level of end of 2017 where we were feeling levels were getting closer to what we see as a fair value for our asset class.

     

    We feel that current spreads (c390bps on AT1 CoCos for example) remain highly attractive and see further upside as well as continued high return contributions from income collected. Dovishness by central banks and a low rates environment bodes well for subordinated fixed income of financial sector. We feel the quality beta of our strategy is the right answer to the continuous geopolitical issues (Trade wars and Brexit) and uncertainty related to global growth i.e. high and steady income from strong issuers.

    happening on a YTD basis.

  • 95. As we hold a big portion in CoCos client is asking what these securities are and what is the attraction to holding these in the portfolio.

    Context:By holding approximately 25% of exposure to the asset class and being this the most subordinated and technical to understand, clients are asking the rationale for holding them and how this securities works

    Impact for the fund: Positive, this is not simply a source of differentiation against our competitors but the reason we want to limit our overall exposure to this asset class is that AT1 coco are more risky than Tier 1 bonds issued under Basel II and Tier 2 bonds from banks. The reason why these are more risky is that for example coupon risk is more elevated as based on regulatory requirements set by Basel III, coupon have to be discretionary and non-cumulative. As our objective is to capture a “high and steady” income from strong companies, this is the reason why we have given a soft guidance of 25% on AT1

    AT1 cocos are all fixed-to-floater perpetual with a high coupon and because of the re-fix of the coupon, on average after 5 years, it makes them also an extremely valuable instruments in a rising rate environment.

    So great carry, attractive valuation and low sensitivity to rates.

    On the other hand, coupons on AT1 Cocosare fully discretionary and non-cumulative. Meaning that not only at fully discretion of the issuer but also the regulator can block the payment of the coupon on such securities which being non-cumulative would result into a loss of accrued income for the funds. In addition the contingency is a pre-set CET1 level and a breach of it means either a conversion into equity or a write-down of the principal as defined by the respective prospectus.

    On the coupon that is the main reason why we give ourselves a 25% soft guidance limit while concerning the risk of conversion our strategy bodes well with this asset class as we are selecting only national champions that already met Basel III requirements and the risk of conversion for such issuers is very low.

    Cocos

  • 96. What is a CMS / CMT?(bond where coupon is not fixed and regularly reset based on swap/interest rates)

    Context:These bonds tend to be correlated to interest rates and as rates went lower, the price of these went lower too. The bonds that we own have been issued under Basel II and Solvency 1 and do not comply with new regulatory framework. We call them grandfathered. There is a lot of optionality owning such bonds in terms of future capital gains as banks/insurance companies will be looking to buy back such bonds at significant premium to current prices over the coming years.

    Impact for the fund:Positive, as the market started pricing the potential regulatory call for loss of eligibility on such legacy bonds

    CMS: Constant Maturity Swap

    CMT: Constant Maturity Treasury

    Discounted Perpetual Floating Rate Notes (FRNs) are legacy capital securities issued by banks and insurers under previous regulatory regimes (pre-Basel III for banks and pre-Solvency II for insurance). There are two broad categories of Discount Perpetual FRNs: Discount Perpetuals (DISCOs) and Constant Maturity Swap (CMS) or Constant Maturity Treasury (CMT) instruments. Given there is currently close to USD 15 billion outstanding securities in issuance between DISCOs and CMS/CMTs, this asset class remains a sizeable portion of the legacy subordinated debt market.

    Both DISCOs and CMS / CMT instruments share common features, both being:

    • – Perpetual subordinated debt instruments issued under previous regulatory regimes
    • – Floating coupons with low margins (where the spread is paid above the reference rate) – typically below 50bps
    • – Periodically callable – this could be annually or more frequently

    Given low floating margins, both instruments trade at deeply discounted prices to reflect these relatively low coupons. However, DISCOs are mostly US dollar-denominated instruments that were issued by banks in the mid-1980s and are indexed to Libor, while CMS / CMTs are mainly euro-denominated instruments issued by both banks and insurers in the early to mid-2000s (with some US dollar issuance) that are indexed to 10- year swap rates or government bond yields.

     

    For more insights please refer to our article on Discos: “An opportunity in subordinated financial bonds?”

  • 97. Clients asking if the investment team has a guidance for performance expectation in 2020

    Context: Given the combination of strong fundamentals and attractive valuation levels, our base case for the next 12 months in terms of performance of the fund is not only income but further capital appreciation too. Hence the performance guidance of 9% for the EUR fund, 10% for the USD fund and 10% for the GBP fund.

    Impact for the fund:Over the next 12 months performance guidance of 9% for EUR and 10% for both

    We keep seeing strong improvement of credit metrics within European financials. Moreover, the multiyear regulatory processkeep forcing financials to build up capital and strengthen their balance sheets, all of which are supportive from a credit perspective as confirmed by the latest session of results. We expect holders of financials’ subordinated debt to benefit the most from this. Furthermore, with spreads of these securities currently above 400 bps, valuations remain extremely attractive.Last but not least we see significant value in legacy capital securities of banks and insurers which offer attractive features in a portfolio context and attractive valuations.
    Given all this, we feel the fund going forward has scope to benefit not only by the usual high steady income but from potential further high capital gains.
    Guidance for next 12 months is 9% for Eur fund and 10% for usd/gbp fund. Of which half coming from income and remaining from price appreciation

    GBP and USD

  • 98. How do ESG factors influence your investment beliefs?

    Context:Development and full integration of ESG within the credit analysis process

    Impact for the fund:Integrate ESG as one of the key building blocks of our fundamental analysis

     

    Atlanticomnium’s approach to ESG is not “one-size-fits-all”. We have always taken relevant market-specific factors into account in our research such as Governance but we decided to implement a robust granular approach on ESG-specific risks. For this reason we are in the process of fully integrate ESG analysis as one of the key building blocks of our fundamental analysis framework.
    This will enhances our in-depth fundamental research approach by adding another source of information and angle for our analysis.
    Better understanding of the risks and credit drivers of our issuers will contribute to strengthen our investment decisions.
    As with other risks – we don’t aim to use the ESG research to exclude issuers but enhance our analysis.
    Integrating ESG fits our strategy of focusing on high conviction issuers that add value for all stakeholders given our long-term buy & hold investment philosophy

    The project will aloud us to report a ESG scoring for the funds and the underlying issuers, we are targeting end of year 2019 early 1Q20 to start disclosing ESG ratings for the GAM Star Credit Opportunities funds framework

  • 99. On a YTD basis, average securities ratings on the fund went from BBB to BBB+, what changes were applied to the fund?

    Context:Reflection on the fund of the multi-year process of capital strengthening that the financial sector is undergoing

    Impact for the fund:Improvement in the credit risk profile of the product

     

    On a YTD basis, despite no structural change in the product, the average rating of the fund went from BBB to BBB+, this one notch upgrade is a reflection of the multi-year process of capital strengthening that the financial sector is undergoing.

    This reinforces our issuers value within the context of historically wide credit spreads and creates opportunities for long term investors as fundamentals of our issuers are improving while valuation of our holdings remains extremely attractive, current spreads do not reflect the strong underlying credit quality of issuers held in the portfolio.

  • 100. Clients asking some update on the legacy papers we hold in funds

    Context: The discountedperpetual Floating Rate Notes (FRNs) which we hold in the fundsare legacy capital securities issued bybanks and insurers under previous regulatory regimes, these will become inefficient capital to maintain for issuers and we can expect them to be recalled by 2022 for Banks and 2026 for Insurers.

    Impact for the fund:The market is starting to price the loss of eligibility of the legacy bonds, we experienced strong capital gains and we expect this trend to continue over the next months.

    Exposure to legacy securities in all three funds

     

    Legacy securities – background on regulation

    • Issued by banks and insurers under previous regulatory regimes (Basel I and II for banks, Solvency I for insurers).
    • As a reminder these instruments are issued as they are eligible as capital and cheaper than equity (cost of equity of c10% compared to issuing AT1 CoCos at 4-6%) and not for funding purposes or to take on additional leverage. As these increase banks/insurers’ capital stacks they make financials safer, unlike corporates that issue debt to incur leverage and increase default risk. Basically no incentive to keep these instruments unless they retain capital value.
    • For banks – under Basel III European banks are allowed to count these old bonds as capital until Dec-2021 (grandfathering period). Additionally, banks have a limit on how much legacies can count as capital – declining at 10% per annum until Dec-2021, so as time passes, instruments become more inefficient.
    • For insurers – under Solvency II Insurers are allowed to count these old bonds as capital until Dec-2025 (grandfathering period). 100% of legacies count as capital until Dec-2021, no gradual phase-out.

     

    Legacy securities – Instrument types

    • A lot of different types of bonds, as issued as back as 1984 up to the early 2010s (until AT1 CoCos and new-style insurance RT1s started to be issued). The features of the instruments reflect regulators’ criteria at time of issuance under the applicable regulatory regime. Hence these have changed significantly through time, explains why no two legacy bonds are the same.
    • In terms of different instrument types (key instruments)
      • Legacy FRN perpetuals (similar to the Santander and Commerzbank called): these are trading well below par due to relatively low coupons, periodically callable at par with floating-rate coupon structures. Due to the FRN structure, highly attractive to mitigate interest rate risk in a diversified bond portfolio (benefits from higher rates)
      • Make-whole bonds – where the redemption price is based on a specific yield. For example, the Commerzbank 8.151% callable in 2029 can be redeemed early upon loss of regulatory value (which will occur in Dec-2021) at a price where the yield is the US treasury rate + 50bps, equivalent to a 140% price under current market conditions
      • Regulatory par call bonds – where the issuer has the option to redeem bonds at par before the first call date upon loss of regulatory capital at par. Here clearly for bonds trading well above par there is downside risk, and for instruments trading below par there is upside risk
      • Insurance Solvency I perpetuals – mostly fixed-to-floating issued ahead of Solvency II as they count as capital until Dec-2025. Typically callable ahead of the end of the grandfathering period, for example Groupama 6.375% Perpetual callable in 2024. Carry no extension risk as ineligible afterwards.
    • Deep expertise is required to analyze these securities given the wide range of structures, different terms and conditions that can greatly impact the upside/downside for investments, and need to understand the regulatory backdrop as well as changes.

     

    Legacy securities – New bonds are the old bonds

    • Regulation is constantly evolving and therefore some AT1 CoCos are becoming  the new legacy securities.
    • In Switzerland low trigger instruments (with a conversion/write-down trigger below 7%) are ineligible after their first call date. Therefore on instruments with a trigger below 7% there is no extension risk – as it loses capital value if not called.
    • In the Euro Zone new changes in regulation (called CRR2) will disqualify certain bonds, such as those issued under foreign law (issued under New York law for example), and these are grandfathered until June-2025. Again, extension risk becomes very limited post 2025 as these will no longer be eligible as capital.

     

    Legacy securities – why invest?

    • Attractive instruments to hold given a wide range of different structures, such as FRNs to manage interest rate risk, long-call perpetuals provided attractive running yields, etc.
    • Regulation is the clear catalyst, whereby these instruments are increasingly inefficient as capital, as will become 100% ineligible in Dec-2021 (banks) and Dec-2026 for insurers. As we progress through the grandfathering period we expect issuers to take-out old-style instruments and issue new-style bonds. We expect banks to be more active in the near-term as the end of the grandfathering period is nearer and bonds are increasingly inefficient. Nevertheless we are also seeing insurers already optimizing their capital structure.
    • Therefore, these instruments provide “free optionality” for bondholders upon a take-out, as we have seen with Banco Santander, Commerzbank and Ageas very recently. All three we trading below par and either outright called at par or tendered above market levels.
    • For bonds trading above par, those with make-whole features remain highly attractive, as these will be taken out at significantly higher prices.
    • Despite the upside potential overall in the asset class, investors need to be conscious of the downside risk embedded in some instruments – and security selection is key. For example Lloyds 12% perpetual notes callable in 2024 offer a c7% yield in USD, however as these contain a regulatory par call and are trading at c122%, the yield upon a reg par call in Dec-2021 is only 1.4%, lower than an equivalent US treasury bond.
    • This is why investors need deep expertise on both regulation and analyzing bond structures (especially understanding the terms and conditions in the prospectus) on top of the in-depth bottom-up analysis of the issuer, to gain exposure to the asset class and find the best value across the capital structure.
  • 101. Clients would like two examples of legacy bonds issued from banks for which we are capturing strong capital gains from the repricing to the loss of eligibility for capital requirements

    Context: As we have been mentioning that we are experiencing strong capital gains from loss of eligibility and repricing to regulatory call, clients would like two examples (one in Eur and one in USD) of grandfathered bonds from banks

    Impact for the fund:Strong potential for further capital gains from regulatory call as these securities arelosing their capital eligibility under new regulatory regime and up to last year have been trading at high discount and can only be redeemed at 100.

     

     

    ING (NL0000113587)

    RBS (US780097AU54).

    Both these securities are reported as becoming ineligible post-2021 and as expected RBS announced the regulatory call at par for the above ISINs.

    The grandfathering of these securities started in 2013. However, regarding undated floating rate notes, the market only started accounting for the potential Liability management exercises (LME) post-2016. LME’s can be tender offers or calls at par. Moreover, we are getting closer to the end of the grandfathering period, and we therefore believe there is a lot of optionality regarding LMEs. For banks, this has been reflected by the recent calls of Banco Santander (the bonds were trading at 67% prior to the call at par) and Commerzbank (the bonds were trading at 95% prior to the call). In 2018, potential LMEs were not priced anymore. We do not expect to see this in the future. Due to the end of the grandfathering period, we expect to see more upside within these securities.

    Banks have been giving indications on how they believed their legacy securities would be considered post the grandfathering period. Those can be found within their Pillar 3 disclosures and have been published since a number of years. Those publications were done in accordance with the regulators, however there has not been any harmonization regarding these reports. The European Banking Authority will provide clarity on the treatment of these securities within the middle of 2020. We expect this to accelerate LME’s and therefore see significant upside going forward.

  • 102. Clients are asking details on the two positions we hold in Rabobank, how have them been performing and what’s our view on the new AT1 coco vs the old Certificate?

    Context: Tighter spreads YTD masks “hidden” opportunities across the capital structure, a practical example on Rabobank

    Impact for the fund:Diversify across the capital structure aloud to capture interesting opportunities with high potential for strong performances from technical and valuation standpoint

     

    We have been mentioning that current valuation levels are very attractive and we have been referring to the AT1 Cocos index to assess the valuation of the financial subordinated debt, despite this very interesting opportunities can be found along the capital structure, looking more in the specific to two examples from the same Issuer, Rabobank 4.625% (AT1 Cocos) and Rabobank 6.5% (Tier1)

     

    Rabo 4.625% (AT1 Cocos) is trading at ca. 320bps, so the Rabobank 6.5% (Tier1) is indeed really cheap at over 501bps (if the certificates were too tightening to 450bps, all else being equal the cash price would go from 127 to 141).

    The Rabobank 6.5% (Tier1) only really performed because of the rates down-movement, and not really because of spread tightening.

    This makes this security extremely cheap and very attractive.
    Moreover, it gives close to 7.5% income when hedged back to USD. Therefore, we believe the Rabobank 6.5% are extremely cheap.

  • 103. Clients asking a view of what to expect in the year to come based on what we experienced last year

    Context: What to expect in 2020 (analysis conducted for USD fund, but same rational to apply to GBP and EUR fund)

    Impact for the fund:Positive for the year with a base case for the USD fund of +9%, EUR fund of +8% and GBP fund of +9%

    What to expect in 2020:

    To understand what might happen in 2020, one has to look back at 2018-2019. Due to external shocks and starting from 1Q18 onwards, price of bonds held in the portfolio started to drop and ended in 2018 on average 14% lower (fund was down 8% during the year, having captured close to 6% income). Since that the price drop had not been driven by idiosyncratic events or credit deterioration from issuers held in the portfolio (by contrary, average rating year-on-year went up on notch higher to BBB+), we knew that 2019 would be a year of price recovery + income. We also mentioned that in theory, performance for the year could be +22% (price of the bonds had dropped 14% and due to the so-called pull-to-par, they would need to recover +16% to be break-even, then adding the 6% income = 22%) but that given political uncertainties related to Brexit and especially trade-war, our base case for the year would instead be “only” +12%. The fund outperformed this base case by 4% as we didn’t anticipate central banks to turn as dovish as they did during 2019.

    It also means that despite the strong performance in 2019, price of the bonds that we own still trade at ca. 6% discount to where they should be trading at….

    As we enter 2020, macro backdrop is very supportive. Central banks are highly accommodative/with a dovish bias, global growth has scope to start to surprise again to the upside/led by a cyclical recovery and interest rates have scope to remain low for longer. What it means for fixed income investors: a very supportive backdrop and 2020 has scope to look like 2017, or a vintage year for bond investors (fund was up 12.6%).

     

    2020 Performance outlook

    Base case for the USD fund of +9%

    Base case for the EUR fund of +8%

    Base case for the GBP fund of +9%

     

    We feel that this is once again a conservative base case, as assuming ca. 2/3 of the performance stemming from income (5.5% gross contribution for USD fund & 4.5% for EUR fund) and only 1/3 stemming from capital gains (3.5% gross contribution). Given the supportive backdrop – contribution from capital gains could easily be 6% instead of 3.5%.

    Furthermore, the USD fund has 35% exposure to grandfathered bonds i.e. bonds that have been issued for regulatory purposes under Solvency 1/Basel II and that don’t fully comply with new capital requirements set by Solvency 2/Basel III. In a nutshell, very expensive/inefficient bonds for issuers, but extraordinary investment opportunities for investors. For example, almost half of the grandfathered bonds that we own in the fund trade at an average price of 77%. As these will be tendered at a higher price or called at par, these should over the coming quarters generate close to 4% additional capital gains for the fund.

  • 104. Clients asking some details on the results of the UK Stress Tests

    Context: The Bank of England released the results of their annual stress test exercise for UK Banks.

    Impact for the fund:The results revealed that UK banks are robust and capable of withstanding a severe stress (much worst than a disorderly Brexit) and rock solid capital levels have increased the overall resilience of the financial system.

     

    Bank of England Stress Test

    The Bank of England released the results of their annual stress test exercise earlier this month. Overall the results revealed that UK banks are robust and capable of withstanding a severe stress and rock solid capital levels have increased the overall resilience of the financial system. All banks passed the stress test, and no bank needs to take remedial action. On Aggregate banks’ core equity ratios (CET1 ratio) would fall by 520bps to 9.3% under the stress scenario, well above the hurdle rate of 7.5%, with no banks’ individual capital positions falling below 8.5%.

     

    The stress scenario used by the Bank of England, is designed to simulate a true “apocalypse” scenario. This is indeed more severe than the global financial crisis, with for example world GDP declining by 2.6pp (1.2pp during the financial crisis) or residential property prices declining by 33% (17% during the financial crisis). At 9.3% CET1 ratio at the low point of the stress scenario, UK banks would still have more than twice the amount of equity buffer than in 2007. This reflects the strong capital accumulation (CET1 ratio c3x higher than pre-GFC) as well as the strong de-risking of banks’ business models towards low-risk activities such as retail mortgages. As bondholders this is highly positive as there is a higher amount of equity buffer to absorb losses that would be significantly lower than that experienced during the GFC.

     

     

    In the face of geopolitical uncertainty (Trade wars, Brexit etc.), bondholders can take great comfort from the very strong performance of banks in the stress test. Nevertheless, it is paramount to keep in mind that the stress test is designed to reflect an unprecedented extreme stress scenario. In particular, there have been some amalgamation between the stress test and Brexit – where in our view even a disorderly hard Brexit impact would be nowhere near the stress test impact. Fortunately the Bank of England, that has previously been vocal about the fact that the stress test is in no way designed to reflect a Brexit scenario, has disclosed an estimated impact of a disorderly Brexit. While the stress test impact is above 500bps of capital drawdown, the Brexit scenario leads to c200bps of capital drawdown – significantly lower impact. Under the disorderly Brexit scenario the average CET1 ratio of banks would remain well above 12%, very strong.

     

     

    For UK issuers held in our Fund – mostly the UK-domiciled global banks (HSBC, Standard Chartered) and national champions (Lloyds, RBS, etc.) the results of the stress test support our positive view of the European financials sector underpinned by ever-stricter regulation. Banks have significantly increased their capital positions and de-risked their business models – leading to higher capacity to absorb losses and lower potential losses in a stress. Furthermore, any impact from current geopolitical issues such as Brexit are highly manageable for our issuers, even in a tail risk scenario (not our base case). We have strong visibility on the future path of capital accumulation over the coming decade – with Basel IV due to be implemented from 2022 to 2027, again setting the bar for capital requirements higher, a continuation of the strengthening of European financials’ fundamentals. Despite the strengthening of fundamentals, we continue to capture extremely large spreads and yields on high quality issuers in our fund, with spreads of more than 400bps in GBP.

  • 105. Why is there a difference in performance between the EUR and USD Funds

    Context: Different Interest rates levels and valuations of EUR vs USD sub debt result in an outperformance of the USD fund over the EUR fund

    Impact for the fund:The USD fund outperforming EUR fund by 1.5% – 2% per annuum

    The difference in performance between EUR and USD fund is mainly due to two key drivers: difference in income & valuations

    • Difference in income – broadly 1.5%-2% per annum is due to interest rate levels
    • Valuations, as prices of subordinated debt in EUR have not recovered to the same extent as in USD (see chart below)
    .

     

    What catalyst could make spreads for EUR securities converge toward USD one (i.e. which would mean EUR fund outperforming USD fund)? We feel that with Trade war concerns receded (Phase 1 deal signed) – economic activity is likely to pick up and PMIs (especially that of export-oriented economies such as Germany) are poised to improved, indicating a cyclical recovery for the Eurozone. In our view this would lead to EUR-denominated subordinated debt outperforming.

     

     

    As an example, in 2017 – the EUR fund outperformed the USD fund (see chart below) despite lower income yields in EUR, reflecting the outperformance of EUR-denominated sub debt.
    This was driven by an improving macro picture – with a strong improvement in manufacturing PMIs and GDP growth rising to 2.5%.

     

     

  • 106. We have been asked what is the impact for Credit Opps concerning the ECB and other Central Banks recent action

    Context:Considering the recent action from central banks, what is the view in the context of the GAM Star Credit Opportunities

    Impact for the fund: No change

    Earlier this week we sent a note in which we said as managers are becoming used to periods of turbulence. As bond mangers our focus is on credit quality, the ability of our companies to continue to pay coupon and return capital. Our view was that :

     

    • Credit risk : remain resilient, average ratings of issuers BBB+ i.e. high quality many of which have been stress tested under Basel III or Solvency 2 to be able  to absorb such external shocks

     

    • Interest rate risk: no changes as we have positioned the funds to have low sensitivity to rates

     

    The central bank meetings today support our view. Christine Lagarde’s comments and measures of support/provide liquidity and extend TLTRO as well as increase of QE (from EUR 240bn to EUR 360bn for 2020). In the UK and the US there has also been co-ordinated fiscal and monetary support to help businesses and individuals ride out the pandemic. If China and South Korea are examples the spread of the virus starts to slow after four to six weeks and economies are beginning to go back to work.  While we are in the eye of a storm of mass hysteria about the extent of economic slowdown and uncertainty of how to price earnings, we do know  as  mentioned above that banks and insurance companies have been stress tested  to ride out extremely severe downturns, scenarios which are double the severity of the financial  crisis and  which did not factor in government support that we have just seen. We have mentioned many times to investors in our fund, that the regulator-imposed multi-year capital since 2012 of strengthening of balance sheets has given us a very strong financial sector designed to cope with serious downturns.

    In summary, from a credit perspective, despite pressure on prices, with large buffers to protect bondholders and government action now being implemented our credit view remains positive.  Current level have become extremely attractive, just looking at coupon income, and without factoring in price recovery.

     

  • 107. Client is asking what is the investment team credit risk policies concerning derivatives?

    Context:The usage of derivatives is bearing some counterparty risk; how does we evaluate that?

    Impact for the fund:No impact

    The fund uses derivatives for currency hedging purposes only, with no use of derivatives for interest rate or credit risk hedging purposes. For currency hedging – we use a panel of top-tier banks (US G-SIBs) to enter into forward contracts, including State Street – our custodian. For each FX forward trades, collateral is posted which significantly reduces the counterparty credit risk. For forward contracts entered into with State Street, no collateral is exchanged as they are our custodian.

    In any case, credit risk of derivatives counterparties is mitigated by the collateral received as well as the high quality of the counterparties. Furthermore, all derivatives counterparties are covered by analysts as part of the investment process and therefore their fundamental credit risk is closely monitored by the investment team which further mitigates the credit risk.

    As with the issuers we own in the fund, if there were to be a deterioration of credit quality of our derivatives counterparties, appropriate action would be taken to reduce exposure to these – following our investment process.

  • 108. We have been asked our view on current market situation in regard to the Credit Opps and the subordinated debt market

    Context: Considering the risk-off created by the incertitude and headlines on the covid-19, this remains a non-credit event for the GAM Star Credit Opport

    Impact for the fund: Temporary risk off / non-credit event

    Credit strength remains strong  for  our issuers,  and while the current crisis will affect profits across the economy we view the impact of the coronavirus as having a minimal impact on credit quality for our holdings and our base case remains that economic weakness arising from the virus should be temporary.

    By “non-credit event”, what we mean and especially looking at the banks is that the potential increase in NPLs, cost of risk, etc due to covid-19 should have no impact on the credit quality of issuers held in the fund as base on current information and backed by stress-tests conducted by regulators, it can be organically absorbed by pre-provision income as well as the excess regulatory capital if needed.

    With our focus on balance sheets rather than earnings , the financial sector has  been forced by regulators to stress test  against scenarios far worse than the financial crisis and the result of stress tests conducted from the ECB and more recently from the Bank of England revealed that the financial sector is robust and capable of withstanding severe stress and rock solid capital levels have increased the overall resilience of the system. Furthermore, the stress tests did not include government or central bank support, which we have seen this week.

     

    For this reason, while not being complacent and being very selective on which companies we hold,  we remain very constructive on the funds’ ability to both capture the high and steady income  and for our companies to ride out the downturn in economic activity with credit intact as well as benefit from price appreciation from this point.

    We continue to be well positioned in mainly national champions – with no exposure to Italian banks.

    Valuations:

    Current spreads on AT1 are above 550 vs 300 in Jan20 and our credit view remaining resilient on the underlying issuers that have just seen an improvement in their capital strength arising from the multi-year process of capital strengthening imposed by the regulators. We note that current valuations, offer an extraordinary opportunity to capture a high steady income of more than 5.5% on a YTW basis from the strongest issuers of the financial sector, in an environment of negative rates where currently more than 14trillion are returning a negative yield.

    Strong fundamentals:

    We have reached the end of the earnings season and we continue to observe strong operating performances and rock-solid balance sheets.

    Overall the tier 1 common capital (CET1) ratios of banks increased, while non-performing loans (NPLs) continue to decrease showing the strength of the overall financial sector and the results achieved by the multi-year process of capital strengthening put in place by the regulator. For insurers, we have also seen strong solvency ratios while we anticipate weaker earnings for the next few quarters, as mentioned above, balance sheets are strong enough to ride out a very severe economic downturn

    Outlook:

    Unchanged, despite negative price movement due to the last days price drop from risk off situation arising from the panic on Covid-19, YTD the “EUR” fund has already accrued 0.85% from income

    Bank earnings remain under pressure from low interest rates, negative headlines on Covid-19 and geopolitical uncertainty – which has resulted in an overall negative equity price reaction

    From a credit perspective, despite a temporary pressure on prices, with larger buffers to protect bondholders and government action now being implemented, our credit view remains positive

    We have managed this fund and its precursor fund through many crises, 9/11, 2008/9, European crises in 2011 and 2016, or travel shutdown after the Iceland Volcano in 2010. And in each case our emphasis on strong credit quality and the continuing capturing of income leads, after initial panic, to a pull to par and our fund recovering when the market reverts to pricing on fundamentals.

  • 109. Clients are asking details on the investment process we follow and if we apply an initial screen based on yield.

    Context:Understanding the four steps investment process and how we evaluate the holdings we invest in

    Impact for the fund:The investment philosophy of Atlanticomnium in the process leading to the investment decisions

    When analyzing potential investment ideas, we conduct a detailed process to ensure that the potential bond fits our strict criteria
     

    This starts with detailed analysis of the issuer (analysis of financial statements, meeting with senior management, etc.) to identify conviction issuers that are consistent with our investment philosophy of capturing high income from bonds of very high-quality issuers. Once we have identified high-quality issuers that fit our criteria, we analyze the instrument itself (understanding the capital structure, term and conditions of the bonds, regulation etc.) to understand the potential upside and downside risk and the attractiveness of the bond structure. When we have identified the attractive bond(s) of high conviction issuers, we then look at valuations to ensure that the bonds add value to the portfolio. We look at a range of indicators such as yields, spreads, potential for price appreciation, volatility. We do not have a pre-defined yield or spread level under which we do not invest, as this depends on market conditions (level of interest rates, spread levels in the market, etc.). However, we will only make investments that make sense in our portfolio context, following the investment philosophy of capturing high income in high quality issuers.

    Finally, we constantly review the portfolio, adding issues that complement the existing holdings, based on relative value and on a risk-adjusted basis. We consider the management of credit risk to be of prime importance. The rigorous bottom-up approach to choosing companies and issues in which to invest embodies very careful consideration of both the return potential and risk of each credit investment throughout the investment process. To this end, the fund managers closely monitor daily changes in:

    – Average credit rating across each fund
    – Individual credit ratings and how they influence investor behavior
    – Prices of both the bonds and their related stocks
    – Relative positions between similar instruments and ratings
    – Liquidity across each fund and of individual positions
    We maintain a strong focus on liquidity throughout the investment process, with the majority of
    holdings within the portfolio typically classified as very liquid or liquid. Liquidity risk is further mitigated by diversification across a large number of positions of different types such as fixed, fixed to floating, floating
    senior, junior, higher coupon and lower coupon bonds which each behave differently from one another
    with the aim to always own some holdings that will be attractive to buyers at different times and in different market environments. Furthermore, the investment team monitors daily liquidity changes closely across the funds as a whole and of the individual underlying positions.
  • 110. Client is asking what the Oil sector exposure for the Credit Opps is

    Context: Concerning the recent drop in oil prices what is the fund exposure to this sector

    Impact for the fund: Non event

    Out of the 3.51% (USD fund) & 2.6% (EUR fund) exposed to Oil&Gas, 2.7% for the USD fund and the whole position for EUR fund is within Trafigura. Trafigura is oil-price neutral and actually benefits from volatility on oil price as well as the fact that the market has turned into contango.

    The remaining exposure or the USD fund is divided between Puma energy holding and Gran Tierra which from the credit standpoint are both quite decorrelated from oil prices and we feel very comfortable with their fundamentals, more in the specific. The 0.09% in energy related is a company involved in renewable energy and not related to the oil price.

     

  • 111. We have been asked our view on potential and timing for CET1 easing going towards 2020 and if yes what might be the implication for the funds

    Context:Regulatory changes are on-going and Pillar 2 Requirement that for European Banks must be met only with equity (i.e. CET1), will going forward be met with CET1, AT1 cocos and Tier 2. While this creates a on-off capital relief for European banks of ca. 90bps, this doesn’t change the trend of more capital and further de-levering, which is very supportive for subordinated debt holders.

    Impact for the fund:No impact as this would be more an equity story

    If related to Pillar 2 Requirement (P2R): Yes, this creates a capital relief Andrea Enria of the ECB Banking Supervision or SSM has been very clear on that:
    https://www.bankingsupervision.europa.eu/press/speeches/date/2019/html/ssm.sp191212~10d96807c3.en.html
    “When considering the impact of Basel III, we should also consider recent legislative changes that will lead to more lenient requirements. For instance, the Capital Requirements Directive V contains new rules on the quality of capital for Pillar 2 requirements, which will impose a change in the policy the ECB has pursued until now – that of focusing only on Common Equity Tier 1, or CET1 for short. When this change was being negotiated, ECB Banking Supervision and the European Parliament voiced their concern about this change, warning that high quality capital was essential. According to our calculations, the change will generate an average reduction in CET1 requirements of 90 basis points, as banks will be able to rely on lower quality additional Tier 1 and Tier 2 capital, which is now available at favourable conditions.”

    What is the SSM saying: Pillar 2 Requirement (P2R) that until now had to bet met only with equity or CET1 can, with the upcoming redefinition of P2R under Capital Requirement Directive 5 (CRD5), be met with a split of equity and sub-debt i.e. 56% CET1, 19% AT1 and 25% T2. This will create a capital easing of ca. 90bps or ca. EUR 30-40bn.

    Timing should be around JAN22, earliest.

    Looking at the bigger picture: this is not really an easing. Namely, implementation of revised-Basel III (so-called Basel IV) should start to kick in in 2022 too, which will lead to a gradual increase in risk-weighted-assets, offsetting this one off and up-front boost in excess capital. Another element to take into account is that banks will not be able to double count their CET1 between P2R and P2G (Pillar 2 Guidance).

    If so, what is the potential implication for AT1/ T2 performance, and in turn, their fund performance

    This is more an equity story (on margin positive) and is neutral for bond holders. We expect the performance of the fund to be strong, independent of impact of the revision of P2R, as indicated by our base case of +9% for the year. Additional info can be found in the Jan Spotlight that will be attached to the monthly comment

  • 112. Client is asking what is our view concerning the non-call of the 6.25% DB AT1 coco

    Impact for the fund: No change

    First of all to be considered that we don’t have exposure to AT1 cocos of DB and we had already communicated to investors few months ago that in our view the call action would have not been exercised by DB on this particular Coco outstanding.

    On DB not calling:

    • DB had confirmed many times in the past that call decisions would be made on an economic basis. Therefore it is not a surprise to us given (i) where this bond is trading now and the high refinancing cost related and (ii) the >EUR200m FX cost it would have cost DB to call (as this bond is equity accounted and therefore not hedged)

     

    • When investing in this kind of bond (perp with NC period and therefore reset at floating rate) we always pay attention to the back-end level (meaning the spread above the reference rate at which the bond reset post the first call). If in our opinion the spread is not high enough and therefore it increases the likelihood of the bond not being called (i.e. maybe more volatility close to the call period) then we don’t invest. But it is to be noted that when we invest we always make sure that we are comfortable as well with the yield to maturity level as we cannot control the call decision. Also, to be noted that the periodicity of call option post the first call date has its importance (callable quarterly, annually or every 5 years post the first call date).

     

    • As mentioned the non-calling of the AT1 was not unexpected and we don’t see a reflection of extension risk for the remaining of the asset class as reflected by the graph below where we compare the reaction of the AT1 6.25% DB vs the US coco index and some of the biggest positions in AT1 cocos we hold in our USD fund

     

     

  • 113. We have been asked by a journalist from Bloomberg our view on the current strength of the AT1 coco market

    Context:During 2019 and beginning of 2020 many subordinated bonds from financials, among others, AT1s bonds have reported strong rallies

    Impact for the fund:Strong performance from capital gains which we expect to continue going forward

    Clearly the tone in markets has been very strong in 2019 and into 2020 with positive sentiment driving the rally in AT1s – and as there was a significant re-pricing to call, bonds with lower reset spreads benefitted greatly from the move. However, there is also a rates component in the AT1 rally, for example the UBS 5% is still trading more than 100bps wider (in spread terms) than when issued (factually – not expressing any view on the bond itself), even though prices have recovered towards par.

    On the AT1 market, we remain very bullish, as valuations remains highly attractive in a very low rates environment, while the macro environment has turned more supportive vs. 2018 (geopolitical issues have receded, well positioned to see a cyclical recovery in the EuroZone economy). For example, in EUR AT1s we are capturing spreads above 320bps – more than 100bps pick-up compared to BB high yield.

    That being said, we remain highly selective, both in terms of bond structure (i.e. avoiding new issues with very low reset spreads that will be more vulnerable to volatility) and issuer – where we think best value remains in the very high-quality national champions. As the market has been very strong this has paved the way for weaker issuers to come to the market at favorable conditions. Despite the relatively high yields, the downside risk of investing into lower quality issuers can be significant – especially those with asset quality issues, as we have seen in the past with Banco Popular, where AT1 CoCos and Tier 2s were written down to 0.

  • 114. Client is asking a view on the new issued AT1 cocos and if we participated in any of the new deals or not

    Context: Low back end AT1 cocos bears a higher extension risk than high back end one

    Impact for the fund: Positive as we are not taking exposure to bonds bearing a high extension risk

    View on most recent AT1 cocos (“newer vintage”): not for us and not now – especially not at current prices. The combination of low spread at issuance (so-called back-end) and longer call dates makes this new vintage highly convex i.e. in a weak market, price of these could easily drop more than 10 points should investors start to reprice these AT1 cocos from next-call-date to maturity as we have experienced during 2018.

    Just to give an example, the most recent 4.5% BNP Perp was issued with a spread of 294bps. On the risk off sentiment created by the Covid-19, Spreads on AT1 cocos already widened to almost 440bps (+140bps) and for this particular bond at the current level of 400bps. This means that for bonds such as the 4.5% BNP Perp which is currently trading on a next call date basis, should investors reprice it on a YTM basis, and for the same level of spread, price of the bond should drop from 94 to 84.

    On the same assumption we have not participated in some of the new issuance of AT1 cocos like the 5.1% CS Perp issued in January this year, the 4.875% ING Perp and the 3.875 UCGIM Perp both issued end of Feb this year.

     

  • 115. What is the structure of the team that manages the strategy (portfolio management, research, trading and risk management

    The fund managers are jointly responsible and have input into portfolio management, research, trading and risk management decisions. Each manager conducts his own bottom-up, fundamental credit research on promising issues and bonds, which they then discuss together and agree how to apply to the portfolio. Anthony Smouha tends to have a dominant influence on the top-down portfolio positioning.

    The investment team, which includes the co-fund managers, analysts and dealer, are supported by Atlanticomnium’s Investment Committee, which meets formally on a weekly basis, and comprises – besides the investment team – , the risk manager, compliance manager and UK CEO Jeremy Smouha, who managed bond funds in GAM for over 12 years. They benefit from other internal resources as represented below.

    Atlanticomnium’s Organisation chart

    Source: GAM a *external service provider s at 30 June 2019.

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP

  • 116. Client is asking what has been issued in the RT1 space and on what name we have been investing/added lately?

    Context: New RT1 bonds have been issued in the market and this securities offer very attractive yields holding less risk than AT1 Cocos issued by banks

    Impact for the fund: An attractive asset class where the Credit Opps is one of the few peers invested

    In a nutshell:

    • RT1s are new-style subordinated bonds issued by insurance companies under the Solvency II regulatory framework
    • Similar structure to bank AT1 CoCo (junior subordinated, non-cumulative coupons, write-down/conversion of solvency falls below a certain level)
    • Nevertheless, RT1s are less risky for investors as (1) compared to AT1 CoCos, coupon risk is much lower as coupons are only cancelled if minimum Solvency requirements are breached (no MDA level like for banks), and (2) there is no bail-in framework for insurers, which limits the tail risk of bonds written down to zero like we have seen with Banco Popular.
    • Valuations on Insurance RT1s offer more than 100bps spread pick-up compared to AT1 CoCos despite a better structure for bondholders and extremely solid fundamentals. Therefore, very constructive top-down view on the product.

    In terms of latest names added:

    • Ageas 3.875% RT1, perpetual callable in 2029, issued in December 2019. Yield of close to 4% in EUR (equivalent to c6%+ in $) and spreads of close to 400bps, highly attractive for a high quality issuer and BBB-rated bond.
    • Ageas, the leading Belgian insurer, with a Solvency ratio of 199% as of 3Q19 (or €4bn excess capital), strong operating performance with a c11% return on equity (strong ability to generate capital organically). Strong fundamentals and therefore positive view on the issuer.
    • Bond has returned more than 7% since it was issued, remains very attractive

     

    For our a detailed insight into Insurance RT1s, please see our article (https://www.gam.com/fr/our-thinking/investment-opinions/a-guide-to-the-rt1-market).

  • 117. Who is responsible for managing the portfolio and how are decisions made (unanimous, majority, individual)?

    The GAM Star Credit Opportunities funds are managed by fund managers Anthony Smouha, Gregoire Mivelaz and Patrick Smouha of Atlanticomnium. The fund managers make decisions jointly and will abstain from making an investment if there is no shared conviction. The fund managers are supported in their decisions by the Atlanticomnium’s Investment Committee.

  • 118. We have been asked why the performances of the fund are trailing to the Bloomberg Barclays AT1 CoCo Index

    Context: The EUR fund has been performing differently than the USD fund when compared to the Bloomberg Barclays AT1 CoCo indexes EUR and USD respectively

    The difference in performance between the EUR fund and USD fund when compared to the AT1 coco EUR and USD indexes respectively are mainly due to the higher proportion of high beta names in the EUR AT1 CoCo Index. While the USD AT1 CoCo index is dominated by the higher quality names that we hold like HSBC, UBS, CS, etc (and therefore is a closer proxy of the AT1s we hold in the USD Fund), over the past few years we have seen more lower quality/higher beta issuance in EUR AT1 CoCos. In particular this has been either smaller names or peripheral names (Italy/Spain), of which we have obviously stayed away from given the weaker fundamentals (15% of the index is now Italy and 28% Spain). Nevertheless, as sentiment has been very strong, these names have outperformed the higher quality names. For example, see the chart below comparing the performance of a few second-tier peripheral names (Banco BPM, an Italian bank or Bankia a Spanish Bank) against Rabobank or HSBC. As these weaker names in the Periphery are more exposed to idiosyncratic events as well as political issues (Italy for example) – this can lead to very poor outcomes for bondholders (Banco Popular for example) as well as very high volatility (see the chart of Monte dei Paschi’s Tier 2 falling to 45% in early 2019).

     

     

  • 119. Please characterise your strategy in terms of:

    Investment Objective : The fund seeks to achieve high income generation with capital appreciation
    from investing in bonds of high quality companies

    Asset Class Fixed income – Specialist credit / Corporate bond

    Benchmark For performance comparison purposes only, each of the funds uses the relevant Barclays Aggregate Corporate Total Return Index in USD, EUR and GBP

    Investment Universe Publicly quoted corporate bonds of any credit quality issued predominantly
    by investment grade companies, with a particular focus on the financial sector and specialist areas such as undated, floating rate and fixed-tofloater debt instruments

    Number of Holdings Each of the three GAM Star Credit Opportunities funds is highly diversified
    to a level suitable to the characteristics of the underlying markets in which it
    invests, typically hundreds of securities.
    Portfolio Concentration Approximately 30% of portfolios in top 10 issuers
    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 5

    Maximum Position Size UCITS limits  Maximum 10% of NAV in transferable securities and money market
    instruments issued by the same body subject to the 5/10/40% rule. There are higher limits for the likes of government issued or
    guaranteed securities and also for deposits. Maximum 10% of the debt securities of any single issuing body

    Liquidity The majority of instruments are liquid or very liquid, in line with daily dealing
    of the funds. The investment team estimates that the majority of each fund
    could be liquidated in a few days without adverse price impact.

    Instrument Types Used Mainly corporate bonds, with limited exposure to convertibles, derivatives
    (currency forwards only) and cash

    Hedging Able to use currency forward contracts to hedge the currency risk of nonbase currency assets. Derivatives have not been used to hedge interest
    rate risk as inclusion of fixed rate and floating rate bonds provides natural hedge.

    Leverage (Typical Gross / Net Exposure) The funds do not borrow to invest and do not leverage their positions to generate a notional exposure in excess of their NAV.

    Duration There is no duration target.

    Volatility There is no volatility target.

    Source: GAM

    There is no guarantee targets will be achieved.

    Please note these are internal guidelines only. The mentioned financial instruments are provided for illustrative purposes only and
    shall not be considered as a direct offering, investment recommendation or investment advice. Allocations and holdings are subject
    to change Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 6

  • 120. We have been asked what the impact of the Covid-19 virus on the Credit Opportunities Fund is

    Context: Considering the risk-off created by the headlines on the corona virus this remains a non credit event for the GAM Star Credit Opportunities

    Impact for the fund: non credit event

    Impact of Covid-19 on our funds: from a credit standpoint and given current information – credit neutral. Our base case remains that economy weakness arising from the virus should be temporary and front-loaded. In the meantime, this will force central banks to remain highly accommodative, with a side-effect of a strong search for yield. as indicated by negative yielding debt at USD 14tr or an increase of 3tr YTD. Obviously, coronavirus is not neutral in terms of earnings growth as well as a potential disruptor of supply chain (bad news for certain sectors/corporates, HY, etc.), but once again, we expect this to be temporary. Furthermore, we expect sub-debt from financials to be somewhat immune given the combination of high steady income, strong fundamentals, supportive technical and last but not least appealing relative value.

    View of recent sell-off/reason for the slight correction: while we expect impact of Covid-19 to be credit neutral for issuers held in the fund, price of the bonds held in the fund have not been completely immune by the sharp sell-off that took place in other markets this week (for example, EU equity that dropped double digit this week) and on average price of bonds held in the fund have decline on average between 2-2.5%. We feel that this price weakness should be short lived and would expect price to quickly recover. Furthermore, we are not changing our base case of +8 for the EUR fund and +9% for the USD/GBP fund – especially given the high level of income that the funds are capturing.

     

    In addition, concerning the pandemic risk from a credit standpoint, the reinsurers sector is the one that could potentially be mostly impacted.

    For this reason, looking through the disclosures of Reinsurers, expectations for the impact of the Coronavirus to be very manageable. An example could be Swiss Re which discloses explicitly the impact of pandemics modelled in their capital planning (1/200 year event VaR type).

    Below is from Swiss Re’s FY17 disclosures (similar as of FY18) where the impact on STT of 1 in 200 years pandemic event would have a c16pp impact on the group’s Solvency – which currently stands at 251%, or a large $24bn excess to requirements (Swiss SST basis). In monetary terms the group models a $2.8bn loss from a 1/200y lethal pandemic event.

     

     

    Secondly, Scor reports that in their Solvency II capital planning they use a 1/200-year pandemic scenario with >10 millions death in the general population compared to close to 3k currently. Scor had a SII ratio of 226%, well in excess of the 100% requirement, or €6bn.

    Even when looking at the most exposed sector for the impact of the Covid-19 this event remains extremely manageable from a credit prospective

  • 121. What are the key strengths of your investment strategy?

    The investment team’s primary strength is their different view on bond investing: safe investment grade companies have low default risk which extends to both senior and junior debt, but junior debt pays more income and allows more nimble interest rate exposure management. This asset class of hybrid and junior subordinated debt offers a rich and growing opportunity set as companies increasingly use them as a lower cost alternative to raising equity. However, many investment guideline constraints and required expertise to analyse the specific features of prospectuses means that only a certain set of market participants can invest in them. The fund managers harness not only the higher yield these bonds pay, but also their unique features, such as being undated, floating rate or fixed-to-floater debt, to calibrate their portfolios’ interest rate exposures over the market cycle.

    1 The full legal names of the funds are GAM Star Fund plc. – GAM Star Credit Opportunities (EUR), GAM Star Fund plc. – GAM Star
    Credit Opportunities (USD) and GAM Star Fund plc. – GAM Star Credit Opportunities (GBP).
    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 2
    The managers have a clear focus on income as well as price, instead of on price alone and a buy and
    hold bias meaning that over the long term, incremental payments of coupons add up, contributing
    significantly to total returns – which is a much more reliable approach than depending on favourable bond
    price movements or trading in and out to drive performance.

    The managers’ approach to credit analysis is also different: they take a holistic, total return approach
    when deciding which bonds to buy. With their buy and hold bias, they believe the traditional ‘credit analyst
    mentality’ of examining payoffs if the company defaults is only one side of the story. Given their flexibility
    to invest in different levels of the credit structure, they also consider carefully what payoffs different bonds
    will provide if the company thrives, to get a clear view on the potential upside.

    Finally, the investment team’s non-benchmarked approach ensures their efforts focus solely on areas
    where they see the best opportunity, for instance in financials. It has also enabled them to cultivate deep
    expertise in the sectors and companies that tend to issue hybrid debt. This freedom to invest according to
    conviction has produced a compelling alternative approach to traditional high income bond investments.

    Focus on income

    Historical rolling annual accrued income for GAM Star Credit Opportunities (USD) since inception:

    Source: GAM as 30 June 2019.

    Past performance is not an indicator of future performance and current or future trends. The gross performance does not include the
    effect of commissions, fees and other charges, which may have a negative effect on the net performance.
    Rolling annual accrued interest is calculated based on summing the quarterly figures as opposed to compounding.
    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 3

    Historical rolling annual accrued income for GAM Star Credit Opportunities (EUR) since inception:

    Source: GAM as 30 June 2019.

    Past performance is not an indicator of future performance and current or future trends. The gross performance does not include the
    effect of commissions, fees and other charges, which may have a negative effect on the net performance.
    Rolling annual accrued interest is calculated based on summing the quarterly figures as opposed to compounding.
    Historical rolling annual accrued income for GAM Star Credit Opportunities (GBP) since inception:

    Standard due diligence questionnaire for GAM Star Credit Opportunities funds : USD, EUR and GBP 4

    Source: GAM as 30 June 2019.

    Past performance is not an indicator of future performance and current or future trends. The gross performance does not include the
    effect of commissions, fees and other charges, which may have a negative effect on the net performance.
    Rolling annual accrued interest is calculated based on summing the quarterly figures as opposed to compounding.

  • 122. What is your competitive advantage?

    The strategy’s key competitive advantages are:

    1. Highly experienced, corporate bond specialist team with three co-fund managers who have a combined investment experience of 60+ years, supported by a team of analysts and strong dealing
    capability.
    2. Clear focus on and track record of minimising default risk while maximising total returns
    3. Fundamental credit analysis expertise and experience to benefit from the growing diversity in companies’ capital structures
    4. Freedom and flexibility to pursue opportunities in under-researched, income-generative segments of
    the USD, EUR and GBP corporate bond markets.

     

     

     

  • 123. Give a brief overview of the strategy

    The GAM Star Credit Opportunities funds1 are corporate credit funds that seek to generate steady, strong income for investors. The managers’ approach is driven by the fact that investment grade companies rarely default, so by extension their junior debt rarely defaults. They use their extensive credit analysis experience to select junior or subordinated bonds of quality companies, capturing the higher yields on offer while benefitting from the low credit default rates. The result is a diversified, liquid portfolio which includes investment grade and non-investment grade, fixed and floating, senior and subordinated debt issues and has produced a track record of steady high income. Compared with other higher yielding fixed income strategies that source their yield from the debt of risky companies (e.g. junk bonds) or risky countries (e.g. emerging market debt), it is a compelling alternative.

    The three GAM Star Credit Opportunities funds are UCITS vehicles that each invests in bonds of different base currencies – EUR, USD and GBP – which were launched in July 2011. All three funds follow the successful investment strategy which has been managed by independent corporate bond specialist (Atlanticomnium) for over 30 years. Atlanticomnium has been managing assets for GAM since 1985 and are authorised and regulated by FINMA in Switzerland and the FCA in the UK.

  • Please read this important legal information before proceeding.

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    The material contained herein is aimed at sophisticated, professional, eligible, institutional and/or qualified investors/intermediaries who have the knowledge and financial sophistication to understand and bear the risks associated with the investments described.

    The information is solely product-related and does not take into account any personal circumstances and does not qualify as general or personal investment recommendation or advice. In particular, the information is given by way of information only and does not constitute a specific legal offer for the purchase or sale of financial instruments. Moreover, nothing contained herein is constitutive of any tax advice.

    Every effort has been made to ensure the accuracy of the financial information herein but the information contained herein has not been independently reviewed or verified. Therefore, Atlanticomnium SA gives no assurance, express or implied, as to whether such information is accurate, true or complete and no responsibility is accepted by Atlanticomnium SA for any errors or omissions. Third-party content is the property of its respective provider or its licensor and is protected by applicable copyright law.

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