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
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
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
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:
3. Market inventories
4. Impact of new supply on secondary issues.
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.
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
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
||Management and monitoring tool
||Risk from uneven distribution of
positions across a small number of
individual issues, companies or
|Portfolio diversification, with individual
positions restricted to 10% of an issue
and 10% of the fund, daily reporting
||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
|Foreign exchange risk
||Risk of the value of an asset
denominated in a foreign currency
depreciating against the base
|Hedging typically through the use of
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