Most fixed-income managers attempt to enhance returns through a combination of (1) credit risk, (2) interest rate duration risk and/or (3) liquidity risk, and engage in very little genuinely “active” investing. We define active strategies as those that seek to identify assets that are cheap relative to rigorous quantitative assessments of fair value and which have a high likelihood of converging back to fair value and thus furnishing capital gains.
Australian fixed-income investments tend, as a result, to be very “hold to maturity” in their focus with negligible secondary trading of mispriced assets to produce risk-adjusted alpha. If an investor is hold-to-maturity, they by definition are assuming there is no credit risk and are not concerned about capital volatility. This probably explains why allegedly “active” fixed-income managers have (1) been systematically unable to beat the AusBond Composite Bond Index benchmark and (2) employ so few analytical resources.
By way of contrast, CCI is distinguished in several ways:
- CCI has an unusually large team of portfolio managers and analysts with significant experience in the fixed-income markets. Key members all have equity exposure to the business to maximise alignment and longevity (see bios).
- CCI has proven itself to be a very active trader in secondary markets with since inception alpha generation over the last 6 years through buying cheap assets and selling them at higher prices. CCI is not, as a result, a passive hold-to-maturity investor.
- CCI retains the flexibility to go to 100% cash in its mandates because it is an absolute return investor that dynamically allocates capital between pure cash (deposits) and credit based on sophisticated relative value assessments. This is borne out in its historical cash (credit) portfolio weights regularly rising to 80% (20%) and vice-versa depending on valuation conditions.
- CCI undertakes rigorous bottom-up quantitative asset valuations, which are surprisingly rare in domestic fixed-income, to price assets based on (a) the issuer’s financial characteristics, (b) the asset’s capital structure position, and (c) statistical estimates of the probability of default, loss given default, and hence expected loss in light of (a) and (b).
- Concurrently, CCI also utilises top-down, regression-based valuation models that assume current market prices are correct and price assets based on their individual characteristics, including the credit rating, maturity, liquidity, capital structure position, industry sector, and the terms of the security in question. These top-down statistical valuation models have very high explanatory power and are used to identify day-to-day anomalies in secondary asset pricing, and to inform CCI about the correct valuations of new primary issues.
- A final suite of quant techniques used in CCI’s investment process are econometric rating models that evaluate the relationship between historical credit ratings and individual issuer financial data to enable CCI to objectively rate any given target company or security based on its hard financial information/performance. These models are useful for informing CCI of situations in which the company’s data has moved ahead of its credit rating and/or circumstances where rating agencies are exercising subjective qualitative judgements that are not supported by the issuer’s underlying data.
- CCI has invested $70 million plus of its own capital (including shareholders and the investment team) into its strategies, which provides for strong alignment of interests.