The Uncomfortable Comfortable Credit Investing with Intentional Focus
Pranab Pattanaik is the Portfolio Manager of the Sanchi Credit Opportunities Fund (SCOF) based in Singapore. The fund invests in global public market credit instruments with a focus on Investment Grade (IG), HY (high yield) and unrated bonds. The fund holds between 25-30 concentrated deep conviction named across DM and EM with no leverage. Current AUM as of September 2021 is under U$100 million.
Before SCOF, Pranab ran the Sanchi Credit Value Fund (SCVF) from 2014-2020. SCVF was ranked among global top 3 bond funds on a 3- & 5-years basis with 3-year return at 18.3% and 5-year return at 14.3%
Prior to SCVF, Pranab managed two boutique private credit funds in Singapore between 2008-2012, with both funds delivering meaningful double-digit returns. He was a member of Lehman Brothers’ Hong Kong special situations investing team, that managed multi-billion dollars of credit assets across Asia-Pacific till Lehman’s collapse in 2008.
AV: Describe the SCOF and its investment philosophy with respect to React, Reflect, Revisit, Review, and Revise
PP: SCOF is in some way reflects my own learning over the years as a credit investor (over 20+ years in the markets). So, we try to include all that credit markets have taught us into our investing process and try to exclude the errors one inevitably makes (either by oversight or no sight (left field events)). Thus, reflection is a big part of our process into what went wrong in past and what can go wrong now in our existing portfolio. Not that we have answers always to that query, but we try to do a multi-situational analysis as to what could go wrong and try to build a moat around the failure touch points. Key is to avoid single point failure points (be it in the underlying credit, counterparty risk, process complexity and so on).
Also, we reinforce those parts of our analysis with additional learning points and data that has worked well for us. Just to give an example, we have learnt that one can nearly exclude Emerging Markets from one’s portfolio and still deliver outstanding credit market returns, not the usual spiel being spouted by the big institutional credit investors who are more asset gatherers than performance deliverers. Our current fund is 100% invested since inception in Developed Market credits and primarily in Investment Grade rated names and we have outperformed by a wide margin our relevant benchmark. Not just on performance (aka Alpha) but also by running a much lower duration risk and with a higher current yield than the benchmark. This shows the power of our iterative process, taking contrarian view at times to credit investing and perhaps what in engineering terms (our investing staff are all engineer MBAs!) will termed as driven by simplicity, modularity and redundancy. These three capture the essence of all that we do.
AV: How do you Balance Information Asymmetry with Behavioral Biases?
PP: There is the saying when one is successful in our asset management industry it is all ascribed to “Skill” and when one isn’t then it becomes “Luck” or market events beyond control. As you rightly ask, Information Asymmetry is a key driver of our performance. And the beauty is given credit market complexity (both of instruments themselves) and being OTC products, the information asymmetry is relatively easy to find particularly for a small fund like ours and one reason we have decided to cap our fund at USD300m. We don’t wish to be just asset gatherers to earn a management fee.
Behavioral Biases are hard to avoid but also sometimes act as tailwinds than headwinds (as most presume) if diagnosed properly. For instance, we trade some credit instruments which are quoted in stock exchanges (NYSE and NASDAQ), and during times of stock market volatility (and drawdowns), these credit instruments also drop. So, the correlation of these instruments with equity increases without any underlying basis and we general add during such periods of market dislocation. And this has always worked out well for us.
So, to answer your query, we remain aware of the mistakes we can (and do) make due to behavioral biases but so far, we have sidestepped major pitfalls.
AV: How does Volatility and Time Arbitrage Factor into your Investments?
PP: I have given an example of how we take advantage of equity market Volatility impacting credit markets in response to your previous query. Time Arbitrage is a big part of what we do, our credit analysis is primarily focused on seeking out such opportunities, that can be bought cheaply today with a 3–5-year view to reap the benefits of credit spread compression. For instance, we have been bullish on energy sector names since middle of last year and we ran some concentrated positions on a few such US centric energy credits. They are now working out extremely well for us due to credit spread compression given the near hyperbolic rise in natural gas prices and major rise in crude prices.
AV: It has been your Intention in both SCVF and SOCF to not hold any China exposure given the “predictable surprise” and the fall of Evergrande. Speculators exist in every market, what makes China unique with speculators vs. other developing markets?
PP: In SCOF, we have decided that we will not invest in issuers based in (or having majority of their business) in a few countries – China, Russia, Turkey, Indonesia, Malaysia, Argentina, Saudi Arabia, Nigeria, and Poland. Each of these countries are unique in their own way and how they throw investors off guard with Black swan events once a while but there is also certain common threads if one can disentangle the signal from the noise of markets(and daily news) such as – lack of rule of law, history of defaults, authoritarian regimes, endemic corruption, concentration of business elite (and consequently poor corporate governance and disclosure), Communism/Islamism- both isms being quite abhorrent to modern notions of rule of law. Just as an aside the current Pandora Paper leak by ICIJ shows most of the offshore hidden wealth is by PEPs or plutocrats from these countries which just confirms our strong view against investing in credit in these markets.
China is unique in multiple ways from the other EM countries we avoid. The sheer size of the economy as the second largest ensures the overseas USD bond market is large (both IG and HY), so by ignoring China, we are effectively restricting ourselves to a smaller universe of names. But the risk of credit investing in China in our view is so high that it’s not worth taking that risk. Primarily China is a country captured by CCP (the political party) (the only other example is Pakistan where a country has been captured by the Army), so every single economic or policy action is driven by survival or success of the capturer i.e., CCP. So, while in good times it doesn’t matter much, during periods of economic stress as we see now with the stress in Real Estate markets, the CCP will ensure the “Nationalist” narrative takes precedence (as they have done in past against Japan and South Korea) and thus foreign bond holders irrespective of their place in the capital structure will come last in the queue for pennies while domestic constituents are protected to the maximum possible extent. Also given the opaqueness of ultimate beneficiary/shareholders in many of these companies and their linkages with CCP power brokers/cliques means sudden downfalls overnight (as we saw in case of Jack Ma/ANT saga and previous examples of Anbang, HNA, Huarong and many others) when the protector falls from power or grace. So, the sheer unpredictability of such autocratic systems makes it hard for credit investors. While most investors have short memories, but we are believer in long histories (and reading up on histories!) and current regime of Xi Jinping is clearly a playing out as Mao regime’s second iteration and we believe it won’t end well for the Chinese people, the Chinese corporates, and the neighboring countries (Taiwan, India, Japan, Vietnam, South Korea, and Philippines).
But we believe there are EM countries where one gets paid for taking the credit risk such as Chile, Colombia, India, South Africa, Mexico, and Brazil (one should avoid government linked entities everywhere in EM is our thumb rule!).