DirectorsTalk caught-up this week with Serge Demay, head of CLO investments at Axa Investment Managers, to discuss Volta Finance Ltd (LON:VTA, LON:VTAS).
Q. Serge you are part of the AXA IM Structured Credit division. Can you bring us up to date on the Assets under Management for your team?
A. I’m in charge of the CLO investment team. The AuM of the team grew from €16.6bn at the end of 2019 to €19.6 at the end of September 2020. We should be near €20.5bn by year with emphasis on AAA/AA/A CLO tranches for our institutional clients.
The broad spilt of assets for the group is around 93% in AAA/AA/A tranches which are predominantly buy-and-hold, only 7% are in BBB/BB/B/Equity tranches.
These sizeable investments in AAA/AA/A are extremely helpful to Volta and the few other funds like Volta that are investing in CLO mezzanine and CLO Equity tranches.
It is due to our scale that we can access deals from first tier managers and we can control deals documentation when we invest in the CLO equity tranches.
Q. How does Volta fit into this structure?
A. In terms of public facing flag ships we have only 3 products : firstly Volta Finance. Then a fund dedicated to CLO Equity (Andante OPERA III) and a further fund dedicated to CLO debt only (Novalto CLO Credit Fund). These 3 funds are all similar in size so that Volta is clearly on the top list of our priorities. Obviously we are acting very professionally for all our clients but bulk of our AuM is dedicated to single investors (dedicated funds/mandates) with no public communication and a buy-and-hold strategy (requiring much less work than active funds). More than that Volta is the flag ship for the platform as the unique co-mingle fund that can invest in all type of assets (inside the department) and as such is supported by the whole team.
Q. I note the performance of the NAV earlier this year was very difficult. Should we think of this as a permanent loss of capital or is this a feature of market pricing?
A. Volta did indeed suffer some losses with the COVID 19 crisis. In view of the currency hedge we sold a few positions in March/April when the USD appreciated to 108 USD/EUR (we structurally sell forward some USD to hedge USD assets), costing around €0.17 per share.
In addition some assets suffered from the consequence of the COVID pandemic. For some of them it is difficult to state whether this pain is going to be transformed into a permanent loss, but a reasonable estimation is that “permanent” losses may end up in the region of €0.25 to €0.50 per share.
The important factor on the other side of the equation is that the crisis also offered some excellent reinvestment opportunities and the current tightening of spread on CLO debt should allow our CLO equity positions to receive higher cash flows in the future (if and when we will be able to refinance part of the CLO debt at lower spreads) so that part of these possible losses will be recouped through time.
Q. Have you altered the portfolio significantly or were you happy with your positions from the beginning of the year?
A. Earlier this year we were in the process of increasing the liquidity of Volta assets, we have continued on this path (reducing the portion of illiquid assets). The concept was, and is still to have more room to seize opportunities as they occur. Strategically we have for a number of years been reducing CLO debt to increase CLO equity with the intention to bring CLO Equity weight slightly above 50%. It is possible, if spread tightening continues on CLO debt that we look to emphasize allocations of CLO Equity slightly further. In any case , our portfolio breakdown is in line with our convictions.
Q. What is happening to the consensus opinion regarding corporate default rates in the US and Europe?
A. With the vaccines, the market consensus is clearly evolving toward less defaults. And we agree with that. As a result CLO debt and CLO equity prices are going up. It may also affect positively the Bank-Balance-Sheet allocation of Volta. Our view was to consider that the COVID pandemic might cause near 15% defaults in the US loan market (spread through 2020-21-22-23), slightly less in Europe. Post-vaccines our view is that is probably too pessimistic and we may land 2 to 5% lower. This is of course a generic view and we would hope that our selection process gives a more favourable outcome for Volta.
Q. Following the recent Vaccine news are you seeing improved secondary market pricing for CLO Equities?
A. Indeed we have seen a sharp improvement in CLO debt and CLO equity prices.
For CLO Equity there is 2 potential benefits which are driving this optimism.
- The first one is clear, if there are less defaults and less CCC loans, then there is less chance of suffering diversion of cash flows at the equity and there would be fewer losses that would damage the final principal payment to the equity.
- The second one is more technical regarding future refinancing. If for example next year, CLO debt spreads are lower, the CLO Equity of each deal have the power to instruct a refinancing of the CLO debt (all or part of the existing CLO debts are reimbursed at par and new CLO debts are issued with a lower coupon).
- As an example if a CLO Equity is a 10 times leveraged on a pool of loans and the leverage is provided by the CLO debt issuance. Then assume that CLO Equity has an average cost of leverage (the average spread of the CLO debts) at Libor+180bp and if it were possible to refinance part or all the CLO debt so that the average cost of leverage decrease to, for example, 160bp. This 20bp improvement on the cost of leverage, directly leads to a 2% (10 times more) higher annual cash flow to the equity (if everything else is unchanged). This is of course a theoretical example, but indicative of the powerful benefits that can come in a positive refinancing environment.
- There are further considerations however which potentially work against this scenario, as some of the loans inside CLO may also be able to refinance leading to a lower WAS (Weighted Average Spread). It is realistic however to suspect this may be a more delayed outcome given rising default rate and in any case a less important factor in the equation.
Q. Volta has for many years paid a very high dividend. Is the intention to continue with this ambition?
A. The willingness and ability of Volta is clearly to continue paying a “high dividend”. For many years it has been in the area of 8%. I can’t make a forecast but we must consider that available yields have been dropping for a number of years and the company cannot be immune from those trends, but our intention is to stay as a “high dividend” company, capturing the enhanced yield that the investment policy allows.
Serge many thanks for your time today
Mr. Demay joined AXA Investment Managers in 2007 as the Structured Finance Division’s Head of Multi-management, covering multi-assets products. He joined AXA IM from CAAM where he spent twelve years. From 2001 to 2007, he was senior manager of the fixed income and diversified portfolios in the multi-management team, and from 1996 to 2001 he was one of the senior managers of the Global Bond team of CAAM. He started his career in 1992 in the financial research department at CCF before joining the market floor as fixed income market strategist. Mr. Demay completed two Masters degrees in Applied Mathematics and Economics at the University of Toulouse as well as an undergraduate degree in Mathematics and Econometrics.
