Corporate Credit Spread Signals

In this note I describe some of the ways we at ActiveAllocator bring an active approach to investing in corporate credit.

Contents:

Credit Spread Signals    

Valuation Relative to a Fitted Curve       

Bid Book            

Event Risk Indicator      

Liquidity Signal 

Equity Signals and Covenants    

Testing Equity Signals Without Bond Covenants

EDF and Rating Agency Measures of Credit Risk 

Flags to Identify At-risk Credits  

General Point   

Wealth Management Industry Destroys $400 Billion in 2020

2020 again demonstrated that RIAs, Private Banks, independent Broker Dealers, Wealth Management platforms and financial firms can’t provide quality advice to everyone profitably. Few customers want to pay for it, and many investors don’t trust financial advisors. Meanwhile, traditional forms of asset allocation advice are costly, inefficient, and impersonal. We estimate that retail investors lose more than $400 billion annually in advisor fees and portfolio inefficiencies. This value destruction is both explicit in typical 1% or higher advisory fees charged and implicit in 0.5% or more asset allocation inefficiency.  Moreover, these costs are in addition to other contracting frictions, product commissions and costs. To serve a broader audience, advisors put investors in cookie cutter, one size fits all “model portfolios,” which in turn commoditizes their own service and expertise. Model portfolios also fail to account for personal investment views, preferences, and limitations. Worse still, clients rarely know how inefficient their allocations really are and have no objective means to measure and value advisor performance.

The Fallacy of Model Portfolios

One Size Fits All.

In this opinion piece we argue that the notion of putting retail investors in cookie-cutter mass-produced standardized buckets of allocations, referred to as model portfolios, is a remnant of antiquated ‘90s thinking. In 2021, it is akin to paying a doctor expensive fees for an over-the-counter pain medicine prescription. Wealth management firms, RIAs and broker dealer systems that ignore the disruptive ability of new asset allocation frameworks and technologies do so at their own peril. No longer can financial advisors take clients for granted and present them with undifferentiated canned finished asset allocation models.

Sovereign Wealth Funds – ESG Activity Lagging

These, as a cohort are lagging other institutional investors such as pension funds. Some exclusion criteria is used; and in a few  cases some environment related investments have been made. They can do a lot more.

As long-term investors: They can reap long-term returns of environmental, social risk adjusted portfolios and ESG engagement. They can provide a source of stability in the capital markets.

As passive investors: Not always a good thing as this could dilute shareholders power and create a governance gap

As active investors: Engagement with the companies in which they hold some stakes.  Make clear that the influence is purely economic based for any other type of  influence could be a risk for other investors and the companies in which they  hold stakes.

Anatomy of Special Purpose Acquisition Company (SPAC) Transaction

Here we model a live SPAC deal to illustrate the details of a SPAC transaction. We show that the SPAC structure results in severe dilution of the value of SPAC shares: post-merger share prices fall, and price drops are highly correlated with dilution or cash shortfall. We show that SPAC investors bear structural cost of the dilution and pay for companies they bring public. SPAC creates substantial costs, misaligned incentives, and losses for investors who own shares at the time of SPAC mergers: SPAC shares tend to drop by one third of their value or more within a year following a merger

Only those who buy shares in SPAC IPOs and either sell or redeem their shares prior to the merger do very well. We demonstrate that IPO investors who are pre-merger shareholders should exit at the time of the merger, either by redeeming their shares or selling them on the market. Investors that buy later and hold shares through SPAC mergers bear the costs of the generous deal given to IPO-stage investors. Sponsors promote, underwriting fees, and dilution of post-merger shares caused by SPAC warrants and rights all transfer value from SPAC investors to pre-merger IPO investors and sponsor. Modelling a transaction shows that Sponsor has an incentive to enter a losing deal for SPAC investors if its alternative is to liquidate.

Board Duties of Directors in M&A Situations

Amongst my great learning privileges on Wall St was to be deep in the weeds as Managing Director at NYSE: RCS Capital Corporation (RCAP) in 2014. A firm into investment banking, capital markets, transaction management services, wholesale broker dealer and transaction manager.. inter alia. The only investment banking and capital markets business focused primarily on the specialized needs of the direct investment program industry then, and with exceptions none today.

That’s when I developed practitioner expertise in listings, mergers and acquisitions, tender offers and capital markets fundraising. An important part of that learning was I figured out – what is the role of Board members or of appointed directors in frequent M&A?

Here are my takeaways from that period in my career.

Autocorrelation for Rolling 36 Month Intervals Suggests Risk Underestimation

My analysis today suggests that it seems that we have a lot more autocorrelation between asset class returns than what meets the eye. The past period’s return should not determine the next period’s return for they need to be independent and identically distributed. Therefore, relying on conventional historical correlation and volatility assumptions for asset allocation is less than optimal now.