Tell us about your assets and the funds you offer.
We manage $1.1 billion across four accounts, one of which is the Drake Absolute Return Fund, which is $925 million. It's a multi-strategy fixed income hedge fund that invests in taxable U.S. and non-U.S. bonds, as well as convertibles. Our Global Opportunities Fund is more macro and incorporates currency strategies; its objective is LIBOR plus 1,000 and last year it was up 28%. And, now we're starting a low volatility fund for investors seeking returns in a rising rate environment but not looking for super-high rates of return. Its goal is LIBOR plus 500-700.
Tell us about your management style.
We break it down to the simplest form, in the base elements of risk. We invest across four main strategies: credit, term interest-rate, volatility (referring to option-based products such as callable agencies) and liquidity, where we exploit liquidity premiums through relative value trades, such as in structured products.
What's your view on credit?
We run between 0% and 60% of our unlevered net asset value in credit and currently are in the middle of that range. We like to focus on short double-B securities, on average, and we are sector- and issue-diversified. No more than 1% of our NAV is held in any below investment-grade issuer. We like double-Bs because they are orphaned on the credit curve. Hedge funds tend to buy single-B or below and traditional high-yield managers take more credit risk than the index to outperform. We're looking to deliver the best risk-adjusted return and the double-B portion of the curve offers the best risk-adjusted part of curve because of these segmentation issues. And, if you go down the curve, you screen out all the asset liability matchers who are matching either their liabilities or are measured against the indices. It's an area where traditional managers are unable to play.
As for our views, we're middle of the road and are neither bullish nor bearish on credit. We think this year will be the proverbial carry trade. We don't think a rise in short rates dramatically affects the market, since you're not borrowing a lot to invest here. Obviously, the sector has a history of fits and bits of illiquidity. Our bias is not to leverage this paper. When bonds pay down, we have reinvested, but we are not increasing our allocations to credit with new capital we receive.
What about term rate-sensitive rate assets?
Again, we like to focus on the short end to screen out asset liability matchers. If you map out sovereign government bond yield curves to determine the absolute number of positive versus negative months at any point, you generally find it is on the two-year note, where it's steep but not too far out. We like to invest generally outright long at the short end of developed yield curves in government bonds around the world. We're looking for investor segmentation anomalies. I want to know who's on the other side of the trade and why certain constituents can't do it. It's our view that there are better anomalies off the beaten path. Some of the markets where this is the case are Switzerland, Iceland, Poland and Denmark. In Switzerland, for example, you cannot as an international investor buy government bonds without the stamp duty, so it's prohibitively expensive. The only way to participate efficiently is through the application of interest rate swaps at the front of the curve.
What about the liquidity element?
We generally buy short, floating-rate asset-backeds and commercial mortgage-backeds. We're investing generally in seniors with healthy subordination. We're about three and four times capital in this sector. We buy generic pass throughs, or one agency or coupon or tenor versus another. But, you do have to worry about structural risk, so we limit what we buy and don't own IOs, POs or inverse floaters.
How does the prospect of higher rates affect your investing?
We have taken a contrarian view in rate markets and are strategically long at the front end of developed markets around the world. After the fiscal, tax and economic stimulus run its course, there will be sustainable economic activity, but not as much as is currently priced in. We are taking these exposures off as I imagine there's less risk-adjusted returns to be had as we go further into the cycle. We own the front end on an outright basis of developed markets around the world, but are unwilling to carry this because it's less clear what the Federal Reserve's posture will be. Last fall, our view was firmly rooted that the Fed would not tighten in the first six months out. It's nice to see that view has been ratified.
What is Drake's long-term plan?
The objective of the firm over time is to build a traditional real money business and compete at the level of the total return managers such as PIMCO. We're definitely building the type of organization that can sustain that kind of capital base.