Wharton Asset Management runs a $1.5 billion total return asset-backed hedge fund called Y2K. Cook joined the London-based shop as head of structured products in September. Previously, he spent 11 years at UBS Securitiesin London, where for the last five years he was managing director and head of the European ABS syndicate and trading.
Describe your investment strategy. Are you planning to make any changes?
What the flagship Y2K fund aims to outperform by applying leverage on the triple- and double-A assets without volatility. We apply various techniques to achieve that. One of the primary ways is the in-depth research into the transactions we buy and on-going monitoring and surveillance of the portfolio--an area where we concentrate more than ratings agencies and investment banks.
We view ourselves as doing triple-B work to buy triple-A assets. The volatility of the assets has been very low, the annual volatility being about two basis points. Over a four-year period we have never had a negative return and over four years have had total of over 100% on a gross basis. The strategy employed has been very successful and we will use this strategy to grow the business.
We have the ability to buy all sectors of ABS. We have a fair proportion of that in mortgage-backed securities, auto loans, whole business securitizations, pubs, leases, commercial mortgage-backed securitizations and credit cards. We don't like the CDO market. We have been highly invested in CDOs in the past, but very early in the cycle we saw this was a deteriorating asset class and were able to wind down positions successfully. We still believe CDOs should be considered with caution. And we don't buy CDOs of ABS, because we don't see the need to have another manager manage ABS because we think we can do it better.
How is Wharton's new fund going to be different from what the firm has done before?
We want to continue to use the same strategies we've employed in the past. However, we have a variety of new ideas and we're working on a number of things. It's too early to say how the structure of the new fund is going to be. We may move down the credit spectrum and would be doing the same analysis we would be doing anyway. The new fund should be off the ground in the next couple of months.
Despite the amount of new ABS issuance, spreads for the most part remain quite tight. How can an asset manager add value in this type of market?
We are currently in a market where we are seeing new issue spreads tightening, but in the triple-A sector there is a lot of difference between the tightest and widest spread assets. We can add value by identifying a negative trend in a transaction and acting on that. Also, if we can see improving situations, we act on that when we see something is undervalued. Also, through our research and portfolio monitoring we can see where switching an asset for another will be beneficial. We are very active in the management of our portfolios, more so than other managers.
We have our own internal ratings systems for assets we buy and expected liquidity is one of the factors we look at. We need to have the ability to get out of an asset if we have a change of credit view. We are continuously updating mark to market on our positions. It's not to say that we won't invest in a smaller transaction that will only be traded by one or two houses, but we need to make sure we are rewarded for that with the spread. If we can't mark something to market, we're not going to buy it.
Are you seeing more interest from a wider range of clients in European asset-backed investing? If so, what is the cause of the increased interest?
U.S. investors are seeing value in the European ABS market. For example, U.S. sub-prime MBS trades a lot tighter than its counterpart in Europe. There is also interest from an increased range of European clients. Ratings stability and spreads have attracted a lot of investors, especially as there has been a lot of headline and event risk in corporate bonds. With ABS, investors have security over the assets and the vehicles purchased have very limited covenants about what they can do.
The vast majority of European ABS assets are eligible as repo assets. It means that a number of the smaller banks are building up ABS portfolios instead of loans because they are less volatile. We are also seeing more funds and more specialized vehicles like structured investment vehicles and asset-backed commercial paper conduits from insurance companies and banks.
What is going to be the next big development in the European ABS market?
I think what we are waiting for is final details for Basel II. After Basel II, the capital needed to buy high-grade assets is going to be significantly lower than what it is currently. For all the top investment-grade tranches there will be a benefit, while sub-investment-grade may be more expensive for a bank to hold. The European market will continue to grow, but in terms of major things, Basel II is the largest event on the horizon. Also, there will be more ABS funding for infrastructure projects. We will see more countries in Europe doing similar things to what has been done in the U.K. and, to a limited extent, on the Continent.
How has your switch to the buy-side been going so far? Any advice for securitization bankers looking for a change?
I'm really enjoying it. It's a great opportunity to use the expertise I have on other side of the fence in a focused way. Investment banks churn out transactions. You do one and then you go on to the next one. It's different to work in a large organization than it is in a smaller one. Smaller firms are free of the bureaucracy and I really enjoying looking at the market from the other side of the wall.