Independent Thinking^®

Q&A with Michael McEachern

An Interview with Michael McEachern at the Muzinich Credit Opportunities Fund

Evercore Wealth Management supplements its core investment capabilities with carefully selected outside funds across the range of the firm’s asset classes. Here we interview Michael McEachern, the manager of the Muzinich Credit Opportunities Fund, which seeks to deliver high-yield income and capital appreciation by investing in corporate bonds, both below-investment grade and investment grade, and in bank loans and floating rate loans issued by U.S. and foreign corporations.
 
Q: The Credit Opportunities Fund was launched in 2013, which makes it a relatively new strategy at Muzinich. What was the impetus? ?
 
A: We think this strategy combines the best of the Muzinich credit offerings. We have a proven track record managing portfolios across the credit spectrum, credit asset classes, and the various geographic regions. For the Credit Opportunities Fund, we rely on our fundamental relative value experience to determine allocations across the global credit markets. Within the allocated markets, we have the knowledge base and experience to evaluate the full capital structure of corporate credit and to build a bottom-up portfolio of securities that targets what we believe is the best relative value.
 
Q: The strategy has a lot of flexibility, but isn’t entirely unconstrained. Please tell us about some of the constraints on the portfolio and why you thought those constraints were important??
 
A: The fund is constructed within guidelines that include restrictions on issuer and industry exposure, maximum duration and minimum credit rating. These include a 30% minimum exposure to U.S.-dollar denominated assets; a 15% maximum to any country, other than the United States; a 20% maximum to any one industry; and a 5% maximum to any one issuer. We aim to maintain a minimum of 75 issuers and a maximum duration of five years.
 
We are very cognizant of concentration risk in portfolio construction and we believe that portfolio diversification is an important aspect of risk control. A maximum duration of five years helps keep our volatility in line with that of an intermediate-term index. These guidelines still afford the strategy of significant discretion to allocate across a broad range of global credit sectors, to target maximizing total return or avoiding volatility.
 
Q: The fund can invest internationally, in domestic, European and Emerging Markets, and also across sectors, including high-yield and investment-grade corporate bonds, leveraged loans and Treasuries. On what basis do you determine the fund’s positioning among these different geographic regions and sectors?
 
A: The portfolio managers representing the various asset classes and geographies help formulate the tactical decisions at the Muzinich’s Investment Policy & Risk Group, or IPRG. Portfolio managers provide scorecard rankings on the technicals, fundamentals and valuations for their respective asset classes and discuss their respective markets. The group forms an opinion that is followed closely in making the majority of asset allocation decisions for the fund.
 
IPRG tracks historical rankings to review during meetings to see if there is a significant shift in sentiment by the group. In addition, we use proprietary data to review each asset class by region, credit quality, and duration. We also look at cross-region proprietary data for regional relative value comparisons.
 
Ultimately, the lead portfolio manager finalizes asset allocation decisions for the fund in the framework of an overall plan that is formed during the monthly IPRG meetings.
 
Q: The fund can invest in companies based globally, but does it take on foreign currency exposure? Why or why not?
 
A: The fund has the ability to invest in non-dollar and emerging markets debt, but we do so in the hard currencies of the U.S. dollar, the Euro, Sterling, and the Swiss franc. Currency management is generally not used as an active source of investment income, as we feel this can add volatility to the portfolio that is not within the risk/return profile of this strategy.
 
Q: How do you manage risk within the portfolio?
 
A: The fund offers a “go-anywhere” flexible credit strategy that can be positioned appropriately in up and down markets. The strategy offers the portfolio manager the flexibility to shorten duration in a rising interest rate environment and adjust portfolio credit risk when volatility picks up. We believe that the strategy’s flexibility to move in and out of global credit sectors, as well as up and down the credit quality and duration spectrum, combined with our bottom-up credit selection process, gives us the ability to add value above single-directional credit strategies over a market cycle.
 
For example, if we are in a positive credit environment but believe interest rates are likely to move higher, we could position the portfolio with a shorter duration and take more credit risk, which could have a positive impact on portfolio returns if our thesis is correct. Conversely, if credit quality is deteriorating and interest rates have a higher propensity to move lower, we could position the portfolio with higher credit quality bonds that have longer durations. The wide dispersion of returns across the global credit markets creates the potential for value to be generated through tactical allocations across regional and sector credit markets.
 
The fund seeks to identify the best investment opportunities within the global corporate credit markets, and to take advantage of these return variations as they move in and out of favor. These top-down decisions, along with duration and credit volatility management, should have the greater influence on returns when there is increased volatility in the market. In relatively lower volatility markets, where asset classes have a higher degree of correlation, bottom-up security selection should influence returns more.
 
Q: What is your investment outlook for global credit, both short-term and long-term? How about for U.S. interest rates?
 
A: We believe we have entered the next phase of the global credit cycle, moving from an environment of mostly positive factors to an environment that now has both positive and negative factors. It seems to us that there will be a much wider dispersion of returns across global credit, driven by differences in regional fundamentals as well as industry-specific fundamentals. For example, U.S. credit fundamentals in general remain strong, while Euro-zone fundamentals are more varied. Energy prices have fallen precipitously, making energy one of the worst performing industries in global credit. Lower-rated bonds have started to underperform high-quality bonds.
 
Longer term, we believe interest rates will remain relatively low and that the credit markets, while not as robust as they used to be, still represents a valuable and transparent way to potentially generate additional yield above U.S. Treasury yields.
 
We also believe that secondary market liquidity for corporate bonds will remain low by historical measures. This has become more pronounced in the last several months, especially in lower-rated bonds. We have positioned the portfolio for less secondary corporate bond liquidity by increasing the overall portfolio credit quality and reducing exposure to low-rated bonds.
 
Q: Muzinich is a large credit manager, but isn’t well known in the United States, although it is headquartered in New York. Your thoughts?
 
A: That’s right, we are better known in Europe, where our first corporate credit investors 24 years ago were insurance companies. But we are well known to both the market-making community and to the hundreds of issuers we invest in. We can leverage the size of our firm and access senior management at the companies we hold. We have a seat at the table when it comes to new issuance.
 
Here in the United States, our investor base has been growing quite strongly over the last several years. These clients see the value in our independence, our exclusive focus on global corporate credit, and our willingness to partner with our clients to customize strategies that meet their risk/reward expectations.
 
For further information on the Evercore Wealth Management Efficient Architecture® investment platform and the Muzinich Credit Opportunities Fund, please contact Brian Pollak at [email protected].