Funding & Investing

SGAM Alternative Investments’ SG Treasury Plus Fund

Published: Jan 2007

Offering attractive returns for medium-term sterling investment

The role of the corporate treasurer has become increasingly demanding. Treasurers are expected not only to ensure the availability of funds as and when these are needed for operational activities, but also to earn a substantial return on any surplus cash.

The instruments of choice for the European treasurer and investment manager have so far often been the triple-A rated money market funds, due to their safe nature and low liquidity risk. However, the interest earned in money market funds reflects the low risk of this type of cash investment. Long-term investment (bond) funds, on the other hand, have the potential to earn significant interest, but are more risky and often tie up cash for too long to be able to meet the operational demands that most companies have.

Enhanced cash funds

Enhanced cash funds, also known as liquidity plus funds, fill the gap between triple-A rated money market funds and long-term investment funds in terms of the risk and return of potential cash investments. Their objective is to offer a better yield than triple-A rated money funds. As such, they are a complementary investment product to traditional money funds, rather than a mutually exclusive alternative. The increased return is typically achieved by investing into slightly lower rated, riskier credits or by investing for longer periods of time and thereby increasing the credit duration and volatility of the fund.

It is important for the investor to realise that by investing into an enhanced cash or liquidity plus fund, the risk is higher than by investing in triple-A rated money funds. Each liquidity plus fund will also have a different maturity/duration, credit quality and liquidity profile. Nevertheless, the risk taken by the investor may still be relatively limited.

“We don’t compete with AAA funds. We provide corporates with a different solution for the use of their cash, as they are so far used to looking at their cash on a weekly basis, to the detriment of the return.”

Vincent Lauwick, Sales Director Structured Products, SGAM Alternative Investments in the UK

SG Treasury Plus Fund

Enhanced cash funds invest into the money market, but also into instruments that are outside the scope of traditional money funds. The SG Treasury Plus Fund invests into money market securities, deposits, fixed or floating rate securities – such as bonds and equivalents – asset backed securities and credit financial instruments, including credit derivatives and structured credit instruments. While the fund’s investment activity is not limited geographically, it only invests in the credit and money markets.

“I think a lot of enhanced cash funds use mixed strategies of currencies, commodities etc. Here we are really focused on credit; the outperformance is generated by only investing in the credit universe.”

Karine Seguin, Sales Director Structured Products, SGAM UK

The fund owes much of its positive performance so far to its ABS position. Nearly 40% of the fund is currently invested in assetbacked securities, a market in which SGAM feels it has strong credit research, long-standing expertise and a successful track-record.

Asset-backed securities (ABS) are also an asset type that offers several advantages to enhanced cash funds. Interest rate risk and duration of ABS is similar to money market instruments. The rating volatility of ABS is relatively low compared to corporate or bank credit ratings and as a result credit spreads on ABS have a lower volatility. ABS will therefore yield a relatively safe premium over money market instruments.

Fund objectives and investment horizon

The SG Treasury Plus Fund has the target of outperforming the sterling 7-day LIBID by 30 basis points per annum net of fees. At the same time, it is the objective of the fund to provide daily liquidity and preserve capital.

In order to benefit from an enhanced cash fund, the investors must be prepared to leave funds invested for a longer time period than in traditional money funds. Given the nature of the invested instruments this means months rather than weeks. The minimum investment period should therefore be not less than three months with a typical investment horizon of six to twelve months.

“When you invest in a AAA rated fund you would expect that after one week redemption is at least equal to the cash that you have put in. Our fund, given the fact that we manage credit instruments and ABS among others, is not a recommended investment for only one week. It is possible that if you invest into this fund for two to three days you could have a slight drawdown. An investor needs to be aware that this fund has a different time horizon than the usual money market fund.”

Vincent Lauwick

Investment strategy and guidelines

Liquidity plus funds aim to outperform cash targets by increasing the duration of the invested instruments and/or taking on a higher credit risk. In contrast to a triple-A rated money fund, the SG Treasury Plus Fund has the ability to invest into lower rated instruments and instruments of longer maturity. This obviously translates into a higher credit risk and a higher volatility of returns.

However, the fund’s internal investment guidelines provide for maximum limits to the overall credit duration of the portfolio, which is slightly under five years.

Interest rate duration of the fund is capped at three months and averages at 60 days. At the same time expected volatility should not exceed a target of 1% and currently averages 0.2 to 0.3%.

The fund does not carry any currency risk as non-sterling bonds are hedged directly. The credit risk to which the fund is exposed can be mitigated by buying options on the iBOXX and the iTRAXX or by directly investing into these bond and credit derivative indices themselves.

“We are always trying to optimise the performance of the fund whilst keeping a conservative profile.”

Karine Seguin

Portfolio Breakdown

Top 7 Sectors % Asset Class %
Diversified Financial Services 16.7% Financial Bonds 32.3%
Banks 9.2% Corporate Bonds 27.0%
Engineering & Construction 4.1% MBS (Commercial) 23.2%
Iron/Steel 3.7% MBS (Residential) 15.3%
Chemicals 3.7% Consumer Loans 2.2%
Auto Manufacturers 3.5% Cash
Insurance 3.1%

As at October 2006

Within these constraints, the fund has the ability to invest into the whole spectrum of the credit market and does not exclude any submarkets.

In terms of strategy, the SG Treasury Plus Fund replicates SGAM Alternative Investments’ euro funds, in which the asset manager has more than €11 billion under management. The fund diversifies not only by investing into a large number of instruments, but also by pursuing different strategies, such as combining long/short strategies and curve strategies. This corresponds to a recent trend in the credit market to move away from static long-only strategies, and is a point of differentiation for the fund from other enhanced cash funds.

Another feature of SGTreasury Plus Fund is that it has the ability to use synthetic derivatives on credit instruments and options on credit indices. This strategy enables the portfolio manager to source additional value even when the market is quiet, but also to protect the portfolio against a downturn of the credit market.

The sterling fund is domiciled in the UK as an ICVC (Investment Company with Variable Capital) by SGAM UK and is FSA regulated. It is managed from Paris by SGAM Alternative Investments, a specialist division of Société Générale’s asset management unit. The fund benefits from SGAM’s size and the role that the asset manager plays in the market. As a result of this, the portfolio manager is guaranteed excellent allocation on primary deals, for example in the ABS market, as well as the fastest secondary market execution.

Interview

Société Générale

Portrait of Stephane Parlebas

Stephane Parlebas

Co-head of CDOs and credit management

Stephane Parlebas graduated from IEP Paris and he holds a Masters in Finance and is a candidate for CFA level 3. He has 14 years’ experience in credit markets including eight years at Commerzbank. He joined SGAM AI in 2004 as a Portfolio Manager and currently manages over £2.4 billion in total return credit funds. He is also in charge of managing equity linked CDO products.

What was the idea behind the SG Treasury Plus Fund?

One of the driving ideas from my point of view as the portfolio manager was to launch a fund in the sterling market which we think offers interesting opportunities. As a general rule, there is a pick-up in spreads for similar risk for the issuers compared to both the global corporate and ABS markets. In particular, we believe there are a lot of opportunities for ABS in the sterling market. We thought the best vehicle was to have a direct fund for investing in those strategies which also give the performance in sterling. I expect also that some indices referencing sterling bonds will develop in the next years, so with this vehicle we will be prepared to capture these strategies in the credit market as well.

How does it differ from other ‘liquidity plus’ or enhanced cash funds?

There are several differentiating factors as far as the investment strategy is concerned.

It is not a fund that invests long only. Even at a time when the market is quiet, we still want to be able to do long/short trades. There is always adjustment in credit risk and there are some names where we think the fundamentals can deteriorate, and it is important to be able to express negative views. I think this ability to be short on selective names is a plus.

Secondly, we are also exploring curve strategies. So again it is not only being long, but long and short on an issuer on the credit curve. This is also interesting because it is a way to generate positive carry, which is the key factor when you launch a credit fund. At the same time, you are not too exposed when the market widens because you have a curve position. So for instance if you play with the steepening of the curve, which is usually the case when the market widens, you even have a positive mark to market and you have a carry. This is not common with all credit funds and I think we can differentiate in this area.

Thirdly, especially in the ABS market, we have a strong credit research here that is based in Paris. They started to analyse ABS ten years ago already and really have a strong knowledge in this area. We are buying ABS every day and include it in our fund portfolios. We think our analysis of the European ABS market is one of our key strengths.

And also since we are integrated into the Société Générale group, and SGAM is one of the largest asset managers in Europe, we have access to one on one meetings with group treasurers of large companies. There we can go into more detail on management strategies, potential threats and weaknesses, or business expectations in terms of results etc. Not all asset managers have this direct access to CFOs or Group Treasurers.

Fee structure, minimum investment and redemption

The fund does not have any entry or exit fees. The all-in management fees are 25bp and include all fees (eg trading, custody, administration) related to the management of the fund. In addition, there is a performance fee of 30% of the net gain exceeding the notional 7-day LIBID benchmark.

There is no minimum initial or subsequent investment limit as SGAM is interested in diversifying customer types and investment horizons for the fund. However, the only available share class of the fund is an accumulation gross-paying share class. The target deal ticket is between £5m and £10m, but SGAM UK is able to accommodate tickets up to £50m.

Redemption of the fund is effective two days after the deal is placed (T+2), based on the NAV communicated at T+1.

Performance

While past performance should never be taken as the sole indicator of potential future returns, the SG Treasury Plus Fund has exceeded its targets since the launch of the fund in June 2006. During this period, the fund outperformed 7-day LIBID by more than 82bp net of all fees (as at November 30th, 2006).

Performance Chart (from 27 June 2006 to 31 October 2006)
Diagram 1: Performance Chart (from 27 June 2006 to 31 October 2006)

Source for all performance: SGAM UK NAV to NAV net income reinvested, net of fees

Performance (Net of all fees)

Dates Fund Annualised Rate Index Annualised Rate Spread1 Volatility
October 0.50% 5.69% 0.42% 4.77% 0.92% 0.17%
Since 27 June 2006 1.91% 5.53% 1.63% 4.71% 0.82% 0.25%

Annualised using daily data – Arithmetic method.

  1. Fund less benchmark

Conclusion

Liquidity plus funds like the SG Treasury Plus Fund offer a good opportunity for companies, local organisations and investment funds to earn enhanced returns on any cash surplus that is not required for operational use during an investment horizon of three to twelve months. Companies will therefore need to ensure that an investment into enhanced cash does not impede their cash liquidity needs and that it complies with the company’s own investment guidelines, in particular with regard to the use of derivatives by investment managers. As with any investment it is important to understand the investment strategies used by the portfolio manager, the risks that the fund is exposed to and how they are managed.

Société Générale Asset Management

Société Générale Asset Management (SGAM) is the fund management division of Société Générale, the global French Banking and Finance Group. As at 30th September 2006, SGAM had £233 billion in assets under management through its four management centres in the UK, Continental Europe, USA and Asia, ranking SGAM as one of the largest fund management groups in the world.

Société Générale Asset Management Alternative Investments (SGAM AI) is the specialist alternative investment division within SGAM, specialising in developing and managing specialist structured products tailored for investors needs. SGAM AI has developed successfully by combining active management processes with a capital market culture that mixes innovation and risk management. As at 30th September 2006, SGAM AI had a total of £22 billion in structured asset management products including £8.9 billion invested in enhanced money market funds. Our enhanced money market funds are available in EURO, USD and GBP.

For more information on SGAM AI products in the UK, please contact one of the following:

Contact details:
Vincent LAUWICK
+44 (0)20 7090 2673
Fax: +44 (0)20 7090 2983
www.sgam.co.uk
Karine SEGUIN
+44 (0)20 7090 2674
Fax: +44 (0)20 7090 2983
www.sgam.co.uk

Disclaimer

No statement in this Product Profile is to be considered as a recommendation or solicitation to buy or sell securities or other instruments, or to provide investment, tax or legal advice. Readers should be aware that this publication is not intended to replace the need to obtain professional advice in relation to any topic discussed.

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