When Gennaro Pucci, chief investment officer of credit hedge fund PVE Capital looks at Europe, he sees... Japan.
“What we see in Europe right now is basically the Japanization of the European economy,” Pucci told FINalternatives. “In fact, more than half of Europe is already in deflation.”
For Pucci, the "Japan experience"—a long period of economic stagnation—is “possibly the best thing that we can hope for in Europe,” it will eventually make equities “very dangerous, in our opinion. We think fixed-income and credit is the best way to approach this market.”
Pucci has been in the European credit market since the mid-'90s, when he worked as a structured credit trader at Commerzbank in London and head of structured credit at MPS Finance. From 2005 to 2009 he was head of trading at Credaris, a London-based asset manager, overseeing in excess of US$1.3 billion, including the Credaris Credit Fund, which generated outsized returns during the financial crisis—59% in 2007, 56% in 2008. Pucci attributes this success to his background in credit.
“Because I come from a special credit perspective, I had a sort of privileged point of view about the collateralized debt obligation crisis,” he said. “I took advantage of what happened in 2007 and 2008—I was up over 50% each year during the crisis shorting CDOs .”
In 2009 he left Credaris and founded PVE, where he was joined in 2010 by portfolio manager Loren Remetta, a former credit trader with both UBS and Bank of America, and in 2012 by portfolio manager Derrick Herndon, the former head of European credit trading at UBS. The firm, which now employs 10 people and manages US$300 million, began with about €50 million (about US$70 million at the time) and, although the strategy lost 24.92% in 2011, on a weighted-average basis, all PVE accounts were up 19.83% in 2009, 21.79% in 2010 and 20.62% in 2012.
PVE runs and manages the PVE Special Situation Credit Account and the PVE Credit Value Fund (MAP6)—the first a managed account portfolio that invests in special-situation credit opportunities, such as legacy corporate credit CDO products; the second a long/short credit fund that focuses on Europe. There is also a UCITS-compliant version of the latter fund.
The Special Situation Credit Accounts returned 67.7% in 2012 and are up 14% this year, while the PVE Credit Value fund generated 9.69% in 2012 and is down 4.88% year-to-date.
The investment process, says Pucci, begins with a top-down evaluation of the markets. They are fundamentally-driven and try not to be distracted by “momentary” technical issues.
“On a quarterly basis, we assess the market to see how we want to position ourselves from a fund perspective and a firm perspective. For example, we've not always been involved in peripheral markets in Europe. Last year we concentrated on core countries, and then like any fund, we try to express our views through different sectors, taking a bottom-up approach in each fund to try to pick up the assets which are most compliant with the overall view of the firm.”
Currently, Pucci says, Europe is “still very cautious because the expectation about the future is much bleaker” than that in the U.S. But PVE is “pretty comfortable” investing their in the region, where it likes two main things: legacy corporate CDOs (cash and synthetic) and U.K. commercial real estate.
Of the corporate paper, Pucci says, “It's quite extraordinary: You can get paid 5% or 6% for the senior tranche of a corporate CDO. This is something that we like just because the default rate is so low because there are very few buyers left in the market. Banks are sellers, insurance companies are sellers, so there are no buyers and very high-quality pieces of paper, where there is just technical pressure. We like this type of asset a lot.”
As for U.K. real estate, Pucci says, “We have now seen eight quarters of declining prices in commercial real estate and we think that we are starting to see a turning point in the market. The assets are now being priced out of very stressed expectations about the recovery rate of building. If the cycle turns, I think if you start putting a different recovery rate assumption, and things look much better.”
Pucci says PVE's primary concern in Europe is the continent's broken banking system, particularly the deflationary forces that have resulted in credit crunches in Spain and Italy.
“The situation you have now is the sharp acceleration of non-performing loans on the balance sheet. It went from around 7.8% in October last year to something like 13%— almost double in a few months—and if this continues, over the summer or by the end of the summer we might see a similar sort of exercise in Italy that Spain did last year in terms of creating sort of FROB-type of exercise," Pucci said, referring to Spain's Fund for Orderly Bank Restructuring. "Italy has to go into the European Stability Mechanism as well, really testing the ability and willingness of Europe to deal with this crisis.”
From the beginning, when managing only €50 million, PVE boasted the institutional infrastructure of a much larger firm.
“We spent an important portion of our initial budget and performance fees in the first couple of years building out our risk, tax and management-reporting systems and processes, which are typically adopted by much larger credit funds and companies,” Pucci said. “We also bought and built out a bespoke portfolio-reporting system called Glide from AlphaKinetic, which gives us the possibility to go into deep analysis and risk in terms of portfolio trading or even single-name trading and which really interfaces very well with our proprietary risk system.”
Pucci, who co-wrote a book on risk in 1997, said each quarter his firm drafts a risk policy document which it gives to investors. “In this risk policy document we show all the kind of risk that we intend to take, and these are kind of binding limits for us in terms of concentration, leverage and maximum exposure that we aim to take.”
Pucci's estimated capacity for the Special Situations Credit Fund is US$1 billion, but the long/short credit fund would probably struggle to deliver results at anything over US$350 million, he said, “just because the market is really missing liquidity, so we want to be nimble enough to feel comfortable in delivering the return we expect.”