Algebris Ramps Up Cash, Warning of Further Disruptions From War

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(Bloomberg) — Algebris Investments, a heavyweight in European bank debt, has increased cash levels in its credit funds to some of their highest levels ever, warning that markets are underplaying risks related to the war in the Middle East.

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The asset manager now holds 15% cash in its €17 billion ($19.5 billion) Financial Credit Fund and 20% cash in its smaller Global Credit Opportunities Fund, portfolio managers said in an interview. Typically, cash would comprise about 10% of those funds. Algebris’ Financial Credit Fund is one of the world’s largest Additional Tier 1 bond-buying vehicles.

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“We are running the lowest level of risk that we’ve had in the past three years,” said Gabriele Foa, co-manager of the Global Credit Opportunities Fund. “What is happening in the Middle East can be very disruptive and the market has not appreciated that fully.”

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Investors have been recalibrating since the start of the war almost three weeks ago. Bank of America Corp.’s latest fund manager survey showed the biggest jump in cash since March 2020, while investors have been cutting long positions in high-grade credit-default swap indexes.

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Read: Credit Traders Are Unwinding Their Gigantic Bullish Position 

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But Algebris and some others are warning that markets are still too optimistic about a quick resolution to the war, and that the impact of soaring energy prices on inflation and global growth isn’t fully priced in. Strikes continued in the region overnight while a report said the US is considering plans to take over Iran’s Kharg Island, its major oil-export site, to reopen the Strait of Hormuz.

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“This risk sentiment is a bit excessive,” said Sebastiano Pirro, chief investment officer at Algebris and a manager of the Financial Credit Fund. “Selloffs don’t last a day, but they may last six months, a year. We’ve seen that many times, we tend to forget.” 

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Foa said he’s been buying credit-default swaps to add protection to his portfolio. He’s also running select short positions in European and emerging market credit, as well as a long dollar position.

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He’s keeping the duration of his portfolio a bit below three years, given the potential for markets to price in more central bank interest-rate hikes.

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“The genie is out of the bottle,” Foa said. “If tomorrow there is a $20 move in oil, the market will be green-lighted to price four or five hikes.”

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Markets have moved to fully price three quarter-point hikes from the European Central Bank and Bank of England this year. Meanwhile, traders have scrapped bets on a rate-cut from the Federal Reserve, with swaps pricing the US central bank will stay on hold through December.

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Algebris is a key player in AT1 bonds, with the risky bank debt making up around two-thirds of the flagship Financial Credit Fund. Selling pressure in the AT1 market has remained relatively contained since the start of the conflict as the asset class has become increasingly popular in recent years with new buyers attracted by high yields. 

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AT1s carry risks including skipped coupon payments and the danger that a bond is left outstanding, meaning that they offer yields much closer to junk than high-grade bonds. For many investors, those risks are worth taking — especially because AT1s are sold by the world’s largest and most capitalized banks, making defaults unlikely.

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Pirro said he’s not worried about the fundamentals in the banking sector, and that lenders can withstand a higher cost of risk and higher provisions and still be profitable.

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