Wait and CDO

Axa Investment Managers is well known for breaking new ground in structured credit. At the same time, it refuses to rush headlong into new markets. Mark Pengelly explains why

The development of Paris-based Axa Investment Managers (Axa IM) traces the evolution of the structured credit market itself. The firm purchased its first asset-backed securities (ABSs) and its first collateralised debt obligation (CDO) tranche in 1995, commenced trading credit derivatives in 1997 and began investing in infrastructure loans in 1998.

"We were born with the structured credit market," says the firm's head of structured finance, Pierre-Emmanuel Juillard. As the credit market has matured, more banks, investors and managers have become involved in the asset class, leading to rising liquidity and falling risk premiums. Despite being an early mover in the credit market, Axa IM's emphasis on strong fundamental research and relative value trading is well suited to this mature market environment.

"What we have been doing in the past seven years is moving upstream - finding the new areas," says Juillard, stressing that Axa IM's strategy is not just to innovate for innovation's sake.

The company has more than EUR33 billion ($43 billion) invested in structured credit, including around EUR6 billion in ABSs, EUR5 billion in leveraged loans and EUR1.2 billion in infrastructure assets. With a further EUR18 billion in investment-grade corporate CDOs and EUR4 billion in CDO tranches, this is one area where Axa has made a big impact - although Juillard says this was not always the case.

"In early 2000, most large managers were doing investment-grade CDOs, with all the tranches fully funded and placed. We decided not to do any due to the high cost of financing."

The firm stayed on the sidelines, liaising with rating agencies and biding its time until the right opportunity came along. Then in 2002, Axa IM and Deutsche Bank jointly unveiled Jazz - the first CDO to invest in both cash assets and credit default swaps. This landmark transaction was soon followed by another hybrid CDO, Jazz II, also arranged by Deutsche Bank. It comprised mainly investment-grade bonds and synthetic assets, with the rest in ABS. The Jazz II notes were called in December 2006 and paid investors an internal rate of return (IRR) of 26.1% at maturity, powered by more than 1,200 trades by Axa IM.

"You have to do a lot of small trades. People who have a strategy of avoiding default without active management cannot produce a 20%-plus return," explains Juillard.

The value harvested from this active management was helped by a reasonably volatile credit market after Jazz and Jazz II were issued in 2002. And while the original Jazz deal has not been called yet, Juillard believes it may deliver an IRR of more than 20%. It is due to mature in 2011.

Axa IM's latest hybrid, Jazz III, is designed for a less volatile environment that might see credit spreads widen. Closed in August 2006 and arranged by Merrill Lynch and Ixis Corporate and Investment Banking, the $3 billion CDO is backed by an investment-grade corporate credit portfolio (making up 97% of the deal) and a structured finance element (making up the remainder).

"The corporate credit portfolio is there as a wait-and-see carry trade. When the market corrects we will be able to reposition the BBB+/A- portfolio into a BBB/BBB- portfolio, but with a much wider spread and higher opportunity to generate alpha," says Juillard.

Axa IM also had a hand in another structured credit development in 2006. It acted as a sub-manager in the first multi-manager transaction, Confluent Senior Loan Opportunities, which was launched in July and arranged by Calyon. Paris-based Credit Agricole Asset Management acted as senior manager to the EUR600 million deal, presiding over five sub-managers, with the ability to reallocate funds from one manager to another.

While seeking new markets for structured credit, Axa IM is also keen to take structured credit to new investors. In December, it helped seed Volta Finance, a Euronext-listed closed-end investment company targeting structured credit. Volta's listing raised EUR300 million. Axa IM teamed up with Goldman Sachs and Citigroup to capitalise the vehicle.

Also in December, the firm announced its partnership with Deutsche Bank to create a credit derivatives product company, NewLands Financial (see page 10). From this month, the Bermuda-registered firm plans to specialise in selling super-senior credit protection on highly rated CDO tranches. It may expand into other asset classes, such as ABS, from 2008.

"We believe the combination of Axa and Deutsche Bank will make it very successful. We don't try to be in fashion, we just try to be in at the right time," says Juillard.