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A $10b euro credit manager girds for high-yield 'dislocations'

[OSLO] European high-yield investors should prepare for shakier times.

The market may look "benign" now, but with interest rates set to rise from record-low levels there will be "a lot of dislocations," according to Danish hedge fund manager Capital Four.

"It's very difficult to imagine that this won't create huge amounts of opportunity going forward," Sandro Naef, chief executive officer, said in a phone interview. "No one knows how this is going to turn out. No one has experienced that." Years of extreme central bank stimulus and signs of an economic recovery in Europe are driving down yields on the riskiest bonds, bringing them closer to investment grade debt. The Bloomberg Barclays Pan-European High Yield Total Return Index has risen more than 50 per cent in the past five years as demand for junk bonds has soared.

Copenhagen-based Capital Four, which manages about 10 billion euros (S$15.8 billion), focuses on the merits of individual companies rather than macroeconomic trends - a technique known as bottom-up. Its Credit Opportunities Fund has returned 14 per cent a year since its inception in 2010, with 6.5 per cent volatility. The 225 million-euro fund had a duration of 0.4 at the end of June, meaning the average maturity of the securities it holds is less than a year.

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"This is the time to be very cautious," said Rene Kallestrup, a portfolio manager at Capital Four. "Spreads are extremely tight at the moment. We're running a very low leveraged fund." The fund is ramping up long exposure to senior secured leveraged loans, especially in more "defensive" companies. It's short the iTraxx Crossover and individual weak credits.

It's clear that the current credit cycle has reached its extreme, and companies that couldn't sell debt three to four years ago are now managing to find funding, Mr Naef said.

"We are very concerned about companies that have too much leverage - when interest rates start to go up, they don't have a sustainable capital structure for higher interest rates," he said. "That will definitely be a challenge for some of the deals that are being made at the moment."

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