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Digital Subscriptions > The Hedge Fund Journal > Issue 131 – Apr 2018 > East Lodge Exploits New Structured Credit Landscape

East Lodge Exploits New Structured Credit Landscape

Ali Lumsden’s unwavering focus on fundamental research

“Tomorrow’s Titans” 2010 - 2016: Revisited

Alistair (“Ali”) Lumsden and the investment team at East Lodge Capital have been underwriting and investing in global structured credit markets since the 1990s. Today they are managing over $1.25 billion, and the opportunity set remains compelling. This is in large part because of their global focus, and in particular their expertise in Europe at a time when opportunities in US structured credit markets are far fewer than they were just a few years ago. A decade on from the financial crisis, the spectre of loose monetary policy pushing equities to record levels and spreads ever tighter has meant those with expertise in less travelled markets have an advantage given their ability to seek unique opportunities outside of traditional markets. For East Lodge, it is certain segments of the UK mortgage market that they view as offering the most compelling risk/reward, and these last few years have provided vindication of this view. “Given high valuations for equities and low yields on investment grade fixed income, floating rate ABS is attractive and offers better yields than corporate debt”, argues Lumsden. These instruments have been trading at a discount to par over the last few years, making them “a very defensive investment, with several types of optionality.”

East Lodge essentially invests in UK ‘non-conforming’ mortgages, which have been compared to ‘subprime’ bonds in the US, although the borrowers are quite different. A typical UK non-conforming borrower is self-employed, versus being lower income or credit impaired. In fact, Lumsden is very comfortable with the credit quality of these securities. “We own seasoned mortgages that were underwritten ten or more years ago when LIBOR was 5% and total interest rates could be as high as 9-10% for these borrowers. When UK LIBOR dropped to 0.25%, rates on these now floating rate mortgages effectively halved. Prime borrowers in the UK were paying the lowest rates since records began over 400 years ago”, he points out. The significant reduction in rates has put these borrowers in a much better financial position, and this combined with the strength of the collateral package makes these bonds highly attractive. “The weaker borrowers already defaulted years ago (credit burnout)”, Lumsden adds, “further improving the securitisation as a whole.”

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