Hitting new heights in subordinated debt
The Spectrum Asset Management team unpacks its unique fixed income strategy.
may 2025
Source and Copyright: Citywire.
Welcome to another edition of SOURCE, the publication that shines a spotlight on selected strategies and their managers. This time, we focus on Spectrum Asset Management, a fixed income subordinated debt expertise of Principal Asset Management and their funds, the Principal High Grade Capital Securities Fund and Preferred Securities Fund. Discover more in our profile and Q&A with Spectrum Asset Management, plus supporting analysis from Citywire.
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Source and Copyright: Citywire.
In the competitive bond space, the temptation to enter certain parts of the market can be high. Spectrum Asset Management has largely endured by sticking to its original focus.
Subordinated, not subprime
Spectrum Asset Management’s subordinated debt approach is seeking to capitalise on higher quality opportunities without being drawn into more controversial areas. This is why contingent convertible bonds – so called CoCos – are not on the menu.
Fixed income has rarely been this fiercely competitive, with the changing interest rate envi-ronment opening up opportunities for an array of different approaches. So, how can an as-set manager stand out against this backdrop?
Established in 1987 – and turned into an affiliate of Principal Global Investors in 2001 – Connecticut-headquartered Spectrum Asset Management is the brainchild of Mark Lieb, who currently holds a Citywire A rating for his risk-adjusted returns in the US dollar bond markets.
Lieb, who cut his teeth on Wall Street in the hyper-competitive 1980s, saw the European market as a true growth area, which led Spectrum to expand its Ucits-compliant fund base over time and further establish a base in Zurich.
With this expansion came the opening up of his long-running Preferred Securities fund to a European investor base in 2003. Lieb co-runs this strategy with the team of Phil Jacoby, Manu Krishnan and Bob Giangregorio – all of whom are Citywire A-rated and have worked at Spectrum for over 20 years.
Spectrum sought to further leverage its established lengthy track record by bringing the Principal High Grade Capital Securities fund to market in 2024. This Dublin-domiciled fund, which is managed on a team-based approach, has already accrued more than €177m in assets and aims to serve as an alternative for investors looking at the euro-denominated investment grade capital securities market.
The fund is partly defined as much by where it doesn’t go as where it does. Despite many investors equating the subordinated debt space with contingent convertibles – where debt converts to equity based on certain parameters being met – this is not where the Spectrum team wants to put capital to work. And it believes this decision could provide a vital edge in today’s markets.
Isabel Faragalli, managing director at Spectrum, said: ‘If you look at most subordinated debt managers from across Europe, you will see the majority of funds are typically rated in the double-B-plus space, chasing higher yields. This comes about through a large exposure to the CoCos/Additional Tier 1 capital bonds.
Investment profile
Managing director
Isabel Faragalli
‘There’s no subordinated debt manager anywhere with zero allocation to CoCos – except us’
• Focused on Euro denominated capital securities and hybrids
• 100% investment grade
• No exposure to CoCos
Fund facts
Fund size:
Principal High Grade Capital Securities Fund*
Preferred Securities Fund*
€177.48m
Base currency:
Euro
Launch date:
2024
SFDR classification:
Article 8
Investment philosophy:
26
FEB
Institutional share class (I Acc):
IE0000R8LK58 / PGIGRCI ID
ISIN / Bloomberg tickers:
• Focused on US Dollar denominated preferred and capital securities
• Minimum 80% investment grade
• Exposure to CoCos with maximum 30% exposure
• Average portfolio BBB- or better
Fund size:
$4.16bn
Base currency:
USD
Launch date:
22
APR
2003
Investment philosophy:
Institutional share class (I Acc):
IE0032591004 / PGIPSIA ID
ISIN / Bloomberg tickers:
SFDR classification:
Article 8
download fund fact sheet
download fund fact sheet
‘However, we are different in that we remain on the investment grade side, investing in the safer, high-quality investment grade paper with lower volatility. For that reason, we believe that investors should place the High Grade strategy within their investment grade bond port-folio allocation, rather than within a high yield asset allocation.’
Faragalli said yields of the securities in the strategy are typically between 1.5-2% above the senior unsecured bonds of the same issuers and slightly below high yield debt yields. This comes despite deliberately omitting CoCos, which would expand the current €300bn of eu-ro-denominated securities market by a further €80bn.
‘Currently, there are no subordinated debt funds which have zero allocation to CoCos,’ said Faragalli.
Gemma Tomas, who is a managing director alongside Faragalli, said the credit process is a key difference compared with many of Spectrum’s competitors. ‘For us at Spectrum, this fundamental credit analysis is the very first step of the investment process,’ she said.
‘We have a team of extremely knowledgeable people with 20 to 30 years’ experience as credit analysts in each of the key three sectors in which we invest – banks, insurance and utilities. They do a thorough bottom-up credit analysis of the issuer, on not only the quanti-tative elements, but also qualitative elements including ESG screening. This is combined with a top-down analysis of the industry and the regions in which they do most of the business.’
Having focused their efforts, Tomas said the credit analysts then select a subset of names, which currently runs to 170 across the three sectors.
‘This is the only universe of approved issuers where portfolio managers can find the best relative value amongst the underlying papers. Portfolio management will do the next step of the investment process, in terms of getting the paper with the best coupon and structure characteristics.’
So, where are the opportunities now? Faragalli name-checked utilities as being particularly attractive, despite having been, in her words, a ‘particularly dull sector’ for the past five years.
‘There has been very little utility bond issuance over the past five years because there hasn’t been a huge demand for energy and there have been many ways to make energy more effi-cient over the last 25 years. However, this all of a sudden changed last year.
Managing Director
Gemma Tomas
‘Fundamental credit analysis is the very first step of the investment process’
‘The utilities companies, realising that they would have to increase their capex over the next five to 10 years to keep up with the new demand in energy and the transition to clean sources, have had to go out to the market and procure additional financing. That has basically changed the market completely.’
Emphasising the change in pace of issuance, Faragalli said utilities hybrid bond issu-ance has leapt from around €12bn worth of new paper in 2022 to €19bn in 2024. ‘This is a huge growing market, and a lot of these companies have not accessed the debt cap-ital markets for many years. With their increased capex needs, they’ve realised that they do have to do a lot of issuance over the next few years and therefore need to offer very attractive coupons.
Faragalli said current thinking is aided by the ability to take a top-down view on the en-tire landscape of subordinated debt. ‘Whether it’s telecommunications, industrials, util-ities, banks and insurance, we can invest across different sectors and not just in single sectors such as banks or insurance. Basically, we can add value by overweighting and underweighting the sectors we find more attractive or less attractive.’
Spectrum said this helps differentiate its approach from rival asset managers, who may be focused solely on the financial sector, for example. ‘You can often find an insurance bond fund or a financial bond fund or corporate hybrid fund, but I think we add value by really being able to see which sectors have the best value and the best credit profiles.’
Tomas added that the fund also isn’t rigid within its geographic reach: it targets euro-denominated debt but the portfolio managers are empowered to go where the position-ing is the most advantageous for investors.
‘We think about that positioning, as it’s important to reiterate that we are positioning this fund as an investment grade fixed income portfolio. We’ve run a number of regressions, and we can show that correlation of our asset class to investment grade credit bonds is low – at around 0.5.
‘So, an investor with a traditional investment grade fixed income portfolio that would consist of Treasuries, investment grade credit, maybe some investment grade emerging market bonds, would be better off allocating to euro-denominated Capital Securities, optimal weight of 20%, to deliver a consistent positive alpha with lower volatility. Playing with this diversification but strictly staying within investment grade is very unique to the Principal High Grade Capital Securities fund.’
Bond market fluctuations have left many investors unsure of the best way to capture returns while also remaining well defended against future shocks. This uncertainty has strengthened the case for the relatively specialist area of euro-denominated subordinated debt, which has seen a surge in issuance over the past five years.
Spectrum Asset Management, which runs the Principal High Grade Capital Securities fund, believes now is the time to capitalise on this growing opportunity, which spreads beyond the traditional bastion of the US, as well as expanding outside the realm of solely financial issuers to new areas seeking to use the securities to fund capex spending.
In this video, key members of the team – including Spectrum AM’s founder Mark Lieb – outline why the boutique investor is best positioned to unlock growing opportunities and how the High Grade Capital Securities Strategy can find the best that investment grade issuers in this space have to offer.
Managing Director
Gemma Tomas
‘Fundamental credit analysis is the very first step of the investment process’
*This product may not be registered in all jurisdictions for sale and may not be directly or indirectly offered or sold to investors in all jurisdictions.
Data as at 30 April 2025
Mark Lieb, Founder, President and Chief Executive Officer
Frank Talbot
Principal High Grade Capital Securities Fund
When thinking of subordinated debt funds, one often thinks about strategies investing in high yielding contingent convertibles – or CoCos. Principal High Grade Capital Securities Fund is aiming to do something different by investing solely in higher rated investment grade subordinated debt and forgoing the lower quality but higher yielding hybrids that have become synonymous with the sector since their creation in the credit crisis.
The objective is to provide superior returns relative to euro investment grade corporates on both an absolute and risk-adjusted basis, given the fund has an average credit rating of A- at the security level and a zero allocation to CoCos and non-investment grade bonds.
The fund has so far delivered on its investment objective of out-performing investment grade corporates both on an absolute and risk-adjusted basis (higher returns with lower volatility). Since inception to 22 April 2025, the fund has returned 6.7% relative to 6.54%, and 7.38%, for the ICE BofA euro Corporate Senior Index, and ICE Bofa Euro High Yield Index respectively, as seen on Figure 1.
Performance overview
Head of investment research, Citywire
From Figure 2, it can be seen that the Principal High Grade Capital Securities Fund has had lower volatility relative to euro investment grade corporates. Volatility has increased as of late given the tariff chaos which has brought the volatility of the fund in-line with IG corporates; but the increase in volatility in high yield has been quite remarkable.
While the Principal High Grade Capital Securities Fund is an outlier in European subordinated debt, the firm also runs the flagship strategy, the Preferred Securities Fund, launched in 2003 and with assets under management of $4.16bn. This is a global fund invested along similar lines, but including investments in CoCos, up to 30%. However, with a large chunk of its assets in US subordinated debt, which is a much lower-quality space, where CoCos and retail bonds make up a portion of the assets, this position is just a product of the issuance available.
That same strategy of investing in high-credit-quality bonds persists. Over the past decade, the fund has more than doubled the returns of its reference index – Bloomberg Global Aggregate Corporate. It also nearly kept pace with global high yield benchmarks – all the while presenting drawdowns to 14.1%, versus 20% for the Bloomberg Global Aggregate Corporate index and 20.6% for the Bloomberg Global High Yield benchmark in US dollar terms.
Spectrum Asset Management has operated for over 37 years in overlooked or underappreciated areas of fixed income markets and has leveraged its working relationship with Principal Global Investors to expand into new markets.
Thinking differently in subordinated debt
Fund manager Q&A
Isabel Faragalli, Managing Director: We’ve been around for over 37 years. We’ve seen just about every crisis there has been in the markets. Our philosophy is generally more defensive and more conservative than others. We’re not chasing yield. We’re really trying to offer a very defensive, long-term, stable strategy where there’s not too much volatility.
Gemma Tomas, Managing Director: The dollar market is more mature and deeper, but today’s euro market has considerably grown. We’re talking about a market size of over €300bn in euro capital securities. If you add the euro-denominated CoCos, that would be €80bn-plus. It’s a large and liquid market. On top of that, when companies in the financial sector – that is, banks and insurance – issue euro-denominated paper, they typically need to pay 40 basis points on top versus what would be the spreads they would apply in the dollar market. Why? The euro is seen as a more fragmented market and global investors expect this pickup to invest in euro denominated paper. Also, the volatility in the euro market is lower as the trajectory of ECB rates is more certain. It is a very compelling case to invest in euro-denominated capital securities.
Why invest now in the euro-denominated market for subordinated debt/capital securities?
The subordinated debt market has historically been dominated by US issuers, but with increased appetite for capex and new means of funding growth, euro-denominated securities are growing in size and sophistication.
At the forefront of those funds seeking to capitalise on this €400bn boom experienced over the past five years is the Principal High Grade Capital Securities fund, which is operated by specialist investment house Spectrum Asset Management.
This fund, which is the brainchild of Wall Street stalwart Mark Lieb, aims to capture opportunities presented in areas beyond the traditional markets of banking and insurance, such as energy infrastructure and utilities. In this video, the Spectrum Asset Management team talks through where this strategy would fit in an investor’s portfolio.
Phil Jacoby, Chief Investment Officer: We diversify across three main sectors: banks, insurance, and utilities and energy. In these sectors, we would invest only in the most solid companies issuing in the euro market and select the subordinated debt paper that has the best characteristics of coupon and structure.
There are two current thematic opportunities I would like to highlight. The first is the utilities and energy sector. Today, this is the sector bringing net issuance into the market as European utilities are facing a huge increase in capex to support transition to clean energies and more resilient energy as demand is growing, fuelled by AI and data-centre growth. These companies continue to issue hybrids to maintain their senior debt ratings, and they pay spreads that are higher than bank issuers due to the need to find new investors in the utilities market.
The other investment theme we are playing is insurance. We look globally into the insurance sector, and much like the European and Swiss insurance regulation, which make issuers especially resilient and strong. We expect new and continued issuance from insurers as they look to optimise their strong balance sheets and as investors in their capital, that’s obviously a key topic for us.
What are the main themes or investment ideas on your agenda currently?
Manu Krishnan, Deputy Chief Investment Officer: If you look at most subordinated debt managers across Europe, you’ll see that most of the funds are typically rated in the double-B-plus space. These are mainly managers who are chasing yield. They have quite high allo-cations to AT1 bonds and there has been a predominance of managers buying subordinat-ed debt from banks located in Southern Europe.
How Principal and Spectrum are different is that we play on the safer, high-quality invest-ment grade side. Typically, our European funds have an average credit rating of single A-minus at the security level and we only invest in issuers who have an investment grade rat-ing at the senior long-term rating level.
Our High Grade Capital Securities strategy fits well into an investment grade bond portfolio allocation, where it can provide an interesting yield pickup. Yields on such subordinated debt securities are typically 1.5-2% above the senior unsecured bonds of the same issuers and slightly below high yield debt yields.
Where does subordinated debt fit into a broader fixed income portfolio allocation?
Joseph Urciuoli, Head Of Research: For us at Spectrum, fundamental credit analysis is the first step of the investment process. In our team, everyone has 20-30 years’ experience as credit analysts in each of the three sectors in which we invest. They do a very fundamental bottom-up credit analysis of the issuer, on not only the quantitative elements, but also qualitative elements including ESG screening. This is combined with a top-down analysis of the industry and the regions in which they do most of the business.
Currently, that covers 170 names across the three sectors: banks, insurance, and utilities and energy. This is the only universe of approved issuers where portfolio managers can find the best relative value amongst the underlying papers. Starting with credit and by just choosing the best issuers with the most fundamental solid elements is the key initial step of our investment process.
Tell us about Spectrum’s credit process and what has made it successful?
Matthew Byer, Chief Operating Officer: We’re looking at capital preservation. We’re not try-ing to chase yield. As you can see from our track record, we ensure that we’re not in compa-nies which default. It should be mentioned that Spectrum did not have any allocation to the Credit Suisse CoCos when Credit Suisse collapsed in 2023 and it did not have allocations to any of the Southern European banks which have defaulted over the last decades.
Our credit process looks at many things, but governance and qualitative aspects are very important for us. We interview companies regularly, so it’s not just looking at financial fig-ures and data. It’s also understanding how good the management is. Do they really have a strategy? Are they hiding anything from us? Another thing we do, which is quite different from a lot of managers, is look across the subordinated debt spectrum. Basically, we can add value by overweighting and underweighting a number of different sectors we find more attractive or less attractive, resulting in higher diversification.
Typically, you won’t find many managers who invest across all the different sectors. You can often find an insurance bond fund or a financial bond fund or corporate hybrid fund, but I think we add value by really being able to see which sectors have the best value and the best credit profiles.
There are many managers in euro subordinated debt. What differentiates Spectrum from its competition?
Phil Jacoby
‘Our European funds have an average credit rating of single A-minus at the security level.’
Chief Investment Officer
Chief Operating Officer
Matthew Byer
‘Our credit process looks at many things, but governance and qualitative aspects are very important for us.’
From left to right top row: Matthew Byer, Joseph Hanczor, Manu Krishnan, Joseph Urciuoli, John Kriz.
Bottom row: Phil Jacoby, Mark Lieb