Although much has been made of the recent spike in volatility that has roiled the stock market over the past few months, this phenomenon spread to the credit markets and most others as well.
For proof, look no further than the third-quarter reports from Los Angeles–based Canyon Partners, known for its investments in various fixed-income and credit markets.The firm’s flagship Canyon Value Realization Fund lost 3.29 percent in the third quarter, putting it in negative territory for the year by 0.42 percent, according to its most recent quarterly letter, dated October 19 and obtained by Alpha.
However, the firm told clients it recouped more than half this loss in the first part of October, gaining 2.08 percent during that short period. As a result, the fund was up 1.65 percent for the year through October 9. Altogether the strategy had $9.9 billion under management as of October 1.
Meanwhile, the smaller Canyon Balanced Fund posted its worst quarter since 2011, losing 8.15 percent during the September three-month period. As a result, it was down 5.38 percent for the year. This fund also rebounded sharply in the first week or so of the current quarter, however. It returned 2.68 percent for the month through October 9, cutting its loss for the year to 2.85 percent.
“We have high conviction in the portfolio, and are encouraged by the ways in which the disorder of the third quarter has broadened our opportunity set,” the firm tells clients of the Balanced Fund, which had $3.2 billion as of October 1.
Meanwhile, Canyon tells investors it is launching a new longer-lockup hybrid fund, to be called Canyon Distressed Opportunity Fund II. It explains that now is a good time to create a longer-term vehicle that can take advantage of market opportunities in a concentrated fashion.
“Volatility has increased and security prices have declined (some quite severely) over the last several months in response to tightening financial conditions,” the firm writes to clients. “Contracting access to capital has been a prominent ingredient in the major dislocations (and opportunities) that Canyon has weathered (and capitalized on) over the past 25 years. The increasing fragility of certain business models is beginning to be reflected in a number of ways, including wider credit spreads, lower liquidity, and a material and sudden expansion of the stressed and distressed debt universe.”
Canyon tells clients that over the past two years it has returned $2.6 billion in locked-up capital in the form of distributions from the Canyon Distressed Opportunity Fund, the Canyon Structured Assets Fund and several other hybrid structured separate accounts that entered their harvesting periods.
“These longer term vehicles have allowed us to venture further out on the illiquidity spectrum and take more concentrated positions than we could prudently do in our open-ended hedge funds,” it explains.
Canyon was founded in 1990 by Joshua Friedman and Mitchell Julis, who met at Drexel Burnham Lambert. Today the firm manages more than $24 billion, including separate accounts.
Since its November 1993 inception, Canyon Value Realization has compounded at nearly 700 percent, compared with about 530 percent for the Standard & Poor’s 500 stock index, 461 percent for the Russell 2000 and more than three times better than the Credit Suisse Leveraged Loan Index.
The fund invests in a wide variety of asset classes, including equities, and a range of credit and debt markets. Four markets account for most of its exposure, however. Equities represented 30 percent of its total 104 percent exposure as of October 1. This compares with 21 percent and 94 percent at the beginning of the year. As of October 1, residential mortgage-backed securities had a 22 percent exposure, while bonds and distressed bonds had 21 percent, and loans and distressed loans had 15 percent. The remaining asset classes include private investments at 8 percent, along with very small allocations to aircraft securitizations, distressed municipals and convertible arbitrage.
“A broad swath of asset categories suffered sharp price declines in the third quarter as financial conditions tightened globally,” Canyon explains.
Specifically, on a gross basis, Canyon Realization lost 355 basis points — or 3.55 percentage points — from equities, 70 basis points from bonds and 20 points from convertibles. However, it earned 65 basis points from corporate loans, 55 basis points from RMBSs, 10 basis points from distressed municipal debt and 5 points from structured credit instruments.
Looking ahead, Canyon tells clients now is an especially good time to invest in its fund, noting that historically the best times to invest in Canyon have been during down markets. The firm points out that over the course of the fund’s existence, the S&P 500 has posted negative trailing 12-month returns in a total of 52 months. During any of these months, the fund’s average subsequent two-year annualized net return was 15.6 percent, versus 5.8 percent for the S&P 500. The lowest two-year annualized return for the fund during any of these 52 months was 5.3 percent, versus a loss of 19.7 percent for the S&P 500.
The same holds true for the Balanced fund. Canyon points out that during the fund’s existence, the S&P 500 posted negative trailing 12-month returns in a total of 22 months. The fund’s average subsequent two-year annualized net return during these months was 24.7 percent compared with 10.2 percent for the S&P 500. The lowest two-year annualized forward return for the fund during any of these 22 months was 7.7 percent versus a loss of 9.7 percent for the S&P 500.
Sounds like another case of being rewarded for buying on weakness.
