| Mitchell Julis (left) and Joshua Friedman, Canyon (Julis: Patrick T. Fallon/Bloomberg; Friedman: David Paul Morris/Bloomberg) |
Canyon Partners’ strategy to reduce overall market exposure and increase its exposure to special-situation corporate securities continues to pay off.
The Los Angeles firm’s two main funds are off to a strong start this year and, barring a shock to the markets, 2017 is shaping up to be its best year since 2013. Through May, the firm’s Canyon Value Realization Fund had gained about 6 percent, while the Canyon Balanced Fund had returned more than 7 percent.
The multistrategy firm headed by Joshua Friedman and Mitchell Julis has a strong credit orientation. This year it has thrived in most of the markets in which it participates. One major reason is its natural generation of cash as opposed to selling securities in the secondary market.
Canyon points out in its first-quarter letter to investors in the Canyon Value Realization Fund that 19 percent of its portfolio has turned to cash each year, on average, for the past five years as a result of pay-downs, liquidation distributions, refinancings, and other events. This includes 18 percent last year.
“Over the past several months we have deliberately concentrated the portfolio to a greater degree in short duration, catalyst-rich investments,” Canyon adds in the letter. “We believe this posture is likely to result in an even more rapid pace of cash generation."
When it published the letter on May 10, Canyon told investors that 8 percent to 9 percent of its net asset value might turn to cash over the ensuing four months.
In the first four months of the year, Canyon points out, it did well across most of the asset classes in which it invests. For example, distressed bonds generated a 10.2 percent gross return, distressed loans 7.1 percent, RMBS (residential mortgage-backed securities) 8.3 percent, and equities 6.3 percent. The distressed loans and bonds books each easily outpaced their targeted benchmarks, while the equities book came up slightly short of its bogey.
As a result, bonds kicked in 155 basis points -- 1.55 percentage points -- to first-quarter gross return, RMBS contributed 130 basis points, equities added 120 basis points, and loans chipped in 70 basis points. Private investments, municipal debt, convertibles, and hedges combined added 80 basis points.
Looking ahead, Canyon has boosted its exposure to special-situation corporate securities across the capital structure. “For the most part, these tend to be tied to companies reshaping their balance sheets, whether out of opportunism (strategic M&A, asset sales, cost of capital arbitrage, etc.) or necessity (as companies facing technological disintermediation, policy headwinds, and/or insurmountable leverage are compelled to restructure)," it elaborates in the letter. “While markets are not cheap as a whole, these kinds of asset-liability ‘makeovers’ can lead to meaningful disconnects between the market values and intrinsic values of certain securities."
This year, for example, Canyon has purchased first-lien loans in an unidentified drillship company, which Canyon explains is undergoing a restructuring.
“At our purchase price, we believe we are creating the underlying collateral at about 20 percent of replacement cost, and at about 40 percent discounts to implied public market valuations for comparable assets," Canyon explains.
The fund has also invested in the first-lien secured bonds as part of a restructuring in what it describes as “a legacy IT services business with asset value” but suffering from revenue challenges. Canyon says it received more than 25 percent of the new issue, which came with a double-digit yield that is roughly double that of comparably rated securities, and significant call protection.
Canyon also says it participated in what it describes as a rescue financing for a Spanish construction and infrastructure conglomerate that yields somewhere in the high teens, comes with call protection, and has “significant over-collateralization."
In addition, Canyon has invested in risk arbitrage situations “where we believe headlines, policy uncertainty, and fatigue in the arb community have contributed to artificially wide deal spreads.”
Finally, Canyon says it has made investments in three “credit-sensitive" equities -- two in the packaging sector and one in the gaming and lodging sector. All of these companies are in the process of reducing debt and are becoming significant free-cash-flow generators.
“We believe that all three of these companies may migrate from high-yield to investment grade status, and that lower costs of capital in the future should create greater flexibility for shareholder-friendly activities,” Canyon adds.