Credit funds have staged a pretty impressive rally over the past five or six months after getting off to a slow start this year. As a result, credit is among the better-performing hedge fund strategies this year.
Data tracker eVestment’s all-encompassing fixed-income/credit group has returned 5.53 percent for the year through August, better than most other hedge fund strategies, thanks to double-digit gains in each of the past four months. Last year the fixed income/credit group lost about 0.4 percent.
Investors, seeking higher returns on fixed-income investments, have been piling into high-yield bonds, even the riskiest paper, as spreads narrowed between Treasury bills and high-yield bonds. This played out amid a worldwide decline in interest rates for various fixed-income instruments.
In the search for yield, many credit funds found it in the energy industry, including some riskier paper. Otherwise, many of the gains have come from an eclectic mix of specific opportunities.
Among the biggest credit funds, Los Angeles–based Canyon Partners’ Canyon Value Realization Fund gained about 6.6 percent through August, after losing a few basis points in the first quarter. Second-quarter gains came mostly from bonds, especially the bonds of a distressed gaming company that announced a reorganization plan during the quarter. Canyon earned lesser gains from corporate loans, residential mortgage-backed securities, equities, distressed municipal debt, structured credit instruments and convertibles. At the end of the second quarter, Canyon added to its exposure to corporate debt and securitized products and sharply lowered its exposure to equities.
New York–based King Street Capital Management’s eponymous hedge fund returned 3.23 percent through mid-September. It was down a few basis points in the first three months.
In its second-quarter letter to investors, the hedge fund said second-quarter gains came from energy and power instruments, its investment in longtime winner Lehman Brothers Holdings and structured credit.
The Tilden Park Offshore fund, managed by New York–based Tilden Park Capital Management, netted 4.65 percent through August. The firm — founded by Josh Birnbaum, formerly co-manager of trading in the Structured Products Group at Goldman Sachs — focuses on structured products and mortgages, fixed-income relative value, and corporate credit and equity strategies.
On the other hand, New York–based Anchorage Capital Group’s Anchorage Capital Partners Offshore fund fell 1.5 percent through June, after losing money in five of the first six months of the year.
One smaller fund that invests a significant amount of its capital in credit seems to be faring much better than its bigger competitors. The New York–based Latigo Ultra Fund, headed by David Ford and David Sabath, has gained about 13.5 percent through mid-September. Keep in mind that it lost 11.9 percent last year and nearly 5 percent in the first quarter of this year. The fund, which has more than $450 million under management, had lost money for 11 straight months before it started a string of five consecutive profitable months in April.
“Our performance reflected a strategic repositioning of the fund beginning late in the first quarter,” the firm states in its second-quarter letter, noting it used the sell-off in the first quarter to put a significant amount of capital to work. It initiated many new positions, added to existing positions and overall boosted net exposure from 37 percent to 51 percent.
As a result, four of the fund’s five largest gainers in the second quarter are new positions this year, accounting for 24 percent of capital. They are the bonds of Chaparrel Energy, Comstock Resources, Ultra Petroleum Corp. and Freeport-McMoRan.
Latigo explains that before the second quarter, the firm was very cautious about investing in distressed energy companies, mostly emphasizing operators of oil and gas pipelines, such as National Gas Pipeline Co. of America (NGPL), the Williams Co./Williams Partners and Kinder Morgan (a joint owner of NGPL), which account for about 10 percent of capital.
By the end of the first quarter, Latigo says, it felt distressed securities’ prices had “finally gotten to a point where we had a significant margin of safety.” So it made several new investments in both oilfield services and exploration and in production companies, noting that it thinks these companies offer downside protection.
Latigo says because of its size, it eschews what it calls the “traditional, bellwether bankruptcies” of large companies like TXU Energy, Nortel Networks Corp., Lehman Brothers Holdings or Washington Mutual. Rather, it seeks out companies with $1 billion to $2 billion in debt that the firm feels are liquid enough for it to take concentrated positions in but are not large enough for bigger competitors looking to invest hundreds of millions of dollars at one time. These are the companies that drove second-quarter returns.
Latigo’s managers say there are also compelling opportunities in the media and finance sectors.
“We can’t ever recall having seen . . . a valuation disparity in distressed companies versus their publicly traded peers as large as we see today,” Latigo’s managers assert.
