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Credit hedge funds focused on distressed debt have posted huge profits this year as rising borrowing costs hit weaker companies.
The central bank’s interest rate hikes have put pressure on some small and medium-sized enterprise borrowers considered to be higher credit risks, forcing them to offer significantly higher interest rates to attract potential lenders.
It also makes existing riskier debt cheaper, boosting yields and providing the opportunity for better potential returns.
After a more challenging 2022, the Eurekahedge Distressed Debt Hedge Fund Index rose 5.9% on Friday, making it the best-performing strategy so far this year.
“The longer-term higher (interest rate) environment we are in creates attractive opportunities in credit,” said Danielle, portfolio manager and managing director at Oaktree, a $172 billion credit investor. Poli said.
Analysis by credit fund Alcentra’s special situations team shows that about 120 billion euros of European bonds and loans are at non-performing levels with interest rates above 12%, double the roughly 50 billion or 60 billion euros in 2019. The analysis only considered debt issuances with an issue size exceeding EUR 100 million.
Richard Deitz’s hedge fund VR Capital returned 18.2% through the end of July, making it one of the year’s best performers, according to a person who has seen the data. The fund has $4.9 billion in assets under management and focuses on distressed companies in emerging markets.
Jimmy Levin’s Sculptor has $1.4 billion in assets under management and its Credit Opportunities Fund returned 8% as of the end of August. About two-thirds of the fund is invested in corporate debt, with the remaining one-third invested in structured credit instruments that include loans.
The better performance marks a reversal from last year, when credit investments were hit by falling bond prices as central banks raised interest rates. VR and Sculptor declined 5.7% and 4.1% respectively last year.
“Last year, performance was severely impacted by rising interest rates, which led to credit issues and a lot of forced selling,” said Allan Schweitzer, portfolio manager at credit hedge fund Beach Point.
Hedge funds also make money by lending money to companies that have trouble borrowing from banks.
A $5.5 billion King Street fund gained 4.75% through Aug. 25, with performance driven in part by lending opportunities to smaller companies backed by private equity firms.
“The debt market for sponsor-owned single B- or triple-C debt has typically been closed for 18 months,” said Paul Goldschmid, partner and co-portfolio manager at King Street.
“It’s a real issue for these companies and we’re providing capital to a lot of companies that are facing cash flow issues and need to refinance their debt or help fund their negative free cash flow issues.”
Tougher financing conditions have given hedge funds greater negotiating power, allowing them to demand interest rates of 14% or higher, along with stricter covenants to ensure repayment.
Stuart Fiertz, president of London-based Cheyne Capital, said: “I think this is a golden age for new credit because traditional credit has a lot of flaws, not least the lack of covenants.”
“We can come up with really good covenants and structure the deal the way we like it.”
Svlook
