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October 9, 2006
Debt-focused hedge funds ‘leading way’
Hedge funds focused on debt markets are set to achieve some of the strongest returns in the industry this year, while others such as those focused on macro strategies or equities stumble, according to JPMorgan.
Credit funds, which represent a small but growing portion of assets under management in the industry, are achieving returns of 10-15 per cent in the year to date, analysts at the bank said.
However, the main source of these gains has been increasingly concentrated bets on the booming European leveraged loan market, which suggests the funds could be more susceptible to big losses if their chosen companies run into trouble.
“Amid all the reports of losses at a large multi-strategy fund and poor performance across the macro fund community, it is easy to overlook the performance of credit funds,” said Stephen Dulake, European credit analyst at JPMorgan.
Credit funds’ stronger performance had been a consistent theme all year, he said, as they had been able to sidestep some of the turmoil that has hit other hedge fund strategies.
Those credit funds that have lagged behind in performance have been involved in broader strategies, such as adding bets on equities to their portfolio, or have been caught up in companies that have become distressed, such as German autoparts maker Schefenacker, he added.
The most successful funds have held core stakes in European leveraged loans, the debts raised by companies with low credit ratings that are often used to fund private equity buyouts.
“One change that has taken place is that credit funds’ loan portfolios have become increasingly bifurcated,” Mr Dulake said.
The funds are increasingly taking large positions in a company’s most senior secured loans while at the same time buying the most junior, equity-return-like debt of the same company, for example PIK-loans that can see interest payments deferred. This kind of positioning is known as barbelling.
“Single-company exposures also seem to be getting bigger,” said Mr Dulake. “People seem to be betting more and more on names they like.”
While this meant funds were more exposed to the risk of particular companies struggling, Mr Dulake said the barbell strategies appeared to be more heavily weighted towards the senior debt, which would see better chances of higher recoveries if there were problems.
Demand for loans from hedge funds and other specialist investors remains very strong, which in turn allows banks to feel comfortable in continuing to lend more funds to low-rated companies helping to keep the default rate low.
-FT.com-
Posted by su at October 9, 2006 11:22 AM