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Credit hedge funds wounded with low rates crimping opportunities

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Hedge funds that invest in credit have seen a torrid few months, with a growing list of players closing or halting client withdrawals after racking up losses.

Credit managers -- who focus on everything from corporate loans to distressed opportunities -- have been among the worst performers in a beleaguered hedge fund industry. And while last week’s coronavirus-driven market rout may give managers a chance to recoup some losses, the long-term picture for many is still gloomy.

A low-rate environment has allowed companies in need of financing to avoid defaults or bankruptcy, making it difficult for credit managers to profit. At the same time, the broader market has provided far better investor returns over the past year, at least before the past week.

The latest casualty was Benefit Street Partners’s credit hedge fund, which shut last year after returns slumped, Bloomberg reported last week. Managers at KLS Diversified Asset Management’s special-situations business and at York Capital Management have also made similar decisions.

“Overall, it’s a tough space to be in,” said Jeffrey Fulk of Alvarium, a firm that manages money for wealthy families and that hasn’t invested in credit hedge funds since 2013.

The funds that remain are struggling. A Pacific Investment Management Co. credit hedge fund fell about 14% in 2019, while Solus Alternative Asset Management dropped about half that, according to people familiar with the matter.

York has blocked withdrawals from its $2 billion Credit Opportunities fund while it seeks to unload illiquid investments before closing. Southpaw Asset Management has also told some redeeming clients they’ll have to wait to get their cash.

The dire climate is further evidence of the challenges facing the hedge fund industry. Overall, hedge fund returns last year lagged behind the broader market with the industry gaining 9.2%, according to the Bloomberg Hedge Fund Indices. Credit hedge funds on average did worse, gaining 6.9%.

The pain is likely to continue this year. On Friday, Federal Reserve Chairman Jerome Powell signaled the central bank is prepared to cut interest rates if necessary to sustain economic growth in the face of risks posed by the coronavirus.

“We don’t really see a justifiable opportunity right now because of where rates are, where high-yield spreads are and because of the lack of a distressed cycle or bankruptcies right now,” Fulk, a managing director at Alvarium, said in a telephone interview.

The lack of opportunities drove managers toward several troubled companies -- including PG&E Corp., Frontier Communications Corp., Intelsat SA and energy-related firms -- that they should have avoided.

The decline in energy prices hit several funds including Solus. It saw its biggest losses last year from a tumble in oil services company Hornbeck Offshore Services Inc. and natural gas transporter and processor Southcross Energy Partners LP, one of the people said.

Pimco’s 2019 plunge was also driven by positions in energy. The firm’s $3.2 billion Global Credit Opportunity fund invested in the debt and equity of drillers, producers and pipelines, one person said. The fund, which runs a relative value strategy, has continued its slump this year, with an almost 1% loss in January.

Representatives for the funds declined to comment.

Still, some managers have avoided the land mines.

Jason Mudrick’s Distressed Opportunity fund rose 22% last year, buoyed in part by a short wager on the credit of Dean Foods Co. Sandell Asset Management’s Castlerigg Credit Opportunities fund, run by Raj Dave, gained about 26% last year by focusing on liquid middle-market companies in North America and Europe.

For investors like Fulk, however, razor-thin spreads would need to widen sufficiently for his firm to return to credit hedge funds.

“It’s very hard to take on the illiquidity risk of a hedge fund with stressed or distressed investments,” he said.

Bloomberg News
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