Credit hedge funds profit as companies face soaring borrowing costs

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Credit score hedge funds that concentrate on distressed debt are making bumper income this yr because the rise in borrowing prices hits weaker firms. 

Central financial institution fee will increase have put stress on some small and medium-sized company debtors thought-about riskier credit score, forcing them to supply considerably larger charges to tempt potential lenders.

It has additionally made current riskier debt cheaper, rising yields and providing the chance for higher potential returns.

After a tougher 2022, the Eurekahedge distressed debt hedge fund index was up 5.9 per cent on Friday, the best performing technique of the yr to date.

“The upper for longer [interest rate] setting that we’re in, has created enticing alternatives within the credit score spectrum,” mentioned Danielle Poli, portfolio supervisor and managing director at $172bn credit score investor Oaktree. 

Evaluation from the particular conditions group at credit score fund Alcentra exhibits that about €120bn in European bonds and loans are buying and selling at distressed ranges, above rates of interest of 12 per cent, double the roughly €50bn or €60bn seen in 2019. The evaluation solely thought-about debt with a problem dimension above €100m. 

Richard Deitz’s hedge fund VR Capital returned 18.2 per cent by the top of July, making it one of many yr’s best-performing funds, in accordance with an individual who has seen the numbers. The fund has $4.9bn in property beneath administration and primarily focuses on distressed firms in rising markets. 

Jimmy Levin’s Sculptor has seen his Credit score Alternatives fund, which manages $1.4bn in property, return 8 per cent to the top of August. About two-thirds of the fund is invested in company debt, whereas the remaining third is invested in structured credit score automobiles that comprise loans. 

The higher efficiency marks a reversal from final yr, when credit score investments have been hit by falling bond costs as central banks raised charges. VR and Sculptor have been down 5.7 and 4.1 per cent, respectively, final yr.

“Final yr, efficiency was closely impacted by the rise in charges, which led to credit score points and plenty of compelled promoting throughout the board,” mentioned Allan Schweitzer, a portfolio supervisor at credit score hedge fund Seaside Level.

Hedge funds have additionally made cash by offering loans to firms struggling to borrow from banks.

A $5.5bn fund from King Avenue is up 4.75 per cent to August 25, with a part of the efficiency pushed by lending alternatives to smaller firms backed by personal fairness companies. 

“The debt marketplace for sponsor-owned single B or triple C rated debt has typically been closed for 18 months,” mentioned Paul Goldschmid, associate and co-portfolio supervisor at King Avenue.

“This can be a actual difficulty for these companies, and we’re offering capital to quite a lot of these firms that are going through money stream points and that have to refinance their debt or assist fund their damaging free money stream points.”

The more durable fundraising setting has given hedge funds way more negotiating energy to ask for rates of interest of 14 per cent or larger, whereas constructing in more durable covenants to make sure they’re repaid. 

“I feel it is a golden age for contemporary credit score as a result of legacy credit score has plenty of flaws in it, not least a scarcity of covenants,” mentioned Stuart Fiertz, president of London-based Cheyne Capital.

“We will are available in with superb covenants and form the transaction any approach we like.”