Credit going the long/short route

Institutional investors are answering their own burning question about the prospects for credit investments after the 2009 rally: long/short credit.

After being whipsawed by horrible returns during 2008's credit crisis and a rally that boosted virtually every credit security in 2009, more institutional investors are looking to reduce their long exposure to credit and protect their portfolios on the downside.

”Investors have been riding credit for the last 18 months, but the beta rally now is in the eighth or ninth inning and investors want to get their chips off the table. Institutional investors are ready to take advantage of a lot of opportunities in credit this year, but generating alpha in this market takes a very market-neutral approach,” said Boaz Weinstein, founder and chief investment officer of Saba Capital Management LP, New York.

Mr. Weinstein, who has a long pedigree in long/short credit management, launched his firm in April2009. The firm's long/short credit hedge fund now has $875 million and is enjoying “a very big spike in interest from institutional investors,” Mr. Weinstein said.

Investors definitely are sweeping those chips off the table, confirmed Steve Vogt, CIO of hedge funds-of-funds manager Mesirow Advanced Strategies Inc., Chicago.

Mesirow “got into credit opportunities pretty early,” Mr. Vogt said. At the end of the second quarter of 2009, the firm began to shift weightings within both commingled and separate account versions of its hedge funds of funds toward long/short strategies.

“Our credit managers all were dead long at the beginning of 2009. We've been selectively harvesting (assets from) long-biased managers and redeploying assets into long/short credit. The portfolios are pretty much long/short neutral at this point,” Mr. Vogt said. He noted that many institutional investors already are long corporate credit exposure in their other portfolios and recognize they need to reduce that exposure.

Mesirow managed $12.7 billion in hedge funds of funds as of May 1.

Other institutional investors were less deliberate in managing their credit investments in 2008 and 2009 and now are seeking a way to ensure alpha generation through strong long bets and to achieve downside protection through short bets.

“Institutional investors got out of jail. Their credit investments sank in 2008, but they were able to ride a beta rally in 2009 ... The real question now is what they do with their credit investments,” said Peter Warren, head of new business for credit hedge fund manager CQS (UK) LLP, London.

“In 2009, everything went up and credit spreads tightened. But in November, spreads became more volatile and widened in January, (when) there was more debt supply, more choices and more dispersionbetween individual credits.

“The choppier trading environment that started in the fourth quarter lends itself well to long/short credit strategies,” Mr. Warren said.

CQS managed $6.9 billion as of May 1, of which $115 million was in a dedicated long/short credit hedge fund that launched in the third quarter.

Managers of long/short credit hedge funds report growing interest in the strategy.

Concordia Advisors LLC, New York, a relative value fixed-income firm that manages both a long/short credit and long/short municipal bond fund, has been seeing more interest from “some early adopters, institutional investors that are making serious inquiries, especially from pension fund boards that understand the nuances of credit,” said Basil Williams, CEO and portfolio manager of the firm's multistrategy portfolios. Mr. Williams declined to name potential investors.

“With rates and credit markets as they are, institutional investors can readily see that the environment is ripe for really capitalizing on credit opportunities this year,” he said.

Concordia Advisors managed a total of $1 billion as of May 1, of which $150 million is in the long/short credit strategy.

Investment consultant David Shukis said dedicated long/short credit hedge fund strategies are “a tactical play that people are making to exploit opportunities. Institutional investors aren't moving away from directional credit investment, but given the environment, there's a fundamental play to be had in investing long in undervalued credits and shorting overvalued companies. Everything is up for consideration, but you have to be selective. Having a manager who is experienced in shorting is going to be invaluable.”

Mr. Shukis, director of hedge fund consulting and research at Cambridge Associates LLC, Boston, said many of his firm's clients are considering stand-alone long/short credit investments, although some already have exposure through multistrategy credit hedge funds. “It's a good time to be looking at long/short credit,” and should continue to be “for at least the next year as the credit and economic cycles play out,” he added.

Mr. Shukis noted that many credit multistrategy hedge funds have long encompassed a hefty dose of long/short in their funds, but at the request of institutional clients some managers — including CQS and BlueMountain Capital Management LLC — launched dedicated long/ short credit funds.

Stephen Siderow, BlueMountain's president and co-founder, said the firm carved out the long/short credit strategy used in its flagship credit fund to meet institutional investor demand for a simpler approach that's easier to explain to pension fund trustees and to increase liquidity.

He said interest in the new fund, which started trading Feb. 1, has been strong, with $150 million invested as of May 1.

As with long/short equity hedge funds, Mr. Siderow noted that the trend with many larger institutional investors is to include long/short credit hedge funds within the overall fixed-income portion of the portfolio, rather than segregate them in an alternatives allocation.