Price dispersion, volatility offering rich opportunities
A confluence of global trends has created a credit-picker's market that has both portfolio managers and asset owners rubbing their hands together in anticipation.
Dispersion in credit pricing has ratcheted up through mid-November, giving hedge fund and long-only managers a plentiful supply of down-and-out securities to be bought cheaply, sources said.
“Clearly, dispersion in credit markets has increased,” said Stephen Siderow, managing partner, co-founder and co-president of credit specialist hedge fund manager BlueMountain Capital Management LLP, New York.
“The market is differentiating between companies, which gives you choices because everything isn't moving together,” Mr. Siderow added, noting the percentage of securities in the BofA Merrill Lynch US High Yield Master II index trading above par dropped to 48.5% as of Nov. 11, from 61% as of Dec. 31 and 78% at year-end 2013.
BlueMountain manages $22 billion.
Diversity in high-yield bond pricing signals a sharp dichotomy in the market, said David Warren, founder and chief investment officer of DW Partners LP, New York, which manages $6 billion.
While some companies are healthy enough to attract retail and institutional inflows, a significant number of corporations, especially in the energy, minerals and mining sector, are experiencing significant trouble, Mr. Warren said.
Mr. Warren said he is seeing the most interesting opportunities among companies with bonds trading between 30 cents and 50 cents on the dollar that have been downgraded to a CCC rating and are restructuring or defaulting on bond payments. One driver of credit price has been the disruptive influence of daily valued exchange-traded funds and mutual funds.
“We'll see higher volatility, price dislocations and more persistent mispricings in credit as long as daily liquidity credit-orientated funds such as ETFs and mutual funds continue to grow,” said Simon Finch, chief investment officer-credit at CQS (U.K.) Ltd., London, in an e-mail.
The environment is providing patient investors with opportunities to exploit relative value differences between high-yield securities and loans, between U.S. and European credit securities, and across corporate capital structures, he said.
“I think that current market conditions are providing the best credit-pickers' market for fundamentally driven investors ... since 2011. Flexible capital with a mandate to invest in multiple types of credit assets across currencies, markets and capital structure is key,” Mr. Finch added.
CQS manages $13 billion.
Birch Grove Capital LP, New York, has a flexible strategy allowing it to invest in any part of the capital structure, said Jonathan Berger, CEO and chief investment officer.
After two years of maintaining a market-neutral exposure in its flagship hedge fund strategy, now “there are dislocations between credit — where yields are in the mid- to high teens — and equity, which is trading in multibillion - that let us go long a company's equity and short its credit to make money when an event is on the horizon,” Mr. Berger said.
The firm has increased the portfolio's long/short weighting to 40% this year compared with 10% last year, Mr. Berger said.
Birch Grove manages $800 million with a focus on deals in midcap companies.
Another factor working in favor of credit managers has been the regulatory-induced retreat of banks from all but the largest financing deals, sources said.
That has “opened an enormous opportunity for financing,” said Carlos Mendez, co-founder and managing partner, of credit special situations manager Crayhill Capital Management LP, New York.
The bank principal desks that underwrote and structured the complex financing needed for unusual deals are “mostly gone and we are filling the funding gap,” Mr. Mendez said.
“Nothing is packaged, so we have to set up a unique structure for every deal,” added Mr. Mendez, noting would-be borrowers need patience with the sometimes lengthy negotiation process because “if someone hangs up the phone on us, there aren't very many other companies they can call.”
Crayhill Capital manages $860 million.
Credit managers broadly agree that bond markets are heading for a period of higher defaults and eventually, a distressed cycle.
Birch Grove's Mr. Berger said the high level of price dislocation, a record level of merger and acquisition activity, high leverage and corporate bond downgrades signal the beginning of a distressed cycle, led by the energy, minerals and mining sector, followed by consumer retail companies.
“All the ingredients are there for a distressed cycle with a segment of the credit markets already trading at distressed prices — 20 cents on the dollar — and default rates rising,” said Ashwin Bulchandani, chief risk officer, macro strategist and partner, MatlinPatterson LLC, New York.
Just as the U.S. is leading the global economic recovery, it also will lead the world in moving into a distressed cycle, Mr. Bulchandani said.
“We definitely see more opportunities in the U.S.,” particularly in lower-quality high-yield bonds and lower-quality investment-grade commercial mortgage-backed securities, such as triple B-rated bonds, he said.
MatlinPatterson manages $7.5 billion.
This article originally appeared in the November 16, 2015 print issue as, "Stressed bond market a boon to credit-pickers".