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.