This year, credit hedge funds specializing in distressed debt are raking in substantial profits, thanks to a surge in borrowing costs that is hitting struggling companies. The reason behind this financial windfall is that central banks have been increasing interest rates, which has placed added pressure on smaller and riskier corporate borrowers. These companies have had to offer much higher interest rates to attract potential lenders.

The rise in interest rates has also had a side effect: it has made existing risky debt more affordable, resulting in higher yields and the potential for better returns on investments. After facing challenges in 2022, the Eurekahedge distressed debt hedge fund index saw a remarkable increase of 5.9 percent on a recent Friday, making it the top-performing investment strategy of the year.

Danielle Poli, portfolio manager and managing director at Oaktree, a credit investment firm managing $172 billion, commented on this trend, stating that the prolonged period of higher interest rates has created attractive opportunities in the credit market.

An analysis conducted by the special situations team at Alcentra, a credit fund, revealed that approximately €120 billion worth of European bonds and loans are currently trading at distressed levels, with interest rates exceeding 12 percent. This figure is double the roughly €50 billion to €60 billion seen in 2019, and it only considers debt with an issue size greater than €100 million.

Notable hedge funds are reaping the benefits of this market shift as well. Richard Deitz’s VR Capital hedge fund saw an impressive return of 18.2 percent by the end of July, making it one of the top-performing funds this year. With $4.9 billion in assets under management, VR Capital primarily focuses on distressed companies in emerging markets.

Sculptor, managed by Jimmy Levin, has also seen significant success. The Credit Opportunities fund, which manages $1.4 billion in assets, posted an 8 percent return by the end of August. Approximately two-thirds of the fund’s investments are in corporate debt, with the remaining third in structured credit vehicles containing loans.

This strong performance marks a turnaround from the previous year when credit investments suffered due to falling bond prices caused by central bank rate hikes. In 2022, VR and Sculptor were down 5.7 and 4.1 percent, respectively.

Allan Schweitzer, a portfolio manager at credit hedge fund Beach Point, commented on last year’s challenges, explaining that rising interest rates led to credit problems and widespread forced selling across the market.

Hedge funds are also finding opportunities by providing loans to companies that are struggling to secure financing from traditional banks. King Street’s $5.5 billion fund, for instance, has experienced a 4.75 percent gain as of August 25. A portion of this performance is attributed to lending opportunities to smaller companies backed by private equity firms.

Paul Goldschmid, partner and co-portfolio manager at King Street, emphasized the importance of their role, stating, “The debt market for sponsor-owned single B or triple C rated debt has generally been closed for 18 months. This is a real issue for these firms, and we are providing capital to a number of these companies which are facing cash flow issues and need to refinance their debt or fund their negative free cash flow problems.”

Photo Source: Google

11th September, 2023
By: Delino Gayweh
Serrari Financial Analyst