Hedge funds scale back distressed debt investments
Hedge fund managers have scaled back their distressed debt investments in favour of secured loans, as the length of the recession increases the chances that firms will get stuck with worthless securities, according to a new survey.
About 155 hedge fund managers participated in the Insolvency survey by hedge fund database HedgeWorld, law firm Dykema and news and market data provider ThomsonReuters.
Roughly 78% of respondents said secured loans have become their primary vehicle for investing in distressed debt, up sharply from 43% in 2007, according to the survey.
Oren Cohen, the co-founder of Brownstone Asset Management, a long-short credit hedge fund manager, said the shift was more about common sense than caution.
Cohen said: “People see that’s the only place where real value is left, it’s appropriate in the current environment that more of these would be the focus of investment.”
Hedge fund managers have scaled back their investment in distressed debt over the past 12 months, with 36% of respondents having invested in distressed debt, down from 48% half of all respondents in 2007.
Only one in 10 hedge fund respondents has more than 20% percent of their portfolio in distressed debt or equity positions in financially troubled companies, the report said.
Hedge funds with under 10% of portfolios invested in distressed debt or equity securities are unlikely to change these allocations in the near-term as hedge funds continue to wait for the financial markets to stabilise, the report said.
The majority of survey participants anticipated the banking industry would be the source of the most opportunities for distressed investments in next 12 months, according to the report. Research will be key to determining who will be the right companies to invest with.
Cohen said: “There should be good buying opportunities but it will be a stock-picker's market. You can’t just buy a basket of securities.”
In the past year, hedge funds that focused on distressed debt and restructuring lost 25% faring worse than average hedge funds, which lost roughly 18%, according to data provider Hedge Fund Research.
Distressed debt hedge fund investors that went long on distressed debt too early—believing the securities they purchased would go up in value—fared badly last year, Cohen said.
But he said people have been making the wrong bets on which layers of the capital structure to play, and the debt they purchased often became worthless.
—Write to Stephanie Baum at sbaum@efinancialnews.com
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