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March 2021 | Issue 232
Analysis Credit
Moving fast pays off for hedge funds
Michelle D'Souza headshot
Michelle D’Souza
Reporter
Robin Armitage
Researcher
Credit hedge fund managers which were able to assess rapid fluctuations across markets and react accordingly performed best last year. Conservative positioning in Q1 also helped generate returns
2020 was an up and down year in credit, and credit hedge fund managers had to move quickly to capture opportunities from the dislocations that inevitably opened up.
Early on, covid risks were not priced in, but this quickly changed as lockdowns were enforced globally. The sudden scale of the crisis — and the rapid recovery — meant that timing investments was crucial.
For CLOs, the covid crisis caused short term pain but the pace of the recovery has meant that CLOs have successfully navigated another crisis. Five funds in our top 10 invest in CLOs.
Credit hedge fund highest and lowest returns vs CLO index
Source: Creditflux
Napier Park strategy takes top spot
Napier Park Global Capital’s credit strategy, which invests across junior CLO tranches, leveraged loans and high yield, claimed the top spot in our hedge fund rankings.
Michael Micko, partner and head of European credit at Napier Park, says the general approach is to carefully underwrite individual credits and CLO structures. The firm increased hedging in February and early March, placing individual shorts in travel- related names while also increasing existing hedges through liquid credit indices. Micko says the strategy crystallised most of the gains at the peak of the dislocation.
30.3%
Return of top performing Napier Park strategy in 2020
At the same time, Micko says Napier Park started selling single name credits and CLO mezz and equity, as markets were initially ignoring the growing early signs of covid risk, at least until liquidity dried up in early March. Raising cash early gave the manager firepower to aggressively buy dislocated CLO paper at the peak of the March sell-off. “The bid-offer widened out dramatically for all asset classes,” says Micko. “At the peak, HY was down 20-25 points on average and leveraged loans were down around 20 points. But dislocation was most pronounced in CLOs — double Bs were down 30-40 points, single Bs 50-60 points, and equity maybe 30-40 points from lower starting cash prices.”
Credit hedge fund highest and lowest returns vs CLO index
By April, Napier Park focused on double Bs but Micko says the key was picking the top quartile quality deals, adding that prices were homogeneous across the quality range. The rebound in April and May driven by central banks and liquidity support led to the firm rotating out of double Bs and into single Bs and select CLO equity in order to capture a second leg of the dislocation.
Amit Sanghani, product managing director in the London-based team, says strategy turnover for 2020 in long positions was over 100%. “We traded over $1.65 billion across CLO equity and mezz in Europe alone, in addition to rotating the portfolios and selling around $600 million notional,” he says.
CLO Alpha Compartment Taunus, a CLO fund managed by CIS Asset Management, took second spot in our rankings with 21.80% returns. The firm focuses on niche CLO equity with an emphasis on US CLOs.
>100%
Turnover in long positions for 2020 in Napier Park’s strategy
Inès Bartsch, owner and portfolio manager, says the majority of capital raised for the strategy came in Q1, meaning the firm could utilise this through the downturn.
While most CLO funds struggled with double digit losses in March, CIS was one of only two managers to achieve positive returns in the month (0.19%). “Our investments during the ramp-up period of two CLOs paid off when they closed just before coronavirus restrictions, allowing them to ramp up significant additional par,” Frankfurt-based Bartsch says. “This helped the fund keep its head above water in March and April when other CLO funds struggled.”
The CLO market offers fund managers the ability to invest across a range of tranches, but Zais successfully applied a multi-strategy approach across the broader credit universe. Officials say they repositioned the portfolio throughout the year.
“The bid-offer widened out dramatically”
Michael Micko, Head of European credit | Napier Park
Zais LevHY Fund I locked in fourth place in the 2020 overall rankings and topped the multi-strategy credit category after returning 20.59%. The firm launched the fund at the end of 2019.
Denise Crowley, head of securitised credit at Zais, says the firm was mindful of the relatively flat credit curve and was conservative early in the year.
“As the pandemic advanced, we were able to reposition our portfolio and move further down in credit in order to capitalise on the steeper curve. The chaotic price action enabled us to take advantage of some great buys,” she says.
“We took the opportunity to buy sub-mezzanine classes, especially CLOs, CRTs and CMBS notes, and were able to pick relatively higher credit quality bonds within those sectors.”
Distressed window may open again
Distressed debt managers raised record amounts of capital in 2020, with investors seeking to capitalise on coronavirus-related dislocation. And, after years of waiting for deployment opportunities, the crisis perhaps produced fewer distressed opportunities than many anticipated. The good news is that the high volume of liquidity from central banks and governments is keeping borrowers afloat and could produce excellent opportunities for managers to put dry powder to work in the upcoming year.
Shenkman Capital Management topped Creditflux’s distressed hedge fund listings in 2020 with its Shenkman Opportunistic Credit Fund, after it returned 12.44% for the year. Justin Slatky, chief investment officer at Shenkman, says key to the firm’s performance was being able to analyse credits quickly before governments drove recovery.
“During the March lows, 37% of the high yield market was distressed but by the end of the year, less than 3% was,” he says, adding this recovery took around three years in the 2008 financial crisis. He says Shenkman was able to take advantage of the firm’s research database during the sell-off.
“We capitalised on the steeper curve”
Denise Crowley, Head of securitised credit | Zais
Flexibility and being active in the market also helped achieve steady returns. Shenkman had five distinct rotations through the year. “At the end of the March sell-off, we took advantage of IG names where there were forced sellers and, by April, we had rotated the book into higher quality high yield,” Slatky says. By June and July, capital markets recovered and Slatky says the firm took advantage of lower dollar priced credits they thought would be repriced higher as it was clear many of these companies were not going bankrupt.
Shenkman monetised those positions by the end of summer and moved into a more defensive portfolio by the election, he says. “It was only after the election and vaccine news came out that we started to ramp up on distressed covid-related names.”
Recovery and the outlook for 2021
The historic sell-off in Q1 also signalled an opportunity for many US high yield funds as liquid instruments such as bonds traded up in the aftermath.
Wasserstein’s Debt Opportunities Fund led the category in 2020 as it returned 16.54%. Rajay Bagaria, president and chief investment officer at Wasserstein says the firm re-underwrote its portfolio in March and focused on opportunities that could withstand a lower-for-longer environment.
CLOs: monthly returns
Corporate distressed: monthly returns
Credit multi-strategy: monthly returns
Structured finance: monthly returns
US high yield: monthly returns
* Market average figures are taken from all other funds in Creditflux database
“We positioned our portfolio conservatively in first-dollar debt and focused on covid-beneficiaries as well as GDP-sensitive credits that would recover with improving economic activity,” he says.
Bagaria points to Wasserstein’s positions in home improvement tool manufacturers and specialty chemical producers which helped generate returns in the second half of 2020 as the economy rebounded.
Many fund managers say they are optimistic about the macro backdrop going into 2021, with strong growth potential in the economy and investors awash with cash, while rates remain low. However, they are mindful of the potential for inflation.
For now, though, Crowley says easy monetary policy and economic growth should remain supportive and could reveal opportunities for attractive returns in 2021.
Methodology
  • All figures are taken from monthly NAV returns net of fees.
  • Full data can be found online at creditflux.com/hedgefunds
  • Contact robin.armitage@iongroup.com to add a fund to the listing.
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Global credit funds & CLO's
March 2021
| Issue 232
Published in London & New York.
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