| Hedge fund appetite for high yield grows |
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| 29/10/2006 | |
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Hedge funds, a growing force in the credit markets, are becoming highly exposed to distressed debt, setting them up for future losses in the face of an event-driven forced de-leveraging. While relatively-small historically, high yield strategies have outpaced investments across higher-grade issues and other asset classes. Some 27% of investments in European high yield bonds at the origination level come from hedge funds, while their exposure is only 14% across the entire asset class, a Bond Market Association survey of 20 European bank runners has found. In the high-yield category, the group is only surpassed by traditional fund managers. Insurance and pensions have a 13% exposure to distressed debt. The findings come at a time when defaults on speculative-grade debt are expected to rise to 2.8% by June 2007 from 1.8% a year ago, notes Moody's Investors. "While they can trade on both sides, it is very difficult to short credit, and some are making directional bets, essentially long and leveraged bets, five, six times their assets," says Aymeric Poizot, CFA, at Fitch Ratings in Paris. Hedge funds in (recent) history In the secondary market, hedge funds' historic fixed-income allocation had remained relatively stable at $20 billion during the four years prior to 2001. Then in the following four years it exploded to more than $60 billion, notes Fitch. What does this mean for credit markets and portfolio managers? In the 1998 liquidity crisis, even higher quality investment-grade assets lost as much as 5% of their value, and high yield corporate spreads widened around 300 basis points. There are few signs of such a sell-off: bond and mezzanine debt default rates in Europe and the U.S. remain low and corporate bond spreads tight. Defaults in the U.S. stood at 0.5% in 2004 and 2005, respectively, a marked contrast to 2002 and 2003, when default rates were 6.3% and 25.1%. Meanwhile, European corporate bankruptcy filings have dropped to their lowest level in six years. Yet not everyone is sanguine. A survey by AlixPartners, a consultancy, expects corporate restructurings in Europe to jump and more than 72% of the participants in its poll expect debt default rates to increase in 2007 due to the "high number of acquisition-related debt issues in 2004 and 2005 as well as the rising cost of commodities. The industries that are most likely to suffer are manufacturing, followed by retail, healthcare, banking, insurance and utilities. V.B. |
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