| Distressed is back for hedge funds |
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| 27/01/2008 | |
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A large segment of hedge funds active in M&A investments in 2007 are now starting to name distressed debt as the new home of their funds. "It is no surprise that one of the largest pockets of liquidity for distressed debt is expected to come from investment managers who had previously steered funds towards M&A-related opportunities," notes a new study by Debtwire. The firm interviewed 101 hedge fund managers, proprietary trading desks and other asset managers between November and December 2007 on their expectations for the North American distressed debt market in 2008. The findings reflect an expected increase in the amount of distressed product available this year as well as higher cash levels allocated to the segment. An overwhelming 72% of respondents planned to allocate more of their investment portfolios to distressed debt in 2008 compared to last year. A third of surveyed hedge funds, prop desks and institutional funds expect to allocate less assets to M&A. Another 40% expect defaults to rise from their historic 2%-3% range, while half consider the 3%-4% area as more likely. The figures are more conservative than Moody's, which in early January revised its US speculative grade default rate estimate to 5.3% by the end of 2008 from its previous 4.7% estimate. Banking on troubled banks The most favoured distressed debt sectors among the participants are financial services, construction and retail. "This is a distinct move away from the energy, chemicals, industrial and auto supplier sectors that distressed debt investors favoured in 2007," according to Debtwire. "Despite some of the inherent difficulties in valuing mortgage-backed securities, more than half of this year's poll participants say they expected to allocate upwards of 10% of their portfolio towards distressed MBS in 2008." Investors were also asked if they expect a recession in 2008. A majority (56%) on average said they did, however, opinions differed depending on respondent type. About 70% of prop desks predicted recession compared to 57% of hedge fund respondents and only 43% of institutional investors. "A substantial amount of capital has been specifically raised for this asset class over the last couple of years in anticipation of the yet-to-materialise increase in corporate default rates," says Mick Solimene, Managing Director at Macquarie Securities USA. Gaming and technology are two sectors where investors see little opportunity. In terms of securities offering the most attractive returns, 72% cite first lien secured bank loans, 54%, senior secured bonds, 50% second lien loans, 22% asset-backed securities, 16% CDOs and 7% preferred/mezzanine. The banking sector is identified as the most promising sector in spite a rash of charges and equity injections in Q4. Hedge funds have the most conservative return expectations from distressed debt. While 93% of participants targeted returns exceeding 10% for their primary distressed funds in 2007 and 47% predicted returns of over 15%, the asset class had only returned 6% through November of last year, according to hedge Fund Research. VB |
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