Bumper profits for credit hedge funds

Credit hedge funds profit as companies face soaring borrowing costs

Credit hedge funds that focus on distressed debt are making bumper profits this year as the rise in borrowing costs hits weaker companies.

Central bank rate increases have put pressure on some small and medium-sized corporate borrowers considered riskier credit, forcing them to offer significantly higher rates to tempt potential lenders, write Costas Mourselas and Will Louch.

It has also made existing riskier debt cheaper, increasing yields and offering the opportunity for better potential returns.

After a more challenging 2022, the Eurekahedge distressed debt hedge fund index was up 5.9 per cent on Friday, the highest performing strategy of the year so far.

“The higher for longer [interest rate] environment that we’re in, has created attractive opportunities in the credit spectrum,” said Danielle Poli, portfolio manager and managing director at $172bn credit investor Oaktree.

Analysis from the special situations team at credit fund Alcentra shows that about €120bn in European bonds and loans are trading at distressed levels, above interest rates of 12 per cent, double the roughly €50bn or €60bn seen in 2019. The analysis only considered debt with an issue size above €100mn.

Richard Deitz’s hedge fund VR Capital returned 18.2 per cent by the end of July, making it one of the year’s best-performing funds, according to a person who has seen the numbers. The fund has $4.9bn in assets under management and mainly focuses on distressed companies in emerging markets. 

But while some credit specialists are making hay, across the wider industry investors are warning hedge funds that they will face redemptions and further pressure to cut their fees unless they can improve their performance, as Costas and I explore in this story. 

An aggressive series of interest rates increases by major central banks over the past 18 months has greatly improved the return that end investors such as pension funds can earn while taking minimal risk.

Paul Berriman, global head of Towers Watson Investment Management, which manages $200bn for institutional investors such as pension plans and endowments, puts it like this:

“Whether you are an institutional investor or a private bank it’s a huge deal that the risk-free rate is now 5 per cent. If I can get 5 per cent in the bank, hedge funds need to explain what they can do for me given that the industry has proliferated and charges high fees . . . the whole hedge fund industry needs to do some serious adapting and has a huge set of challenges to face.” 

Are you rethinking your hedge fund allocation? Email me: [email protected]

Investors raise questions after Sequoia Capital’s turbulent year

Over the most tumultuous 12 months in its 51-year history, Sequoia Capital has spun off its highly profitable Chinese arm, slashed the size of a crypto investment fund and lost key partners including veteran Michael Moritz.

Now, Silicon Valley’s most storied venture capital firm is fighting to retain the confidence of its own investors, writes my San Francisco-based colleague George Hammond in this deep dive.

At least one large Sequoia backer is weighing its future position in the US firm and others are concerned by recent mis-steps, including a $225mn bet on failed cryptocurrency exchange FTX in 2021. One of Sequoia’s longest-standing backers deemed that deal a “humiliation [that] is unique in their history”.

This summer, Sequoia’s chief Roelof Botha travelled across New York, Boston, Chicago and California’s Bay Area to meet more than 50 of the firm’s biggest “limited partners”, who invest in its funds.

July’s trip was not to fundraise but to ease concerns from the financial institutions, non-profit organisations, pension funds and family offices that have poured billions of dollars into Sequoia on the back of its reputation as one of the world’s savviest investors in tech start-ups, including Apple, Google, Instagram and OpenAI.

“Who do they want to be; what’s their brand?” said the head of one Sequoia LP, a sovereign wealth fund. He will continue to back Neil Shen, the billionaire boss of Sequoia’s soon-to-be-separate Chinese arm, but is evaluating his position in Sequoia Capital, the US and European business.

“We know what Neil Shen wants to be: the most successful investor in Asia,” he said. “What about Sequoia US?”

“Our goal is to be the top-performing investment partnership in the world,” Botha told the Financial Times. “Just as it always has been.”

Here is the full account of a period that another Sequoia investor describes as “the most profound change in the firm’s history”. It is based on more than 20 interviews with its limited partners, current and former investors at Sequoia as well as rival groups, and start-up founders.

Chart of the week

Venezuelan government bond prices have climbed in recent weeks as investors speculate that the revolutionary socialist government of President Nicolás Maduro is nearing a diplomatic breakthrough that could lead to a softening of US sanctions.

The oil-rich country’s debt trades at a tiny fraction of its face value following Venezuela’s default on $60bn of debt in 2017 and subsequent curbs placed on secondary trading that have frozen US investors out of the market, write Michael Stott and Arjun Neil Alim. Prices plummeted further in 2019 when JPMorgan ejected the bonds from its widely followed emerging markets index.

Now, bondholders say leaks from Washington pointing to progress in the secretive, long-running talks with Caracas have helped ignite a rally in the bonds, which are trading at 10 to 11 cents on the dollar, up from 8 to 9 cents a few weeks ago.

“The US government would like to reach a deal with Maduro because this would solve two issues related to President Biden’s re-election: The migration of Venezuelans to the US and Russian-Saudi attempts to squeeze the oil market,” one bondholder said.

The Biden administration inherited a strategy of “maximum pressure” economic sanctions against Venezuela from former president Donald Trump, which critics say failed to dislodge Maduro from power, helped trigger the exodus of more than 7mn refugees from Venezuela and pushed Maduro closer to longtime allies Iran, Russia and China.

Biden’s Latin America team has pursued a different approach, offering an easing of sanctions in return for guarantees from the Maduro government of a free and fair presidential election in Venezuela next year. Maduro’s last election victory in 2018 was boycotted by the opposition and criticised by the west as rigged. Read the full story here

Five unmissable stories this week

BlackRock and MFS Investment Management both voted against Glencore’s climate plan at the Swiss miner’s annual general meeting earlier this year, marking a rare break between the mining company and two of its largest institutional shareholders over environmental policy.

The business dubbed Outsourced Chief Investment Officer is on a roll. BAE Systems’ pension scheme has appointed Goldman Sachs Asset Management to oversee its £23bn of defined benefit assets, the largest mandate of this kind in the UK to date. 

The roughly $180bn Ontario Teachers’ Pension Plan has agreed to buy UK wealth manager Seven Investment Management, as one of Canada’s biggest investors bets on a sector that is rapidly consolidating.

The Financial Stability Board has singled out a group of hedge funds as a potential source of market instability in an escalation of existing concerns about the impact of their bets on bonds, warning that some managers had “very high levels of synthetic leverage”.

US share-trading app Robinhood, most famous for introducing commission-free trading in the US and for its role in the 2021 meme stock mania, has embarked on a new attempt to launch in the UK. But it faces a daunting battle.

And finally

A new exhibition is opening at the Design Museum in London that styles itself as one of the most wide-ranging surveys of contemporary fashion culture ever staged in the UK. REBEL: 30 Years of London Fashion will look at how careers in fashion are forged, and the multitude of opportunities London’s fashion scene offers young creatives. Highlights include the swan dress controversially worn by Björk at the 2001 Oscars, Harry Styles’ Steven Stokey Daley outfit from his video for ‘Golden,’ and a unique replica of Sam Smith‘s inflatable latex suit by HARRI from this year’s BRIT Awards. From September 16.

Future of Asset Management North America

Hosted by the Financial Times, in collaboration with Ignites and FundFire, Future of Asset Management North America is taking place on September 27-28 at etc.venues 360 Madison in New York. It will bring together senior leaders from North America’s leading asset and wealth management firms, including Capital Group, BlackRock and Goldman Sachs. For limited time, save up to 20 per cent off on your in-person or digital pass. Register here