The year 2015 was one that most corporate credit investors would like to forget. Marked by severe volatility, deterioration in credit quality, and quite possibly a new paradigm for the price of liquidity, all US-based leveraged credit indices finished in the red, posting the worst returns since the 2008 crisis. Selling momentum was strong and a second consecutive year of outflows from the asset class has left spreads on the edge of pricing in a global recession. In Europe, the high-yield bond and leveraged loans markets outperformed risky US distressed debt.
Despite the uncertainty and volatility in credit markets, we believe it is an exciting time in which investors should focus on the risk and return characteristics of the underlying assets rather than just the structure and liquidity terms of the holding vehicle itself.
When assessing today’s credit markets, investors will need to consider carefully how they access the opportunity set, taking into account their return objectives, liquidity budget, time horizon, and threshold for mark-to-market losses. Although strategies targeting credit opportunities will vary significantly in their return objectives and liquidity terms, the following are some broad categories of strategies that may be worthy of consideration:
- Long-only “credit opportunities” funds. These strategies could be thought of as sitting farther up the risk/return spectrum and with less liquidity than traditional multi-asset credit funds. Some such funds may operate a private markets style drawdown arrangement for the investment of capital.
- Credit-oriented hedge funds. These strategies would have the flexibility to invest both long and short and may be described as “long/short credit,” “credit-oriented multi-strategy,” or “event driven” hedge funds. These strategies are likely to be less exposed to the “beta” of the opportunity and will rely to a greater extent on manager alpha than long-only credit opportunities funds.
- Private markets vehicles. Distressed debt funds will often form part of a diversified private markets portfolio, will typically focus on opportunities at the higher end of the risk/return spectrum, and will tend to offer the least liquidity to the end investor.
Return targets will vary significantly, but most of the strategies operating in this area will be aiming for high single-digit returns and above.
As credit conditions and the nature of the opportunity set evolve over the course of the year, we expect to remain active in researching the new strategies and structures that come to market. We look forward to discussing the opportunity and helping investors find the implementation route to suit their needs.
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