Two of the best-known scavengers on Wall Street shared similar thoughts about the state of distressed debt investing late last year. The two firms — Anchorage Capital Group and Oaktree Capital Management — each lamented how years of economic expansion and easy money had kept corporate defaults and bankruptcies low. In turn, that has left few openings for their respective firms to scoop up discounted corporate loans and bonds.
The pair’s similar thinking, however took them on different paths. Anchorage announced in December that it was closing its $7.4bn flagship credit hedge fund, ACP Capital, after 18 years and returning the capital to its backers.
Oaktree, on the other hand, announced in November that it had raised $16bn for a fund after convincing its investors that, even if traditional distressed debt investing had become more challenged for now, its skills could be transferred elsewhere.
While the external market developments in credit investing are noteworthy, the duo’s respective decisions also offer a window into how the internal structure of private investment firms affects their ability to function and ultimately make money.
Anchorage was founded in 2003 and is perhaps best known for owning MGM Holdings, which it sold last year to Amazon for $8.45bn including debt. It had also been a player in such distressed assets as retailer J Crew.
The firm’s soon-to-be-shuttered hedge fund is a traditional “evergreen” vehicle. In such a structure, the fund has an ongoing life in which investors can put in and withdraw their money with relative ease. In its letter to investors seen by the Financial Times, Anchorage wrote that the tradeable part of the leveraged credit world, a key return driver for an evergreen fund, had “to a large degree, been squeezed from the market”.
The firm said the marketplace for buying and selling debt had become more illiquid as “banks’ role in intermediating risk has been substantially reduced”. For hedge funds, the mismatch is obvious: their capital base is highly liquid and potentially unstable, but the opportunities in the market are no longer quickly flippable and instead require time, flexibility and patience.
Other industry observers point to how corporate restructurings and bankruptcies have evolved. Increasingly, if creditors are to have the chance to make real money, they must not only buy up existing bank loans and junk bonds, but also be willing to write big cheques to fund a stint in bankruptcy court or exit financing. Medium-sized hedge funds risk getting steamrollered by the handful of juggernauts such as Elliott or Apollo, which have enough heft to pull the strings in deal processes.
As it happens, the new $16bn Oaktree fund is the opposite of the unstable “evergreen” structure. Rather the Oaktree fund is a “drawdown” vehicle with a 10-year life where capital is requested when needed. Given the cut-throat competition for the limited number of troubled companies at the moment despite the pandemic, the massive capital raising might be surprising. Debt default rates are currently 1 per cent a year compared with historical levels of 5 per cent. But Oaktree thinks it has other tricks up its sleeve until the defaults revert to the higher levels.
“We believe the right move has been to broaden one’s mandate, eschewing boundaries”, the firm wrote in a recent memo. “By doing so, an investor 1) is well-positioned to take advantage of dislocation wherever it occurs 2) has the flexibility to tackle non-distressed situations in which a background in distressed credit can be a potential advantage.”
The Oaktree “Opportunities” fund, as the firm has labelled it, has already quickly deployed billions. This includes investment in the 2021 bankruptcy exit financing of Hertz as well as in funding companies going public through blank cheque companies, as well as in pre-IPO companies.
One former hedge fund executive explains that evergreen funds typically cannot move fast enough to execute when good ideas arise. “Cycles are quick. You can’t be a hedge fund that is already fully invested and also have the ready cash needed to reposition yourself,” says Dominique Mielle, a retired executive at Canyon Partners.
Still, other industry observers caution that one should not draw too many lessons from the choices of any single fund without considering idiosyncratic factors. The firms themselves have hedged their bets. Oaktree also has a small evergreen hedge fund. Anchorage, the broader firm, also is not folding. It still will manage its own existing drawdown funds.