Two of Wall Street’s best-known scavengers shared similar thoughts about the state of distressed-debt investing late last year. The two companies – Anchorage Capital Group and Oaktree Capital Management – each lamented how years of economic expansion and easy money had kept defaults and corporate bankruptcies low. This, in turn, left few opportunities for their respective companies to obtain discounted loans and corporate bonds.
The couple’s similar thinking, however, led them down different paths. Anchorage announced in December that it was closing its $7.4 billion flagship credit hedge fund, ACP Capital, after 18 years and returning capital to its backers.
Oaktree, on the other hand, announced in November that it had raised $16 billion for a fund after convincing its investors that while traditional distressed debt investing had become more difficult for now, its skills could be transferred elsewhere.
While external market developments in credit investing are noteworthy, the duo’s respective decisions also provide a window into how the internal structure of private investment firms affects their ability to operate and ultimately account, to earn money.
Anchorage was founded in 2003 and is perhaps best known for owning MGM Holdings, which it sold last year to Amazon for $8.45 billion including debt. He had also played a role in struggling assets such as retailer J Crew.
The company’s soon-to-be-closed hedge fund is a traditional “evergreen” vehicle. In such a structure, the fund has a continuous life in which investors can place and withdraw their money with relative ease. In its letter to investors seen by the Financial Times, Anchorage wrote that the tradable part of the leveraged credit world, a key return driver for an evergreen fund, had “to a large extent been squeezed out of the market.” “.
The firm said the market for buying and selling debt has become more illiquid as “the role of banks in risk intermediation has been significantly reduced”. For hedge funds, the mismatch is obvious: their capital base is highly liquid and potentially unstable, but market opportunities are no longer easily reversed and instead require time, flexibility and patience.
Other industry observers point to developments in corporate restructuring and bankruptcies. Increasingly, if creditors want a chance to make real money, they must not only redeem existing bank loans and junk bonds, but also be prepared to write big checks to fund a run past the bankruptcy court or get out of financing. Mid-sized hedge funds risk being crushed by a handful of behemoths such as Elliott or Apollo, which have enough clout to pull the strings in the transaction process.
As it happens, the new $16 billion Oaktree fund is the opposite of the unstable “evergreen” structure. The Oaktree fund is more of a “drawdown” vehicle with a 10-year lifespan where capital is requested when needed. Given the fierce competition for the limited number of struggling businesses right now despite the pandemic, the massive capital raising might come as a surprise. Default rates are currently 1% per year, compared to historical levels of 5%. But Oaktree thinks it has other tricks up its sleeve until the defaults return to higher levels.
“We believe the right decision was to broaden its mandate, avoiding borders,” the firm wrote in a recent memo. “In doing so, an investor 1) is well positioned to take advantage of dislocation wherever it occurs 2) has the flexibility to deal with stress-free situations where distressed credit experience can be an advantage potential.”
The Oaktree “Opportunities” fund, as the company called it, has already quickly rolled out billions. This includes investing in financing Hertz’s exit from bankruptcy in 2021 as well as financing companies that go public through blank check companies, as well as pre-IPO companies.
A former hedge fund executive explains that evergreen funds typically can’t scale fast enough to execute when good ideas come up. “The cycles are fast. You can’t be a fully invested hedge fund and also have the cash to reposition yourself,” says Dominique Mielle, a retired executive at Canyon Partners.
Still, other industry watchers caution that too much should not be learned from the picks of a single fund without considering idiosyncratic factors. The companies themselves have hedged their bets. Oaktree also has a small evergreen hedge fund. Anchorage, the larger company, isn’t bending either. It will still manage its own existing drawdown funds.