Hedge fund LNG Capital is eyeing the debt of companies at risk of running short of cash, seeing the potential for high returns at an early stage of the credit crisis when companies are still able to tap rescue capital.
When a corporate borrower raises money or sells assets to get over a liquidity hump, its discounted short-term bonds — those maturing in up to 18 months — can become a buy, said the fund's chief investment officer and founder, Louis Gargour.
Gargour cited British Airways, Danish service provide ISS, Finnish paper company M-real, Italy's Wind Telecomunicazioni SpA, U.S. film studio Metro-Goldwyn-Mayer, miner Rio Tinto and ArcelorMittal, the world's largest steelmaker, as examples.
Many of these companies are industry leaders with healthy cash flows, but which have a lot of debt maturing over the next two years.
"Looking for exploitable dislocations, with the expectation that a large number of investors will be biased toward rescuing a company by lending it money or buying in outright in a trade sale or acquisition should lead to a long bias at initial stages of the credit cycle," Gargour said.
MORE OPPORTUNITIES IN EUROPE
The LNG Zenith High-Yield Bond Fund returned around 27.3 percent in euros in the six months to end-June.
Looking at the performance of U.S. versus European high-yield corporate indexes over the past three credit crises, the hedge fund found that the European side tends to underperform in bad times.
"European corporate spreads tend to overshoot in times of difficulty, and as a result they may offer more interesting opportunities for European credit managers than their U.S. counterparts," Gargour said.
Current global spreads imply that 22 percent of junk-rated companies will default over the next year, far exceeding Moody's Investor Service's forecast of 12.8 percent, and that difference shows the potential for excess returns, he said.
In the next six months, however, Gargour said he would build short positions in companies that have insufficient cash to service their debt.
"As a cycle matures, typical sources of refinancing such as banks, capital markets and direct lending tend to dry up," he said.
"In the final stages, we begin to see debt restructuring, bankruptcies and large-scale corporate failure. This is when it becomes appropriate to seek distressed opportunities such as in debt-for-equity swaps, sales of businesses and new equity listings."
