Blackstone Leads Hedge Funds Attracting Bond-Rally Bears

Hedge funds that seek to profit from credit markets without wagering on the direction of prices are attracting the most new money in five years as skepticism mounts about whether a four-year rally in bonds can continue.

Funds that bet on both gains and losses in credit attracted $12.6 billion of deposits in the three months ended Sept. 30, the most since the period ended Dec. 31, 2007, according to HFR. Blackstone Group LP raised $4.05 billion during the period for its debt unit, which includes so-called long-short funds. Panning Capital Management, which was founded by Kieran Goodwin this year, started such a fund on Nov. 1 with $500 million.

Investors that funneled $79.9 billion into corporate bonds this year are cooling their enthusiasm after pushing yields on the debt to an unprecedented low of 3.6 percent on Oct. 19, Bank of America Merrill Lynch index data show. Mutual funds that buy the debt reported their first week of withdrawals since June, and junk-bond funds reported a fourth week of outflows in six weeks, Royal Bank of Scotland Group Plc data show.

“Long-short credit funds seem to be the flavor of the moment,” said J.J. McKoan, director of absolute-return strategies in New York at AllianceBernstein LP. “We are seeing increased interest in ‘flexible’ and unconstrained fixed-income strategies.”

Losing Steam

Pension-fund managers who benefited from a 115 percent gain in junk bonds in the four years since the worst financial crisis since the Great Depression increasingly are concerned that some of the most attractive opportunities have run their course, according to Monte Tarbox, chief investment officer of the International Association of Machinists National Pension Fund.

The plan, which oversees $9 billion and covers benefits for about 85,000 retirees, has an annual return target of 7.5 percent, he said. It’s getting harder to meet those obligations by owning bonds, he said. The average yield on speculative-grade debt dropped to a record-low 6.84 percent last month and has since held within 0.23 percentage point of that, Bank of America Merrill Lynch index data show.

“A lot of investors we talk to today are more curious about what we’re going to do” with bearish bets than with bullish ones, said Michael Pohly, who manages Kingdon Capital Management LLC’s credit fund in New York. “While I don’t think the credit cycle is getting ready to turn, given the low level of yields, it’s going to be hard for long-only credit to continue the run that it’s been on since ‘09.”

Default Swaps

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increasing 1.2 basis points to a mid-price of 101.4 basis points as of 11:53 a.m. in New York, according to prices compiled by Bloomberg.

The measure typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, rose 0.37 basis point to 11 basis points as of 11:53 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.

Commercial Paper

The market for corporate borrowing through commercial paper expanded for a second week. The seasonally adjusted amount of U.S. commercial paper outstanding climbed $17.9 billion to $963.6 billion in the week ended yesterday, the Federal Reserve said today on its website.

Issuers sell commercial paper, typically maturing in 270 days or less, to fund everyday activities such as paying rent and salaries.

Relative-value hedge funds, most of which are credit funds that take long and short positions, have reported $34.9 billion of inflows this year, compared with $35.9 billion for all of 2011 and $21.5 billion the year before, according to Chicago-based hedge-fund data provider HFR.

The volume of new cash flowing to the funds in the three months ended Sept. 30 was the most since the period at the end of 2007, when they attracted $13.8 billion of new capital, HFR data show. Relative-value hedge funds saw outflows of $86.7 billion in 2008 and 2009, according to the data.

Making Money

“People are trying to figure out, ‘How do I make money in this environment,’” said Beth Chartoff, head of marketing and client relationships at GSO Capital Partners LP, the credit-investment arm of Blackstone. “People are sitting there, scratching their heads saying, ‘We want to maintain exposure to credit, but how do we get comfortable with it at current levels?’”

Average yields of 3.6 percent on Nov. 6 for U.S. bonds sold by companies from the neediest to the most creditworthy compares with the average of 6 percent over the past 10 years, Bank of America Merrill Lynch index data show.

After relative yields on the bonds narrowed 126 basis points to 222 basis points on Oct. 18, they’ve since widened to 236, the index data show. The debt returned 11 percent during the first 10 months of the year.

U.S. corporate bond funds reported $354 million of withdrawals in the week ended Oct. 31, the first outflows since the week ended June 6, according to RBS data. High-yield debt funds have reported $1.9 billion of withdrawals since the week ended Sept. 19, the data show.

Blackstone, Panning

Blackstone’s debt unit including the long-short funds has seen its assets under management swell to $54.6 billion at Sept. 30 from $50.5 billion at June 30, according to company filings with the U.S. Securities and Exchange Commission. Its assets are up 62 percent from the third quarter in 2011.

Panning Capital, led by Goodwin, the former head trader at hedge-fund firm King Street Capital Management LP, capped its fund at $500 million and expects to open it to new investments in the second quarter of 2013, according to a person familiar with the matter who declined to be identified because the information is private. Goodwin declined to comment.

“Traditionally institutional investors assumed every short strategy was riskier than long-only strategies,” said Tarbox in a telephone interview. “We increasingly recognize that combinations of long and short strategies used intelligently can reduce risk. That’s of profound interest to us in this moment in time.”


Company bonds from investment-grade to junk have rallied 65 percent in the past four years after losing 11 percent in 2008 amid the debt crisis that pushed Lehman Brothers Holdings Inc. into bankruptcy. Investment-grade notes will be at best a “low-return investment” for the next few years and may lose value if the economy recovers and inflation rises at an unexpectedly rapid pace, Tarbox said.

After shoring up cash, U.S. junk-rated companies are now increasing ratios of debt-to-income by the most since 2009.

High-yield, high-risk companies had borrowings in the second quarter that on average were 3.26 times earnings before interest, taxes, depreciation and amortization, “creeping higher” from 3.12 times in the same period of 2011, Morgan Stanley strategists Adam Richmond and Jason Ng wrote in a Sept. 14 report.

“There are large parts of the market that are trading at very high dollar prices, which caps their upside, particularly those that are callable by issuer,” Kingdon Capital’s Pohly said. “We are seeing pretty good opportunities from a long-short perspective.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE