Leon Black’s Apollo Global Management LLC is raising a new fund to bet against corporate credit as concerns grow over deteriorating debt markets.
Apollo, which oversees $167.5 billion in assets, cited an expected increase in company defaults and the small difference in yields between Treasuries and junk bonds as reasons for creating the Apollo Credit Short Opportunities Fund, according to a presentation sent to potential clients, a copy of which was obtained by Bloomberg News.
Two of the private-equity firm’s founders, Black and Marc Rowan, said in April they saw signs of a bubble in credit markets thanks to six years of the U.S. Federal Reserve’s policy to hold interest rates near zero and companies’ issuances of loans with loose terms. High-yield, high-risk bonds in the U.S. have gained 145 percent since the end of 2008.
“All the danger signs are there of a future crisis,” Rowan said, speaking at the Milken Institute Global Conference in Beverly Hills, California. “We’re back to doing exactly the same things that were done in the credit markets during the crisis.”
The vehicle, run by John Zito, will focus on so-called event-driven shorts, such as leveraged-buyout candidates and companies with regulatory risks, as well as companies with flawed business models or those facing competitive pressures. It will also ferret out corporations that would suffer from a slowdown in global growth, such as mining companies or those with exposure to emerging markets or China, according to the presentation.
It cites target returns of more than 50 percent if a 2008-type financial crisis occurs, and gains of about 1 percent to 3 percent in a more benign economic environment.
“Even in the absence of a tail event, we believe a short credit portfolio can be well-positioned to outperform,” according to the presentation.
Charles Zehren, a spokesman for Apollo at Rubenstein Associates, declined to comment, and the marketing documents don’t disclose the target size of the fund. The Wall Street Journal reported last week that Apollo is starting a hedge fund to short junk bonds.
Apollo is making its pitch after U.S. junk bonds lost money in July for the first time in almost a year. Investors pulled a record $7.1 billion from high-yield funds in the week ended Aug. 6, accelerating a flight that started last month and bringing net outflows to $9.75 billion this year, according to data provider Lipper.
Rules implemented after the 2008 financial crisis have made Wall Street dealers less willing to take risk, increasing the potential for volatility when investors pull money from high yield.
The document for the fund, which was started nine months ago with Apollo’s capital, cited Genworth Financial Inc., Getty Images Inc. and high-yield ETFs among potential money-makers.
Genworth could be susceptible to real-estate risk in Australia and Getty faces “substantial competitive pressure,” Apollo wrote.
Al Orendorff, a Genworth spokesman, and Getty spokeswoman Colleen McCabe declined to comment.
Genworth sells life insurance and long-term care coverage and backs mortgages in countries including the U.S., Canada and Australia. The Richmond, Virginia-based company said July 29 that it’s reviewing reserves for long-term care coverage, after recording higher-than-expected claims costs in the second quarter. Genworth said its analysis may lead to “material” costs to set aside additional funds.
“Genworth has never been among our favorite credits,” Kathleen Shanley, an analyst at Gimme Credit LLC, wrote in an Aug. 4 note to clients. “Since the financial crisis, periods of optimism have been repeatedly upended by negative earnings surprises.”
Black has said Apollo’s credit business is the 24-year-old firm’s fastest-growing division, managing $105.7 billion as of June 30, compared with $18 billion in 2009. Run by James Zelter, the group can be “a large multiple” of size bigger as it expands its “Chinese menu” of investments with different yield and liquidity characteristics, Black said on a May conference call with investors and analysts.
Apollo, which reported second-quarter earnings this week, said profit at the credit division grew by 53 percent in the first six months of the year from the same period last year.
“Our credit business has plenty of runway and can grow significantly from where it is today,” Josh Harris, an Apollo co-founder, said on a conference call this week discussing the earnings. “We have tremendous opportunity to scale our existing strategies and explore new ones that are adjacent. The dialogue for add-on or new commitments remains quite active.”