Hedge Funds Turn to Raves, Madoff Claims on Distress Scarcity

Hedge funds investing in distressed securities should be finding little to feast on with U.S. company defaults at a six-year low. They’re still trouncing most peers within the $2.7 trillion industry.

Distressed funds have climbed 7 percent this year, compared with 2.5 percent for managers across strategies, according to data compiled by Bloomberg. Firms including Paulson & Co., Mudrick Capital Management LP and Maglan Capital LP have approached or exceeded returns of 10 percent.

The managers are investing beyond the typical vulture fare of large bankrupt companies as the U.S. speculative-grade default rate slid to 1.6 percent in June, the lowest level since the 2008 financial crisis, according to Standard & Poor’s. Instead, they’re profiting from equity in once-bankrupt corporates, the debt of smaller U.S. companies and firms with failed public offerings.

“It’s opportunistic, you have these one-offs,” said Siddarth Sudhir, a managing director at The Rock Creek Group, a $10 billion fund-of-funds firm based in Washington.

Some hedge funds have turned to Europe to buy non-performing loans and lend to cash-starved companies in the region, said Sudhir. Those that focus on the U.S. also continue to profit from older bankruptcies, including claims on Lehman Brothers Holdings Inc., Bernard Madoff’s Ponzi scheme and failed brokerage MF Global Holdings Ltd.

“All those have continued to pay,” said Sudhir. “A lot of the distressed guys have moved away from high-yield that has more volatility and into these areas.”

Global Challenge

Firms that deploy distressed strategies are navigating the same challenges as the rest of the hedge-fund industry as central banks globally push down benchmark interest rates, reduce volatility and encourage investors to buy riskier assets. Macro funds that bet on commodities, currencies, stocks and bonds have gained 1 percent this year through June, according to data compiled by Bloomberg. The best-performing categories are equity-focused funds that invest in healthcare and energy. The biggest losers are those betting against stocks.

Maglan, a $75 million event-driven firm, has gained 15 percent this year. One of its biggest winners has been Globalstar Inc., a provider of satellite-phone services, whose predecessor company filed for bankruptcy protection in 2002, President David Tawil wrote in an e-mail.

Electronic Dance

Maglan surged 59 percent last year, in part because of a bet on film studio MGM Holdings Inc. The New York-based firm said it’s unearthed a similar investment in electronic dance music events producer SFX Entertainment Inc., according to a July 9 letter to investors.

Maglan calls electronic music the “fastest growing genre” as DJs including Deadmau5, Avicii and Tiesto play recurring live events that draw a consistent fan base. SFX shares went public in October and have since plummeted 47 percent. The New York-based company is at an “inflection point” to begin growth and profitability, according to Maglan.

“At Maglan, we’ve found our recipe for the ‘off-season’ of the current cycle -- a focus on turnaround and post-reorganization equities and regulatory/legal plays,” Tawil and Chief Investment Officer Steven Azarbad wrote in the letter, a copy of which was obtained by Bloomberg News.

Mudrick Gains

Mudrick Capital, the $910 million firm run by President and CIO Jason Mudrick, is up 18 percent this year through July 3, according to a person with knowledge of the returns. The New York-based firm has profited from the debt of middle-market companies, including iPayment Inc., Verso Paper Holdings LLC, Catalyst Paper Corp. and Lee Enterprises Inc., said the person, who asked not to be named because the information is private. Mudrick declined to comment on the firm’s returns and holdings.

“There is always some inventory, because unlike the boom and bust in large-caps which is largely driven by the debt maturity schedule, middle-market businesses fail for a larger range of reasons,” Maglan wrote in the letter.

Billionaire John Paulson’s Credit Opportunities fund, a strategy that had $6 billion in assets as of June 1 and includes distressed investments, posted an 8.9 percent year-to-date gain.

The New York-based firm has targeted some of the largest bankruptcies, including Lehman bankruptcy claims. Like Mudrick, Paulson & Co. has also targeted the debt of Energy Future Holdings Corp., which filed for bankruptcy in April in an attempt to restructure $49.7 billion of debt, according to two people with knowledge of the trades, who asked not to be named because the information is private. The company, formerly called TXU Corp., was the largest leveraged buyout.

French Directories

Paulson has also invested in corporates where it can help engineer an event to boost returns, such as the debt of French directories company Solocal Group, according to a first-quarter letter, a copy of which was obtained by Bloomberg News. Paulson bought Solocal’s bank loans in 2013 when they traded at more than a 20 percent discount to face value. Earlier this year it then helped the company sell shares to repay debt.

Armel Leslie, a spokesman for $21.4 billion Paulson & Co. with WalekPeppercomm, declined to comment.

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