Distressed Traders Win Reprieve After Hate Mail, Defections

  • Mudrick Capital, Phoenix soar in 2016 after staggering losses
  • Too-early positions in beaten-down energy debt finally pay off

“WTF.”

The terse message landed in Jason Mudrick’s inbox one day last February.

It was from a client, one of the many getting burned by the brutal stretch of losses Mudrick was suffering in the credit market. The year before had been awful and now, his biggest bets -- on debt issued by troubled energy companies -- were getting crushed again. As losses piled up, he was close to the brink. “We were getting all kinds of heat,” he recalled.

But then, in what would become a hallmark of last year’s topsy-turvy markets, the unrelenting meltdown gave way to an equally stunning rally. Mudrick Capital’s flagship fund ended the year up 39 percent, clawing back all its losses and then some. Around Christmas, Mudrick fished out that February e-mail. He forwarded it back with one addition: “Happy Holidays.”

While this kind of face-saving turnaround played out across credit markets, nowhere was it more extreme than in the world of distressed debt. The asset class delivered the biggest gains in seven years, lifting those like Mudrick atop the rankings. Yet one sobering fact remains: 2016 was ultimately more of a much-needed reprieve than a cause for celebration.

That’s particularly true for managers who staked their firms and reputations to a one-of-a-kind opportunity wrought by oil’s collapse two years ago, only to see those wagers turn out to be too early.

Still Underwater

Even after a 54 percent gain in distressed debt, many hedge funds are still underwater or have barely made up lost ground. Others, notably Perry Capital, Wingspan Investment Management and Raveneur Investment Group, failed to weather the turbulence and were forced to shutter.

And 2017 hardly figures to be a walk in the park. Higher debt prices across the board mean fewer bargains. Unlike in past years, when oil and commodities gave managers plenty to scavenge through, few industries stand out.

“There’s nothing that comes in second or third at this point,” said Diane Vazza, the head of fixed-income research at S&P Global Ratings.

Mudrick, who has held onto many of his energy positions, says the potential for outsize returns will come from debt of private distressed companies, which are trading at 30 to 50 percent discounts to their public peers. Opportunities may also crop up in health care (with the likely repeal of Obamacare) and smaller distressed retailers, but a repeat performance would be hard to come by, according to Mudrick, who oversees about $1.6 billion.

It’s still a better situation than Jeff Peskind found himself in about a year ago. Much like Mudrick, his credit opportunities fund at Phoenix Investment Adviser was deep in the red. After losing 38 percent, his firm was fighting to survive as fears of a worldwide recession rocked the credit markets.

‘Straight Down’

“It was straight down, we were month after month after month of straight down,” he said. “We handled it as well as we could without crying.”

Convinced his investments were undervalued and would eventually pay off, he asked investors not to pull the plug. For those who stuck around, Peskind’s mettle proved to be the difference. His main distressed fund (which holds a majority of the firm’s $1.4 billion in assets) returned 57 percent last year thanks to names like Cliffs Natural Resources, Murray Energy and Comstock Resources, according to people with knowledge of the matter.

Naysayers might write that off as mere luck rather than skill. After all, just about everything in the distressed corner of the market rallied after the first couple of months of 2016. Peskind, however, credits the value-investing style championed by Warren Buffett helping him bring the fund back from the brink.

“We are big Warren Buffett fans,” Peskind said. He isn’t kidding.

An unabashed disciple, Peskind has turned his office in the historic Graybar building towering over Grand Central Station into a mini-shrine to the legendary investor. The Oracle of Omaha’s homespun wisdom jumps out in colorful fonts that line the walls. A framed letter sits in a meeting room.

Buffett Bromides

Peskind points to one particular (and oft-quoted) Buffett-ism, which hangs off the trading floor wall, that enabled him to survive: “Be Fearful When Others Are Greedy, and Greedy When Others Are Fearful.”

Regardless, Peskind concedes he still has work to do to win back his clients’ trust. Despite the banner year, the fund has yet to get back to its high-water mark.

It’s not just distressed debt traders. The same goes for managers at larger, more established firms that don’t typically delve into the riskiest parts of the debt market. Kathleen Gaffney, a protege of famed bond-market guru Dan Fuss, staged one of the industry’s biggest comebacks after her Eaton Vance Multisector Income Fund beat 99 percent of rivals with a 22 percent return.

Like both Mudrick and Peskind, she credits the revival from a 17 percent loss the previous year to sticking to her guns when markets were pricing in a global recession that never happened.

“When you think about how it started and how it ended, it’s just amazing,” Gaffney said. “I don’t think I’ve seen a year like that.”

Fund Shrinkage

Her fund still shrank for a second year in a row. It now manages just $594 million, data compiled by Bloomberg show. Less than two years ago, the fund oversaw almost $2 billion.

For Phoenix’s Peskind, 2017 will be the year when smaller firms can really stand out and prove the recovery wasn’t just a one-off.

After surviving last year’s wild ride, he allowed himself and his team only a modest celebration -- dinner at the gastropub Spotted Pig in Manhattan. Maybe, if the fund tops its high-water mark by the time of the firm’s annual trip to Buffett’s shareholder extravaganza in Omaha, there could be room for something special, Peskind mused.

Mudrick didn’t even go that far.

“My marching order to the team was not to celebrate,” Mudrick said. “This will be a harder year to make money so we have to work doubly harder.”

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