Distressed debt funds tap into fears over credit cycle

Jason Mudrick, Mudrick Capital Management, L.P. speaking at Delivering Alpha in New York on Sept. 13, 2016.
David A. Grogan | CNBC
Jason Mudrick, Mudrick Capital Management, L.P. speaking at Delivering Alpha in New York on Sept. 13, 2016.


A growing number of US hedge funds specializing in distressed debt are raising money in anticipation that the next economic downturn will punish companies that have borrowed record amounts since the financial crisis.

Jason Mudrick, founder of $1.9bn Mudrick Capital, is marketing a second distressed investment fund, according to people with knowledge of the matter. The new fund will lock up investors' money for five years and only charge fees once the capital commitment is invested, according to the people. The fundraising is set to close on December 1.

Distressed debt investors make money buying assets they believe have fallen too sharply in price, typically during periods of economic stress. However, recent years have offered slimmer pickings as yields on junk-rated debt stay low and US stocks remain near record highs.

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"This economy is roaring right now," said Mr. Mudrick, who declined to comment directly on the fundraising, citing US regulation. "It's rocking and rolling. But that's just not sustainable . . . My job is not to predict exactly when [the turn in the cycle] happens but to have the platform ready when it does."

US corporate bond sales have run at more than $1tn annually since 2009, prompting warnings that such reliance on debt will help trigger the next downturn. A widely tracked index of bonds rated below "investment grade" has jumped from $728bn in 2008 to more than $1.2tn this year. That amount will rise if higher-rated companies are downgraded during a downturn.

Mudrick Capital is not the only fund preparing for an eventual downturn in a US economy where growth is accelerating this quarter. Strategic Value Partners in May raised almost $3bn to pounce on distressed bonds and loans, while Sheru Chowdhry, formerly co-portfolio manager of the Paulson Credit Opportunities fund, launched DSC Meridian Capital at the start of June.

In total, seven distressed debt funds have raised money this year, with a record average size of $2.2bn, according to data from Preqin. The largest is the GSO Capital Solutions Fund III, which closed in April after drumming up $7.4bn in the fourth-biggest distressed debt fundraising ever.

"I think we'll be doing a lot of distressed stuff when there's distressed stuff to do," said Mr. Chowdhry. "It feels like we're about 12 months away, but we could get into extended innings."

Mr. Mudrick believes it is a backdrop that will create ripe conditions for distressed debt investors when economic conditions do worsen. The New York-based fund generated returns of almost 40 per cent in 2016 wagering that energy bonds hit by a declining oil price would recover, according to a hedge fund performance document produced by HSBC and seen by the Financial Times.

Putri Pascualy, senior credit strategist at investment firm Paamco, said her firm had seen an uptick in fundraisings for distressed debt funds after falling out of favor in recent years."There's been a sense that valuation has been stretched for too long, coupled with macroeconomic concern," she said.

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