Hedge Funds Aimed at Ailing Companies Will Do Well, Agecroft Says

A report sees higher rates and a weakening economy pushing firms into bankruptcy or restructurings.



Now is a great time for hedge funds specializing in distressed investing, according to a report by Don Steinbrugge, founder and CEO of consulting firm Agecroft Partners LLC. The Agecroft report argued that the prospect is rising that many  bonds and other securities will sour as their issuers run into trouble and file for bankruptcy or restructure loans out of court.

Sectors such as commercial real estate, lodging and retail are suffering from high debts and slipping revenue, the report noted: “Higher interest rates, a weakening macro environment and a reduction of regional bank lending are putting pressure on many businesses, and cracks are beginning to surface.” Hedge funds that invest in distressed bonds, leveraged loans and preferred stock are good areas to put money into, the report recommended.

Distressed-oriented hedge funds have done well over time, although they—like hedge funds in general—have trailed stock and junk bonds lately. The HFRI Fund Weighted Composite Index is up just 2.3% this year, the same as the HFRI Distressed Debt Index, versus 16.6% for the S&P 500 and 13.7% for the Credit Suisse High-Yield Index. But since its inception in 1990, the distressed debt gauge has returned 9.7% annualized, beating stocks’ 8.2% and junk’s 7.8%.

The average yield on BB-rated high-yield debt, has jumped two percentage points in the last 12 months to 8.2% annually. Commercial bankruptcy filings and credit downgrades are increasing. Refinancing of debt is much costlier nowadays, given higher interest rates.

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As a result, investor interest in distressed investments is mounting. Almost two-thirds of investors surveyed by Preqin in 2023’s first half planned to increase their exposure to the asset class. “While it is true that the size of the distressed universe generally has an inverse relationship to the business cycle (peaking when the economy is at its worst), investors can miss out on significant opportunities by staying on the sidelines,” Steinbrugge wrote.

Navigating the world of bankruptcy filers and non-court restructurings is a difficult endeavor. But buying their securities at low prices produces huge upsides, he contended. From the financial crisis of 2008 through 2009 up until the 2020 pandemic onset, companies in their first year after emerging from bankruptcy, with less than $100 million market caps, averaged 8.6 percentage points better performance than the small-cap Russell 2000, he calculated.

While Steinbrugge did not name any hedge funds that stand out for their distressed investing prowess, he indicated that those aiming at middle-market companies had the best opportunities, rather than funds focused on large businesses. Middle-market companies “are more prone to labor shortages, supply chain issues, have less access to public markets and tend to pay higher interest rates regardless of the fundamental soundness of their business,” he declared.


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Illinois Police Pension Seeks Active Manager for Small, Mid-Cap Stocks

The $9.4 billion Illinois Police Officers’ Pension Investment Fund has $450 million in international small-cap stocks.

The $9.4 billion Illinois Police Officers’ Pension Investment Fund is currently soliciting proposals to hire an active investment manager of global or international small- or small/mid-capitalization stocks.

The IPOPIF, a consolidated asset pool of 357 separate police pension funds, has a 5% asset allocation to international small-cap stocks, currently invested in a passive commingled trust worth $450 million as of June 30. The IPOPIF wants to increase investment returns for the allocation through active investment management.

Under the scope of services listed in the request for proposal, the IPOPIF is looking for qualified firms to manage a portion of the plan’s international small-cap equity assets, which can include global or international small- or small/mid-cap stocks.

Candidates are expected to be qualified investment advisers and, if selected, will serve as a fiduciary to the IPOPIF and have independent discretionary authority regarding how the portfolio is managed, subject to the fund’s investment policy. The IPOPIF can use commingled funds, mutual funds, exchange-traded funds or similar commingled vehicles.

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According to the pension fund, candidate responses will be evaluated first by its CIO and an investment consultant, who will determine, based on certain evaluation factors, the top investment managers and will also disclose the non-finalists. The final decision on who to hire will be made by the IPOPIF’s board of trustees. The evaluation factors include, among others:

  • The firm’s background, experience and reputation, including its experience managing institutional portfolios;
  • Investment philosophy and process;
  • Performance, including long-term performance, risk factors and consistency of performance relative to benchmarks and peers;
  • Reasonableness of fees, including availability of ‘most-favored nation’ fee clauses; and
  • Portfolio management and client services, including client servicing, accounting and reporting.

The number of managers and the size of allocations will be determined as part of the search process, but individual allocations are expected to be at least $100 million. IPOPIF also is looking to include in the search emerging managers; minority, women and disadvantaged business enterprise managers; and veteran-owned managers.

 

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