Hey WSO,
I have done a pretty thorough search on long/short credit investing on both WSO and Google, but I still don't have a clue as to how it works. Forgive me if I'm way off base, but given a relative value strategy, would I start by finding a mispriced security? For example, if I was trying to short a corporate bond, would I look for a bond that is trading at a premium and look for reasons as to why the price may decrease in the future? (Vice versa for long)
Also, when pitching the investment thesis, would I back that up with investment considerations, key risks and mitigants, projected financials, etc. (similar to a CIM/bank book)?
I'm obviously clueless, so any help would be much appreciated. Thanks in advance.
Anyone?
Interested. A bump is all I really have to offer here.
Just a few threads to share down here. These threads are more tailored towards fundamental long/short credit investing. Hopefully it helps.
http://www.wallstreetoasis.com/forums/credit-distressed-fund-technicals http://www.wallstreetoasis.com/forums/ama-credit-analyst-at-5b-distress… http://www.wallstreetoasis.com/blog/how-to-prepare-for-restructuring-te… http://www.wallstreetoasis.com/forums/how-to-short-a-corporate-bond http://www.distressed-debt-investing.com/ https://www.lcdcomps.com/d/pdf/hyprimer.pdf http://www.wallstreetoasis.com/blog/focus-on-the-downside-brushing-up-o… http://www.wallstreetoasis.com/blog/ama-credit-hedge-fund-analyst-at-mf… https://www.lcdcomps.com/lcd/na/2012/09/07/2013%20Guide%20To%20The%20US… www.learndebt.com http://learndebt.com/index.php/models/13-week-cash-flow-model http://learndebt.com/index.php/topics/in-court-restructuring/in-court-r… http://www.wallstreetoasis.com/forums/distressed-d... http://www.wallstreetoasis.com/forums/info-on-rest... http://www.wallstreetoasis.com/forums/i-want-to-le...
@California Banker In the past I have started lessons on khan academy. He does a decent job explaining things for newbies like myself. Hope this helps!
can you provide a link to the khan academy videos? would really appreciate it.
Get any introductory portfolio management textbook used at colleges. Will provide much more of a benefit than piecing various things from forums. WSO is great for the more practical questions but it seems to me you need to get some fundamentals down to really get the value out of the discussions.
L/S Credit Hedge Fund (Originally Posted: 12/17/2015)
Could anyone please help me understand the valuation techniques and methods used for a credit hedge fund position taking positions in the public market.
I assume that understanding the balance sheet and the cash flows are key to your analysis, but could someone please help me provide any examples of a credit investment?
From a distressed debt point-of-view you invest in the corporate bond that trades at a big discount to par value - but how do you do your valuation and how would you derive at whether or not this is a good investment?
Is there any good resources that would help me understand this from a basic point of view.
Thank you
There are many other posts on this site dealing with this, as well as resources online. Why don't you look at those first and come back with more specific questions.
The main thing is seeing what's the chances of you not getting paid back.
Think of it like this: you're in some Mad Max-esque future, and you have to buy spots in line to get food. The closer to the front of the line, the BETTER CHANCE YIU WILL GET FOOD because they may (will) run oit of food. However, the the closer to the front, the more expensive the line gets.
You can A. Pay more to get to the front, but you'll have less money for other food lines or B. Estimate how much food is being given out and buy the spot that is the cheapest, but still allows you to get food so you can have more money for other lines.
If the 1st term is trading at .90 of each dollar and it's 20% LTV. This is closer to the front of the line. It's going to have a lower yield if you get food (pay back) because you spent so much money to get it. You basically paid money to reduce your risk of not getting food, or paid back
and the 2nd term is trading at .60 of each dollar and is 50% LTV. This is a little farther back in the line. It has a higher yield because if you happen to get food (pay back) then you payed less than what the guy in front of you payed for the exact same amount of food (pay back). Higher yield.
You have to make a choice:
If the company goes belly up, what's the chances of me recovering my money? You do this by evaluating the company.
Same with mad max and food. You have to evaluate how much food they have to give back.
Okay, I'm going to reply because the above is a terrible explanation of investing distressed debt.
Think of the simple accounting formula: Assets = Liabilities + Equity. The value of liabilities are essentially fixed, but the value of a company's assets are not, and equity is just whatever is left over once you've paid back all the liabilities.
Let's think of assets not in accounting terms, but in economic terms. Unless you are liquidating a company completely, the value of its assets isn't really what you would pay for them on an individual basis in a sale, but rather the value they create for the company on an operating basis. Think of a bakery: It might have an oven for which it paid $1,000, and that oven might be on the balance sheet for $1,000, but if it brings in profits of $5,000 a year, it's really worth much more on an operating basis. This is called "Going Concern" value, and is basically what you are calculating when you slap a multiple on EBITDA or calculate the PV of a company's cash flows in a DCF.
Now, when a company is healthy, Assets > Liabilities so there's always something left over for equity. But what happens when a company isn't healthy/is in distress and the value of its assets are less than its liabilities?
Back to the bakery. Let's say it borrowed a couple bank loans to open its business -- one loan of $10,000 and a second loan of $30,000, and that the first loan has priority over the second loan. In other words, the first loan has to be repaid before even $1 of the second loan can be repaid.
Now, business hasn't been as good as expected, and the bakery is now generating EBITDA of only $4,000 a year. Based on where other bakery companies are trading, or transaction comps, you figure a 5x multiple is a reasonable valuation, so this bakery is worth $20k, ie it has an asset value of $20k. But wait, it has $40k of debt! So now what?
Back to our formula A=L+E. A=20,000, so L+E has to equal $20,000. In other words, it means that L=20,000 and E=0, necessarily. This means that even though the company has borrowed $40,000, there isn't enough asset value to pay back those lenders -- only 50%. But there's an added wrinkle, because the first loan of $10,000 needs to be repaid before the second loan of $30,000 gets repaid.
The first $10,000 of asset value has to go to repaying the first loan, and now there is just $10,000 left to repay the second loan of $30,000. So when you think about recovery value, the first loan has a recovery value of 100%, while the second only has a recovery value of 33%. From an investment perspective then, you wouldn't want to pay more than par for the first loan or more than 33% of par for the second loan (and ideally, less than that if you want to make a decent return).
What will happen if this company cannot repay its debt when due is it will be forced to restructure. So, for example, it might have to sell itself, in which case it will get $20k of cash and repay the two loans accordingly as above. Or the lenders will agree to be compromised in exchange for a combination of new debt and equity. Regardless of how the lenders are paid back, the value they get is the same -- $20k of cash is $20k of equity is $20k of debt.
That is basically how distressed debt investing works: Figure out what a company is worth, what that implies each piece of debt is entitled to in terms of asset value (ie what it would recover in a restructuring), and then buy the piece of debt at a price that maximizes your return on a risk-adjusted/probability-weighted basis.
Hedge Funds that specialize in L/S Equity AND Credit? (Originally Posted: 01/28/2015)
I typically see the L/S strategy divided into Equity & Credit funds...but are there any moderately well known funds out there that typically take an L/S approach, but with both equity & credit? I ask because I'd consider there to be a good deal of overlap between small/mid-cap stocks & high yield issuers, and a lot of the investment analysis done into one can be applied to the other.
Many event-driven funds have mandates that cover both-the "hard catalysts" tend to be similar in nature and have implications across the capital structure. Elliot comes to mind as a good example.
Less common to see generic "value" L/S equity funds with material credit books at this point in the cycle, but many (Greenlight, Appaloosa, Paulson etc) will get involved cyclically when when defaults go up/distressed is more interesting.
Plenty of multi-strat funds have both but often on separate desks with varying degrees of interconnection/cooperation.
Very helpful response thanks. Especially love the Elliot shoutout...Paul Singer is my adult spirit animal.
Appaloosa and Paulson are about as far from L/S equity as it gets. They are both risk arb event guys that have more than half their assets in credit and derivatives.
Anchorage
I think most of the big funds who's names are tossed around on here are too institutionalized to let you do both strats.
You will need to look at smaller funds with smaller investment teams. I think this is actually a pretty common find if you look under the $1.5B AUM point.
Of course, there are exceptions (like Anchorage, stated above). But probably not many.
Saba.
In my experience there are a solid amount of funds even as large as $10-15 B that do long/short across the cap structure. All about where the best risk/reward is.
In my experience there are a solid amount of funds even as large as $10-15 B that do long/short across the cap structure. All about where the best risk/reward is.
There are lots of opportunistic funds that have the capability to invest across the capital structure. That been said, big funds normally would want to you (as an analyst) specialize in one side. I got to work on both sides at my event-driven fund actually, but it's only because we have a relatively small team in London, and I have background in both equity/credit sides. In our NYC office you will be asked to specialize in one sub-strategy. Note that the fund investing across cap structure does not mean individual professional would be working on both sides.
Exit Opps from L/S Credit HF (Originally Posted: 10/18/2015)
I am considering joining a l/s credit hf after graduation; however, I am concerned if for some reason I don't like it or if I have just had enough after my analyst stint that I am not going to be able to leave the hedge fund space.
Do people at hedge funds have the same type of exit opps as banking? What would the exit opps from a l/s credit fund be?
Thanks!
Great question. My personal opinion on that is that you are young enough that you have plenty of time to pivot back into PE or corporate if you don't like the hedge fund space.
That said, I think you can maximize your flexibility on the back end if you go to a shop that approaches investments as longer-term opportunities and not simply trades. If you take time to do the modeling right, be thoughtful on the business and industry, and generally take an PE-intrinsic value approach, then this approach is super transferrable. Credit trading though is not a transferrable skill.
What about L/S credit post-IB?
L/S credit questions (Originally Posted: 08/05/2016)
I posted the questions below on an older thread but wasn't getting many responses, so wanted to put them out there on a new thread. These questions relate to a single issuer's bonds (not an index).
1) Assuming decent tranche size ($400mm+) and issuer isn't distressed, what would typically be the cost to carry a short position on a bond in addition to coupon pmt? 2 pts?
2) If you want to short a fairly large position (say $50mm) and if brokers don't have the inventory, how are they sourcing it for you? Would existing bondholders (i'm assuming mostly long-only MFs and AMs who bought the bond on the run at/near par) actually agree to lend out their exposure? Kind of hard for me to fathom.
3) The above brings up the liquidity issue, how big can short interest actually get in a bond? Is it somewhat constrained by what banks have on their desks?
4) How hard is it to borrow on the run bonds to short out of the gate? Does short liquidity typically get better as issues get older or stay about the same (again, assuming sizable tranche)?
5) Let's say issuer is distressed (tranche trading in 60s with more downside), does it get near impossible to find short supply at this point? How much more expensive can borrowing cost get?
6) What are some other reasons to short a bond other than taking a fundamental bearish view on the issuer, bearish view on that particular part of the capital structure or as one leg of a pair/convergence trade? Want to understand what other common rationale there could be out there.
Less, generally GC to 50bps or so. Obviously varies
No, have to source from prime brokers
Can be hard to know how much short interest there is. One issue I looked at had 10-15% on borrow which I thought was pretty crowded, but again not much context
Don't think it matters, can short new issues
Usually there's always supply at a price. But it gets very expensive to short distressed bonds. You pay the current yield (can be mid teens or higher for a high single digit coupon trading at 60c) plus borrow (can be GC or seen 3-5 points).
Think something priced too tight, will break lower. Or can pair trade within cap structure or to another company. Ex if you think XYZ issuer is trading too tight but want to hedge against overall industry outperformance by buying a bonds of another issuer in the same industry.
Thanks for the response! Re. #2, if prime brokers only market participant with short supply, what % of total issue size do they typically hold on the desk to lend out for shorts?
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