Credit Hedge Fund opportunities

bigcheese210's picture
Rank: Baboon | 104

I wanted to make a quick blurb/ overview of the different pathways in the overarching credit space but also seek feedback and other thoughts from other guys in space - knowing full well plenty of things on my list are guesstimates, anecdotal, etc - and that I'm more coming from a place of trying to create an open discussion on all facets of these pathways, rather than a dictation of what I think.

I think this is more geared to middle to senior level professionals in the credit space, but open to thoughts from anyone else with insight or experience.

The genesis of this is a reflection back on my own career in addition to looking forward, seeing other guys in the space and their pathways (from junior to senior), and not purely in relation to a firm/ investment focused scope but also thinking about lifestyle, fulfillment, and purpose as well.

CLO Platforms

Investment strategy - Structure/ launch a CLO fund with fees from fund management and underlying percentage of CLO equity ownership, trying to beat variety of leverage loan / CLO benchmark indices

Availability of opportunities - A sub-set within the overall credit space, there's ~10-15 Tier 1 shops and a variety of 2nd/ 3rd tier opportunities (mostly NYC focused but believe there's other places sprinkled around in Chicago, Dallas, SF, etc)

Skillset - Fundamental medium-term to long-term credit analysis in publicly syndicated leveraged loans in the primary/ secondary space. Frankly, think given ~$95-par trading levels focus, generally less intensive and more of a focus on risk management, diversification + underlying financial and business quality

Market space - Tied to CLO issuance, leveraged finance capital markets, and LP appetite for investment strategy/ product, has been robust since the financial crisis, but general concerns around lack of covenants/ structural protections in market place.
Compensation - Jr Analyst - $100 - 300k. Sr Analyst - $300 - 500k. MD/ PM status - $500k - $1mm+. Generally, the structure I've personally seen is for each CLO vehicle or group of vehicles, the team will be split into sector/ subsector with a variety of Sr-Jr Analysts covering the sectors with 1 PM/ MD-role in charge of overall portfolio weighting/ management.

Job Security - Relatively more stable within the 'high finance' world, a function of longer-term capital base and a lower yield/ risk adverse underlying product

Lifestyle - More lifestyle-oriented, ~8am - 6/7pm seems to be the average?

Examples of Investment firms - GSO, CIFC, Ares, Fortress, Carlyle, Octagon, Voya (more Tier 1)

High Yield/ Investment Grade/ Leveraged Loan Long Only

Investment strategy - Fundamental long only with a short to long-term horizon in HY and Lev Loan space, generally diversified across sector coverage, trying to beat a variety of aggregate HY and LL indices and sector-specific HY / LL indices

Availability of opportunities - Tied to issuance and size of HY and Lev Loan market, has generally been robust since the financial crisis, although more outflows from HY relative to Lev Loans? General concerns around lack of covenants/ structural protections in market place.

Skillset - Fundamental medium-term to long-term credit analysis in publicly syndicated leveraged loans in the primary/ secondary space, similar to comments for Lev Loan space. HY generally has more volatility given more liquidity, unsecured/ junior status in the capital structure, and more opportunity for higher returns/ losses

Market space - Tied to leveraged finance capital markets - although HY is generally less tied to private sponsor activity and more general UoP/ standardized source of funding. LP appetite for investment strategy/ product, has been robust since the financial crisis, but general concerns around lack of covenants/ structural protections in market place (I think more of a concern with the lev loan space given that lev loan is generally thought of as a more highly protected/ lending product vs HY bonds, but structure drift of lev loans have brought them closer to HY)

Compensation - Frankly, I am less sure - think it depends on the firm/ investment strategy (vehicles under a credit multi-strat vs large investment managers vs investment arms of insurance/ pension/ endowment/ sov wealth funds vs etc). Curious to see if anyone has thoughts?

Lifestyle - I would guess that long-only vehicles under multi-strat credit HFs would have a similar lifestyle to their contemporaries under that umbrella and firm culture, thus more the ~60-80 hour work weeks (12 hrs M-Thurs, 10 on Fri, +0 - 10 hrs over the weekend)?. I have less of an idea, but I would venture that large investment managers and pension/endowment/ sov wealth funds would be more 8a-5pm type of lifestyle?

Examples of Investment firms - credit multi-strat HFs with specific long-only investment vehicles, separate accounts (ex. GSO, Canyon, GoldenTree..?), larger asset managers with direct investing credit groups (BlackRock, Fidelity, State Street, PIMCO), pension/ endowment/ insurance funds (Insurance - Allianz, Legal & General, MetLife, MassMutual; Pension - CPPIB, Texas Retirement System; Endowment - Harvard, Yale; Sovereign Wealth - ADIA, China Investment Corp, GIC, Temasek, etc)

Special Situation/ Distressed / Opportunistic

Investment strategy - I think there's a variety of spectrums that fall under this umbrella, from (a) one end being investment in higher yielding/ opportunistic credits but typically non-default/ restructuring (i.e., higher yield + credit market price appreciation/ depreciation) with generally a more short-to-medium term horizon to (b) 'true distressed' with investment in out-of-court restructuring or pre-, during, and/ or post-reorganization (Ch 11 or 7) with investment framework as 'small' as a quick trade to a potentially multi-year, actively engaged/ managed workout plan with a potentially large equity/ re-organized capital structure ownership

Availability of opportunities - Given the multi-year bull cycle from the ~08-09 (with corrections here and there), there has not been a large scale plethora of distressed opportunities asides from sector-level movements (namely, energy in 2014-2016 but still continuing and retail). There is a thought there should be a much larger set of opportunities driven by the potential recession in 2020 - 2022, but that's subjective / up for debate. Overall, can be tougher to source opportunities relative to other investment frameworks, with many of the larger distressed stories (PCG, etc) being widely owned and fought after.

Skillset - Subjective take, but I think this is one of the hardest/ most complex - asides from understanding the same dynamics as other guys (fundamental analysis of company + sector, financial analysis of company, rel val analysis of credit + mkt, analysis of credit agreement/ governing docs), you have to deal with complex legal scenarios and if taking an active engaging role, there is a large element of scenario analysis, behavioral psychology, and cooperation in groups in creating value with your investment with competing alignments and incentives from multiple parties. Ultimately, I think it's fundamental analysis (typical market HF investor framework) + control-ownership and business 'change' analysis (more of a PE mindset than anything) + legal processes (lawyer perspective).

Market space - Tied to credit/ market cycles and default/ CCC-or-below downgrades as a % of total credit markets and generally comes in waves (2000-2001, 2007-2009, 2014-2016 were the last big cycles)?

Compensation - Reflective of the 'hardness' of the skillset and more of an ability to steer outcomes, generally a distressed fund will target a larger return profile more align with a PE fund (+20-30% IRRs, I'd assume) - and thus, compensation across all ranks would reflect that? From what I've seen, it more follows the typical PE title structure - (a) Associates/ 'associate level analyst' - $200 - 400k; (b) VPs - $400 - 600k; (c) D/ MD - $500k + ~$1/2mm - usually larger component is carry so pretty variable. I think a more 'higher yield'/ opportunistic fund would mirror the more typical market hours investment analyst structure/ compensation.

Lifestyle - Given the moving pieces in a restructuring/ etc and time-sensitive objectives (and from personal anecdotes), this will be more of a 'stressful' PE type of lifestyle - i.e., generally, M - Thurs, 9a to 9-11pm, Fri - 9a to 7pm, Sat & Sun - ~5-10 hours... but work will generally travel in cycles, i.e., a few months of terrible back-to-back weeks in relation to active work in investments, and a few months of easier weeks in relation to more passive processes in investments/ lack of active engagements.

Examples of Investment firms - Oaktree, Elliot, Silver Point, GSO, Baupost

Direct Lending

Investment strategy - Directly originate or otherwise source private lending opportunities with primarily middle market companies (who like size/ scale to access traditional leveraged finance or equity markets), build a portfolio of loans into an investment vehicle with a focus on par recovery and interest income.

Availability of opportunities - Direct origination or indirect sourcing through commercial bank/ investment bank relationships. Seems much more entrepreneurial and ad hoc relative to the more typically defined capital raising pathways in leveraged finance, DCM, or ECM

Skillset - More of a fundamental business and financial skillset, with a more entrepreneurial spirit (in dealing with private management teams, negotiated terms, etc).

Market space - Not sure what public data is there, but think private middle market lending space is there/ available... and not sure about competitive dynamics regarding private lending from an investment manager/ HF platform against typical commercial banking divisions. Growing amounts of capital have been deployed to this space since the recession and I believe at FY17, it surpassed the peaks in 07-08

Compensation - Frankly, unaware - think hierarchy structure is more similar to IB/ CB as far as analyst, associate, VP, MD, etc

Lifestyle - I would assume more lifestyle-oriented, so 9am - 7pm M-F thing? Unsure though

Examples of Investment firms - Ares, Centerbridge, THL, etc

Mezzanine & 'higher yielding' Private Credit

Investment strategy - Directly originate or otherwise source private lending opportunities with primarily middle market companies with structured preferred equity/ equity kicker component to increase overall return

Availability of opportunities - I think the middle market space is relatively open for these opportunities, although more of a niche/ complex source of capital relative to private debt/ lending and public debt and equities. Not too sure about origination, but given complexity and uniqueness of structure, would venture that it would be more direct origination.

Skillset - Blend of a direct lending analyst and private equity - need to understand downside scenarios, risk assessment, and credit agreements/ governance - but also valuation and growth upside

Market space - I think this space may be facing a squeeze given the inflow of capital into private debt funds with a lower return profile target - and on the other end by traditional PE

Compensation - Think closer to traditional PE, but with a haircut given lower return profile in general

Lifestyle - Would venture to think that it's generally M - Thurs, 9a to 9-11pm, Fri - 9a to 7pm, Sat & Sun - ~5-10 hours... but work will generally travel in cycles, i.e., a few months of terrible back-to-back weeks in relation to active work in investments, and a few months of easier weeks in relation to more passive processes in investments/ lack of active engagements.

Examples of Investment firms - HPS Investment Partners, GSO, Crescent Capital, etc

Other strategies - long/ short credit, BDCs, CDS/ rate/ etc-focused strategies?

Caveat -these are just kind of generalized thoughts and guesstimates, I wanted to see if anyone else has thoughts, anecdotes, etc as well?

Comments (21)

Apr 24, 2019

Interested as well

Apr 24, 2019

Thanks for this, been meaning to find notes on credit funds for my career exploration web app!

EDIT: it seems like you've mixed in private credit shops with traditional hedge fund style vehicles.. is there a lot of overlap between these two?

I always thought L/S credit, value/LO credit, structured credit/CLOs/ABS, convert arb, credit arb, distressed securities, etc were what are "typical" hedge fund strategies. whilst direct lending, mezz, distressed control, etc were more private credit fund strategies.

Can anyone chime in on this?

Apr 24, 2019

I think the line between the two has become more blurred over time....have seen a number of HFs start to branch out into more traditional private credit strategies as their business evolves and they start to launch funds that are hybrid structures between HFs and PE. Seeing a lot of credit HFs launching drawdown structures, going away from traditional evergeen funds to take advantage of less liquid, higher IRR opportunities so they have branched out what strategies they will employ

    • 1
Apr 24, 2019

There's also cap structure arb, convert arb, structured credit outside of CLOs, mortgage credit, credit relative value (not just L/S, but actually credit beta-neutral), macro credit (indices, ETFs, options, index skew)

May 2, 2019

Can you give a 1-2 sentence explanation of what differentiates each of those?

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Apr 24, 2019

incredibly simplified explanations...

cap structure arb - this bond looks cheap/rich relative to this bond/equity/cds

convert arb - buy a convert and delta hedge to get convexity

mortgage credit - buy mortgage pools (reperforming/nonperforming) not backed by gov't

credit rv - construct a credit market-neutral portfolio of bonds (can include index hedges to neutralize beta)

macro credit - trading a view of how the overall credit market will evolve (outright or relative)

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Apr 27, 2019

All of this is great, but I'm not sure I'm smart enough to get into a credit HF...I mean have you seen the insane math behind bonds? I could barely understand the fixed income portion of the Cfa exam. It's redic

Apr 28, 2019

Leveraged credit and distressed aren't insane from a quantitative standpoint, most of the value add from investors in the space comes from qualitative approaches. Structured credit is a different ball game though, far more quantitative

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Apr 24, 2019

but even the qualitative work is technical in a way.. i would be super lost reading all those covenants and agreements

    • 1
May 1, 2019

Bump! Great thread. Hoping someone could give more color on direct lending. Can anyone comment on lifestyle, hours and compensation at the larger NYC based credit funds (Ares, Golub, GSO) and what career trajectory looks like? How do roles and responsibilities change through career progression? I've heard it can range from a modeling heavy role to one focusing on managing sponsor relationships, but would appreciate more insight.

Can anyone speak on how feasible a transition is from private credit direct lending to a distressed role and maybe even performing credit? Assuming if the DL role is more cap structure flexible, including mezz and pref equity, one would have an easier time with maybe more transferable skills. Are you at a disadvantage if your group or fund does mostly 1st and 2nd lien secured loans?

What could an analyst fresh out of college starting at an NYC based direct lending private credit fund with $5bn+ in aum expect in terms of work, day to day tasks and assignments, hours and comp? Would starting in a role like this be comparable to starting in LevFin in terms of career preparation, knowledge and training?

Thanks in advance & sorry for onslaught of questions, just another clueless monkey looking for answers

    • 1
May 2, 2019

This is really a great write up. I do think the lifestyle/hours are very overstated for the Long only and Distressed below. I'd peg both around 50-60, sometimes less and for the distressed side times where it can be more but that's more infrequent than not.

edit * - mezz/private credit hours seem over stated too.

    • 4
May 2, 2019

I had the opportunity to job shadow/extern at a credit-focused HF and it was an awesome experience. It had a very unique structure and wasn't too big (~$3B AUM). I'd highly recommend visiting one of these firms or doing an informational interview.

May 2, 2019

What was notable about it?

May 3, 2019

Can anyone comment on the requirements for post-undergraduate credentials such as MBA/CFA for credit funds?

Most Helpful
May 6, 2019

I'd be interested in hearing people's views on public vs. private credit. I work on the public side inside of a large alternative/PE platform with ability to look across the structure (loans, HY, CDS), but have seriously considered direct lending. It was tempting given all the buzz and potential ability to do deeper dive DD, but ultimately decided against it because I enjoy the social/psychological/volatility elements of public market investing. But from a junior/mid level perspective, I can see why getting a couple yrs of private credit experience can be beneficial to develop a well balanced skillset. I'll start with my views on the two segments and would welcome anyone with experience in either or both to chime in:

Diligence:
Private side generally seems to go deeper on business diligence as you're always underwriting to maturity. But it also seems shop/culture dependent -- in many cases you're just taking what the sponsor tells you and maybe stress testing a little bit, particularly if you're senior focused shop. Not sure how many shops out there do truly differentiated, independent research given turnaround requirementd and relationship considerations with sponsors. Also, middle market business models are often simpler and easier to understand. On the public side, the limiting factor is that you simply do not have the level of granularity of private-side data access without getting yourself restricted. However, I do think the ability to piece together a mosaic from various third party/internal sources is a skill unto itself. But no doubt you're working with less transparent data on the public side.

Strategy/mandate:
Depending on what your strategy/mandate is, certain public fund structures can be more rigid with ratings, diversification, or liquidity requirements. By definition, private funds are set up to extract premium from these inefficiencies and perhaps can be more flexible in what they invest in. This also seems to vary though as plenty of senior lender type shops will only do certain types of deals and refuse to go lower in the structure.

In a workout situation, I think public guys have more ability to be aggressive and there is more interesting game theory dynamic. I don't know how this works with private guys if you're the only lender in the structure.

Structuring:
On the public side, you are trying to find value in an existing structure. In more volatile situations, there are opportunities for public side guys to drive terms and negotitate directly, but generally we are term/structure takers. On the private side, structuring a deal from scratch is part of the job. But I wonder how much variance there really is in markets like this where there is so much competition and the direct lending product is increasingly getting commoditized -- I suspect there is a race to the bottom here with covenant/pricing/leverage terms increasingly converging with public side, despite taking more illiquidity/concentration risks.

Career/prospects/comps:
From what I've seen, I think the comp is pretty similar at the junior/mid levels. As with most jobs on the buyside, the comp trajectory will start to diverge significantly as you get more senior based on AUM, your economics with the fund, performance, etc.

In terms of exits, assuming you don't want to keep doing what you've been doing, I've seen credit guys from one side cross over into the other side pretty easily. Private credit guys can exit more into MM PE roles which is not common for public credit. Public credit guys can go into other HF strategies (equity, special sits, arb, etc) more easily. YMMV on this based on your network, specific investing/deal experiences.

I think the best of both worlds is a hybrid mandate where you can straddle both worlds and go wherever the value is. But for the purposes of this discussion, I'm bifurcating the two to draw some comparative conclusions. Also, there is some gray area between the two as "public" credit can get super illiquid quickly in smaller/off-the-run situations and "private" can look more syndicated in clubby deals with a banked process.

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May 2, 2019

Solid post. I think you laid out somethings out pretty well.

To me the main driver to trying to go private credit is less of the additional experience (dd, structuring), so much as I think it poses an existential threat to the public markets - taking mkt share from 2L, 1L and even HY. Thus its more "skate to the puck" to be cliche. Not to mention its locked up capital, which inherently provides for greater job security. There is more of a team, managerial perspective, similar to PE that provides a broader skill set than merely being an investor that largely works independently - this can be transferable to more than just investing roles. Also, dealing with mkt volatility can be annoying when a name trades off - so eliminating MtM and 5-10pt moves based on short term noise despite long term status quo would be nice. I actually think this is likely a big driver to private credit from an LP perspective. If the public loan mkt trades off 5pts for the year you're book would be flat, but private credit guys wouldn't move their book and would be up on the year and thus the LPs have "less volatility" though that's obviously kinda bs/semantics.

I do think there is a greater level of diligence and structuring as you outlined; however, that said, I do think its somewhat marred in the actual deal flow / relationship component of private credit. That said, and potentially more importantly, the market is just hyper competitive now. I dont think the relationship aspect can be understated - it's all about getting first looks and being quick for the sponsor. Size and scale matter and to a degree I'd imagine there is a push/pull trade off from the investment team and the BD team and the interconnection of managing sponsor relationships. You can be picky but not too picky if you want good deal flow.

Diligence its deeper with much better access to mgmt, but its still relatively quick. Instead of monitoring all your names, plus the new issues and drive byes, etc. - you're usually just staffed on a deal at a time, with a team so it can be your complete focus. In term of structuring, I dont think you're literally getting tons of structuring experience per se - kinda boiler plate and mkt driven (also if you're an a large aum public shop you probably drive terms). That said, from a skill set perspective, I think its a pick up of managing a process, dealing with attorneys, etc. I don't think you're really getting creative with structure. This is certainly helpful and a skillset expansion vs. just being an ivory tower public mkts guy.

To your point about workouts etc, I think there is a lot less flexibility and creativity and opportunities to capitalize on distressed situations. You want to be in the PE shops good graces and certainly don't want a reputation as a lender that takes control - deal flow will die.

Depending on where you sit in the public mkts, I'd guess the private side is more "boring" just doing tons of 1L and unitranche stuff. Nothing too hairy.

Another important distinction is decision making. In the public side its likely your ideas that you're pitching. So you in some respects there is a lot more ownership and actually making investment decisions so to speak. On the private side I think its likely a lot more top down, similar to PE - you have input of course but not to the same degree.

I agree a hybrid model would be best from a personal stand point but to an extent likely hard to get good deal flow. Likely just they super hairy stuff the big guys with rock solid relationships have passed on.

    • 5
May 6, 2019

Appreciate your insights. My reaction to some of your points in no particular order:

  1. Managerial/Team Skills: I agree in general private credit builds more of a process and team management skillset. It's essentially PE-lite in terms of how the work flows through the firm. On the public side, if you're at a single manager HF you will most likely be doing solo work on all research work, which tends to create work styles that become increasingly incompatible with working with other people (because you develop certain habits and ways of doing things on your own as you get more senior). You do have peers on the street to bounce ideas off of, but it's just a different dynamic. In a MF environment, you often do have enough resources to have team structures and have legal teams/law firms on tap to review credit agreements, etc. I also frequently collaborate with our PE/Private Debt guys if there is some relevant industry expertise or deal experience that resides inside the firm. In workout scenarios, you basically enter deal mode even as a public guy, working with FAs, other lenders, and law firms.
  2. Skating to the puck / market share: agreed then increasingly middle market / upper MM will see market share gains on the private credit side. However, syndicated loan market growth has been in tandem with the private credit side, evidenced by the explosive growth in CLOs. The real story is not private taking public market share, but alternative lenders taking share from traditional bank balance sheets overall as banks get punished for taking leveraged principal risk. Also, issuers with access to HY will not trade the flexibility for covenanted private lending unless they lose access to capital markets and have to do so. There will always be a place for syndicated deals in my view for larger deals and you will most often be more price competitive on the public side. Private credit seems it's still got some room to run, but so does the syndicated market.
  3. Terms / Structuring: agreed that as a large AUM shop we do drive terms on a lot of deals that are not straight down the fair way. DL structuring also seems to be driven by market terms and not much room for creativity unless you look at truly off-the-run, funky deals -- which is not a scalable strategy and this space wkll always be fragmented with boutique lenders rather than large institutional flow shops.
  4. Trading dynamic: I think this is truly a matter of personality and preference. If you are a principled value-driven investor, you always like the credit better when it is cheaper. But I get that it can be viewed as annoying from a career standpoint as it is not always the case that PMs can see volatility as a source opportunity rather than a source of risk or annoyance. Most of us do answer to LPs with a lot of questions, after all, who may or may not have ability to redeem on short notice depending on your fund structure.
    • 4
May 7, 2019

Thanks OP for the post. I work in the credit research field and was thinking about exit opportunities and found this post really informative. Just a few questions.

  • What are the exit opportunities for CLO analyst/"associate" level analyst? I seems CLO is the exit, but still I wonder.
  • Does direct lending = private credit? It seems so from what I have pieced together from this forum.
  • How does the comp for mezz fund compare to direct lending? Should it be higher since it's higher yielding?

TIA!

Jun 3, 2019

Can anyone shed some light to CLO tranche investing? Working with a team for the summer that does this; the team is split between CLO issuance and tranche investing (usually mezz and equity) in the primary/secondary markets. Can that skillset land you at credit HFs?

Apr 24, 2019
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Apr 28, 2019