Credit Hedge Funds Booming

The bad news for credit hedge funds is they're lagging behind a broad index of bonds this year. The good news is that investors don't seem to care.

While relative-value credit hedge funds barely eked out a positive return in the three months through September, they're on track to receive the most new money since 2007 after amassing $40.57 billion in the first three quarters, Hedge Fund Research Inc. data show. Assets in the funds, which can go short as well as long, have about doubled in the past six years, reaching $756 billion as of September.

The reason for their appeal? Pensions, insurers, and other big investors are getting nervous about lofty asset prices as the Federal Reserve prepares to raise interest rates. They want money managers who have the flexibility to profit in a falling market and are piling more cash into funds managed by firms such as CQS U.K. LLP, Pine River Capital Management LP, and Tricadia Capital Management LLC.

“We've seen our investors want to pull funds from traditional fixed-income strategies and look at alternative credit strategies,” Michael Barnes, co-founder of New York-based Tricadia, said in a telephone interview. In a world awash with central-bank stimulus, “you have to look for alpha in other places than liquid markets.”

The credit-focused hedge fund manager's US$2.8 billion Tricadia Credit Strategies fund has returned 2.53 percent this year through Oct. 15, and posted an average 7.5 percent annual gain in the three years ended 2013.

Tricadia, which oversees $4 billion, separately started a short-biased strategy a few months ago that focuses on trading indexes of credit derivatives. It aims to provide some positive return in stable markets and a bigger payoff in a market rout, Barnes said.

“Each point of positive performance that people see in the fixed-income space becomes a liability with how low the rate is,” said Kenneth Heinz, president of Chicago-based research firm HFR. Investors “are seeing the benefit of strategies that can go long and short.”

With yields on corporate debt hovering near record lows, it's becoming more attractive to bet on a market disruption than to just own a batch of frequently-traded bonds, Barnes said.

Low Yields

Yields on corporate bonds around the world have fallen to 3.36 percent from 3.67 percent at year-end, according to a Bank of America Merrill Lynch index that includes investment-grade and junk-rated debt. Yields have averaged 4.94 percent during the past decade.

Investor interest in hedge funds hasn't translated into bigger returns this year. The Bank of America Merrill Lynch Global Broad Market index gained 1.13 percent in the three months ended Sept. 30, compared with an average 0.13 percent gain earned by credit-focused relative-value hedge funds, HFR data show.

The BofA bond index returned 5.4 percent in the the first nine months of the year, versus a 4.94 percent gain for the hedge funds.

The performance has done little to curb demand for the product. The hedge funds received $11.08 billion in the three months ended Sept. 30 following $29.5 billion of inflows in the first six months of the year, HFR data show. In fairness, much of that money flowed toward hedge-fund managers who've had a good track record over the past few years.

Growing Funds

CQS, the debt-focused hedge-fund firm started by Michael Hintze, has received a net $3 billion of new money this year, according to a person with direct knowledge of the matter. Its credit multi-strategy fund started in February 2013 has amassed $2.3 billion since then, said the person, who asked not to be identified because the information isn't public.

Its $3.2 billion CQS Directional Opportunities Feeder Fund Ltd. has returned 3 percent this year and 20 percent annualized since its 2005 inception.

Michael Rummel, a spokesman for CQS, declined to comment.

Pine River, based in Minnetonka, Minnesota, increased its assets under management to $15.6 billion as of September from $13.9 billion at the beginning of the year, according to an investor memo obtained by Bloomberg News. Pine River Master Fund has grown by about $1 billion in the period, to $4.5 billion.

The fund said in June it would close the fund to new investors. It has returned 4.1 percent in 2014 through September, compared with 9.6 percent last year.

Patrick Clifford, a spokesman for Pine River at Abernathy MacGregor Group, declined to comment.

Yields on 10-year Treasuries have dropped to 2.35 percent from 3 percent in December 2013, defying analyst predictions for the opposite to happen as the Fed ended its monthly bond-buying program.

When the market does start going the other way, debt investors are counting on this $756 billion bet to protect them.

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