Credit Funds

kr · Post by kr » Mon Dec 13, 2004 10:25 pm

Well, depends on what your strategy is - I don't think you've really said enough here, can't really give you a yes/no answer. For shops whose value-added is the workout process, I'd say yeah, those guys aren't financiers and hence shouldn't be long market risk - they should run an investment-banking business. For guys who are identifying strategic plays, I'd say no, there is no reason why your strategic choice should behave like an index benchmark. You are long industry positioning, and since the liquid HY stuff are mostly market leaders in their segment (at least relative to m-m), this is clearly the wrong hedge. Finally, trying to be long HY idio credit vol is not so easy but not impossible, for this you'd be doing long+short. The real difficulty is figuring the hedge ratio, for instance with m-m workouts it would not be 1:1, and because half of the equation is not observable, there is real exposure here (not to mention that the credit underlying is sufficiently volatile to be an issue all by itself). There really is a method to the market madness in the form of structure, but because that game is not played quantitatively in any serious sense, there are other risks as to what's really tradeable/convergeable.

did you have somebody specific in mind vis-a-vis this comment?

Rookie_Quant · Post by **Rookie_Quant** » Mon Dec 13, 2004 10:56 pm

a couple of people come to mind...in general, i continue to hear the pitch that the opportunities in middle market names are increasing of late, and that, either by way of a "hedge" or an additional profit center, the opportunity to be short HY names is increasing as well.

The specific group im referring to (offices in NY and Alabama, starts with an H) is doing alot of short CCC issuance, and they characterize it as a hedge and a proft center; but there longs are much more obscure names. I bring it up because they advertise this as approzimating market neutrality from a credit perspective, but to me it seems like the poster child for basis risk...

If someone believes the HY markets are rich, and has some issue-specific credit work done as opposed to just shorting an index, it seems ok, but to call it a hedge is cheating a little, right?

kr · Post by kr » Tue Dec 14, 2004 1:01 am

Well I think you are taking a pretty simple view for a complex market, neither leg is liquid enough for somebody solely on the data side to really voice an opinion on the basis risk. Specific example: if your long hits Ch. 11 and you are certain that, for industry-structural reasons, the short will purchase the long (for example, because the short can't compete against a player with significantly lower cost-of-capital after Ch. 11 debt forgiveness), then: you have a strong conditional correlation. You may think that this is an unlikely scenario, but these kinds of situations rule the middlemarket world (in large part because it is the only pricing mechanism). I would actually be more comfortable with this kind of hedge than one which has been demonstrated in a statistical sense through extensive data analysis, because there is a structural reason why it should be true in the future (whereas trades based heavily on historical statistics might actually have a bias towards trapping technically-focused traders).

Rookie_Quant · Post by **Rookie_Quant** » Tue Dec 14, 2004 4:15 pm

got it..ill shut up.

rowdyroddypiper · Post by **rowdyroddypiper** » Fri Mar 11, 2005 5:33 am

"Specific example: if your long hits Ch. 11 and you are certain that, for industry-structural reasons, the short will purchase the long.... (in large part because it is the only pricing mechanism). I would actually be more comfortable with this kind of hedge than one which has been demonstrated in a statistical sense through extensive data analysis, because there is a structural reason why it should be true in the future (whereas trades based heavily on historical statistics might actually have a bias towards trapping technically-focused traders). "

Resurecting a dead thread....walk my son..

KR the point about structural reasons for trades to happen is excellent. I am getting a bit tired of living with a bunch of atheoretical pricks.

Me: Doesn't that seem like it would make sense?

Them: Well...we're not seeing that in the historical data...

Me: You're right...if it's never happened it ain't never gonna happen...

No one seems to give a shit why something should happen, they just want to have seen it happen in the past.

I think in When Genius Failed, one of those geeks equated what they did to vacuming up nickles from all over the world based on things they see in the data. I'm getting to the point where I find myself wheelbarrowing off greenbacks because people are too focused on the data, not really thinking about strategy. Anything similar in your space?

James · Post by **James** » Thu Mar 31, 2005 11:05 am

"i think its time to short."

A friend of mine and I pitched a one-off credit fund to some seed guys in Monaco last week.

The whole strategy? Just buy protection on pretty much everything. It is a completely naked short-credit fund.

Our bet is that within a year it will either be the best performing fund in the universe, or neutral.

You guys laugh, but we are serious and we were talking to serious money guys too. And they have asked for more details.

Rookie_Quant · Post by **Rookie_Quant** » Thu Mar 31, 2005 5:21 pm

met with a short-only credit fund last month...seemed interesting (esp. since we continue to get more and more credit exposure) from a portfolio standpoint perhaps...but here is what gave me pause...

i said, what type of return to you think you could generate if something cracks...he said...about 15%. So you will be flat/down through 3 years of a cycle and then up 15% if things go your way. That annualizes at about a credit union bank account rate.

Nonius · Post by **Nonius** » Thu Apr 28, 2005 8:34 am

Really starting to see a lot of these funds.

I need to get better up to speed on synthetic tranches (plus the delta hedge) and some other sort of dubious sheah like EDS vs CDS and basis trading (on basis trading, I fully understand how an evil bank can just sit on a positive carry, but, for a HF it sounds like winging it on the basis).

jungle · Post by **jungle** » Thu Apr 28, 2005 10:16 am

[i]some other sort of dubious sheah like EDS vs CDS[/i]

i think JPM have been recommending that trade for some time in their strategy pieces. interestingly enough, analyst comp at JPM is linked to performance of trade recommendations, which strikes me as slightly unusual.

Nonius · Post by **Nonius** » Thu Apr 28, 2005 10:25 am

not surprising....Credit Funds tend to be set up by two different camps:

1. Ex JP+GS dooods.

2. a melange of a mafia spanning (BT, UBS, Merrill)....there is a connection in this trio of banks...BT guys went to UBS....hung with TJ Lim...moved to Merrill...also, there is a scary component that is UBS/Merrill related, but I won't mention names.

btw, how did Merrill structured credit derivatives fare in late 90s to early 2000s?