Evening Brief – 07.28.23
Long/short credit hedge funds can profit from impending market dislocations, as opportunities in high-yield and distressed debt increase amid rising loan and bond default rates, according to UBS market commentary.
Credit markets are getting increasingly complex and difficult for traditional investors as lending criteria in developed nations tighten, according to UBS.
Analysts cited increased default rates, which surpassed $7.2 billion in bonds and $6 billion in loans in May, as well as a doubling of US business bankruptcies to 236 during the first quarter compared to the same time in 2022.
With the economy becoming increasingly unpredictable, attractive possibilities throughout the credit hedge fund spectrum are anticipated to emerge in the second half of the year.
“We see growing opportunities for credit hedge funds to provide investors that can bear their risks with attractive carry, lower sensitivity to interest rate and credit risk, and potential for greater gains than losses thanks to ‘convexity’,” analysts wrote.
Managers have already generated 2.8% in the first half of 2023 in fundamental credit long/short, with less than half the volatility of traditional credit assets. UBS expects more improvements in the second half, with managers trading between issuers and hedging to limit exposure to broader credit market swings.
UBS stated that spread dispersion amongst high-yield issuers is at a year-to-date high, implying that long/short credit hedge funds have a higher return potential.
“In today’s uncertain economic environment, we see most merit in seeking exposure to managers with low net exposure and with the ability to go net-short in credit markets should economic worries prove worse than expected,” UBS noted in the commentary.
Meanwhile, hedge funds trading distressed corporate debt can take advantage of mid-single digit default rates in high-yield and loans over the next 12 to 18 months.
“The growth in size for lower rated credit markets over recent years may provide additional opportunities for distressed managers to generate returns,” UBS added.