Here’s another from the front lines - allocators rarely scrutinize distressed debt manager performance for alpha and factors the same way they do with public equity strategies.
Among the sub-sectors of hedge fund and hybrid private equity strategies, allocators still embrace distressed debt investing.
Mangers play hand-to-hand combat in a zero sum game against other investors holding securities across the capital stack. Each often has a seat at the table and can influence outcomes. Great set-up for a skill-based strategy.
When you talk to managers, they describe an idiosyncratic process for each investment independent of market moves. That’s true at the individual security level.
In aggregate, each of these situations sums up to create a universe of opportunities with a very high correlation to the high yield index.
In every situation, owners of one part of a capital structure negotiate and receive a disproportionate amount of the assets of a company, another gets less, and together they get the total value. On average, they get an average outcome (or worse after fees).
Sound familiar? It should - it’s the same as the case for passive management of equities.
These managers are knowledgeable about the bankruptcy process, well resourced, savvy negotiators, and very good at what they do. The more sophisticated they get, the harder it is to beat each other.
Sound familiar? It should - it’s the same as the paradox of skill referenced by @mjmauboussin.
@mjmauboussin Unlike in equities, allocators rarely hold distressed debt managers accountable to exceeding the high yield index and rarely insist they pay incentive fees only of the outperformance of that benchmark.
@mjmauboussin And that’s before adjustments for sector, market cap, and style you’d expect in an assessment of an equity manager before determining if it adds value.
@mjmauboussin And yes, private equity (LBOs) is right there too. Buy a levered S&P 500, call it a Private Equity Index Fund, put it in a lockbox for 12 years, and compare that result to private equity managers. It's a tough benchmark to beat.
@mjmauboussin Distressed opportunities today are scarce, and it's a tough opportunity set as it is. Regardless, managers shouldn’t get the free hall pass that the hall monitors are issuing.
