Credit managers scoff at great rotation bond doomsday

By Lawrence Delevingne

Mon Mar 25, 2013

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Views from Pine River, BlueMountain, Cerberus, Brevan Howard and more at the Absolute Return Symposium.



L-R: Kuhn, Smith, Stelzer, moderator Mark Johnson, Stewart, Warren (Photo: Axel Dupeux)

The great rotation to stocks that will crush bond investors is a myth, according to leading credit managers.

Top hedge fund investors largely scoffed at the thesis, which was much repeated at the Absolute Return Symposium, saying that the credit markets still had plenty to offer, including plays in mortgage backed securities, high yield and convertible bonds and options on various defaults.

"People are not selling bonds and buying equities. They are buying bonds and buying equities and selling cash, which is exactly what the Fed wants us to do," said David Warren, chief executive officer of $4.1 billion DW Investment Management and chief investment officer for the Brevan Howard Credit Catalysts Fund, which gained 15.34% in 2012 and is up 1.87% through February. "The great rotation? This is just not happening. It may happen at some point in the future, but there isn't any evidence anywhere as we start 2013."

Warren, who specializes in high yield corporate credit, said defaults will remain low and recommended such opportunities as going long the bonds of retailer J.C. Penney, mortgage insurer MGIC, bond insurer Radian Group, Texas electricity company TXU Energy and radio station company Clear Channel Communications. "There are lots and lots of credit opportunities and ways to trade that have nothing to do with getting long or short the beta of credit," Warren said.

Pine River Capital Management fixed income trading head Steve Kuhn said mortgage investors like him were unlikely this year to replicate the blowout returns of 2012 but that there was still plenty of money to be made in mortgage backed securities.

"The 1,000 basis point tightening game is over, but I don't think 6% is a horrible level," said Kuhn of residential MBS, whose $3.53 billion Pine River Fixed Income Fund rose 34.95% last year and is up 6.09% through February. "As a base source of beta it's a terrible investment, but there's a lot of work to do in security selection...there's a lot of alpha in that."

Scott Stelzer of Cerberus Capital Management emphasized the opportunity is commercial MBS. "I think the opportunities are in securities that are structurally or credit complex," said Stelzer, who likes riskier CMBS tranches in part because of the relatively inexperienced investors moving into the space. "There's certain areas where it's the deeper end of the pool, frankly, and there's a little less competition."

Stelzer, Cerberus' CMBS head is preparing to launch a dedicated CMBS fund in the second quarter. Distressed specialist Cerberus manages more than $20 billion overall, including $8.9 billion in hedge fund assets, according to the Absolute Return Billion Dollar Club.

Derek Smith of $8.9 billion BlueMountain Capital Management said unsecured credit was risky relative to other credit investments. "It's significantly rich as an asset class," he said.

Smith likes both longs and shorts because of increased dispersion within the sector but said now was also a good time to buy tail risk protection given widespread economic optimism. "This is exactly the time when you want to start buying volatility and convexity," he said.

Smith also noted long opportunities in the equity tranches of collateralized loan obligations and short opportunities in such potentially distressed industries as steel and shipping. The BlueMountain Credit Alternatives Fund gained 14.47% last year and is up 1.54% through January.

Despite the relative optimism for niche, short term credit investing, panelists urged some measure of caution. "It's not a bad environment for credit but the factor is do you have a disadvantageous move in interest rates at some point during the course of the year which could unsettle it to an extent where folks start to pile on losses on an absolute basis," said Joe Stewart, a hedge fund sales executive at UBS. "That could create some fear."

ISSN: 2151-1845 / CDC10004H