Distressed Debt Blurs Boundaries

Chidem Kurdas
Large portfolios often contain one “bucket” for hedge funds – sometimes called liquid alternatives – and another for private equity. But increasingly the line between the two is hazy, especially when it comes to distressed securities and activist investing.

While a hedge fund is supposed to allow regular redemptions – whether monthly, quarterly or annually – specialized investing in troubled or bankrupt entities requires sufficient time to resolve problems before a sale can be achieved. Hence managers do not want to agree to a periodic redemption window that could force them to sell.

Monarch Alternative Capital’s structured credit fund, to take one example, requires the clients to wait until it sells all assets and distributes the proceeds—a private equity-like illiquid arrangement. Despite this, Monarch Structured Credit is to be found in hedge fund portfolios.

Some investors do not usually invest in private equity because they want to be able to withdraw if and when they wish. But they are willing to make an exception and put up with illiquidity because they find distressed strategies attractive—-last year these were among the best performers.

Hence illiquid distressed funds end up in the same bucket as highly liquid trading funds.
The issue is the investor’s decision-making process, says an analyst. The approach used to pick funds needs to be adapted to the different levels of liquidity.

Aside from that, clients tend to accept the time frame of distressed strategies. Monarch buys troubled loans and securities from European banks. When the firm opened an office in London last year, it said that it already owned more that $1 billion of investments outside the United States (out of $5.5 billion total assets). For the success of such investing, it is no doubt essential to be able to wait for the right circumstances.

Monarch was started in 2002. Co-founder Michael Weinstock was at Lazard before that.


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