Pre- and post-crisis credit hedge fund returns diverge

Credit hedge funds performed well above expectations last year, with returns from one portfolio monitored by Schwartzkopff Partners almost doubling the returns of the Dow Jones Credit Suisse HF Index. However, a stark difference in performance between pre- and post-crisis launches is also apparent.

Schwartzkopff's portfolio of 12 credit hedge funds generated a net return of 19.73% for 2010, with positive returns every month, against a 10.95% return for the Dow Jones funds, which had three negative months. "Last year in May, when things turned sour in many markets, I thought it would be a good idea to look at investable funds in the universe of credit funds we are aware of to see how they were performing. Credit funds had performed very well before that, but we wanted to see how they had performed in the first really negative month since 2008," says George Tintor, Schwartzkopff md.

He continues: "May 2010 was the first real test for credit funds, so we looked at the portfolio, added them all up and found they had managed a positive return. These guys held their own when the stormy weather came, so we continued to track them."

Tintor explains that the selection process for the 12 funds the firm follows was fairly simple, with the key criteria being that they must be investable. Six of the funds existed before 2007 and so are labelled as 'pre-crisis' funds, while the other six are defined as 'post-crisis' funds.

"Clearly the pre-crisis funds have proven risk management systems because they managed to survive in 2007 and 2008. They returned something like 15% last year, while the post-crisis group returned around 26%," says Tintor.

From his analysis of the funds, Tintor has found that the pre-crisis funds are far more diversified, taking in not only ABS but CDS as well. Even those funds that are purely ABS tend to invest across the ABS spectrum, taking in both major sectors and smaller niches where they see opportunities, from RMBS to aircraft lease ABS.

In stark contrast, the post-crisis funds are very concentrated. Some invest almost exclusively in US RMBS and within that one is exposed exclusively to subprime. Another of the post-crisis funds invests purely in Trups CDOs. For all their concentration, Tintor reiterates that the post-crisis funds have achieved higher returns than those set up before 2007.

He says: "The disparity in returns can be attributed to the fact that the pre-crisis funds are more diversified across sectors and strategies, as opposed to the post-crisis funds, which tend to have more concentrated portfolios. Also, the pre-crisis funds tend to focus more on portfolio hedging than the post-crisis funds."

Some new credit hedge funds have managed to launch recently. Tintor cites as an example Boaz Weinstein, formerly of Deutsche Bank, who has set up Saba Capital Management. Other planned credit hedge fund launches are rumoured to include new offerings from Highbridge Capital and TPG Credit Management.

Tintor believes the strong performance of credit hedge funds from last year will continue this year too, although whether returns will remain quite so high remains to be seen. He says: "I do not know if it will be as high as 19.73%, as in 2010, but then again I would never have predicted that kind of return a year ago either. Returns of around 12%-15% seemed more realistic then and again I would say that is realistic for this year. Clearly strong performance can continue."

He concludes: "There is a lot of opportunity out there in a large and inefficient market that does not have many players. There are fewer bank proprietary trading desks and definitely fewer hedge funds in the space. The wheat has really been separated from the chaff and the guys who survived the 2007/2008 market stress have been able to take advantage of tremendous opportunities."

JL