Hedge Funds Looking At Distressed Debt

As reported at Reuters, hedge funds have been raising capital and are looking for ways to deploy it in the current market. Possible outlets include distressed debt and higher quality mortgage debt. Funds also hope to take advantage of lower stock prices as forced selling of equities is expected to intensify as the summer progresses. Famed hedge fund manager John Paulson, who made a correct (and profitable) bet on sub-prime last year, predicts more gains from distressed debt as he expects to see an additional $10 trillion opportunity develop over the next 6-24 months.

Changes in focus are already showing benefits. The Credit Suisse / Tremont index rose 2% in May, as long/short equity, event-driven, and emerging market funds outperformed. High volatility and widening credit spreads are also creating opportunities for convertible arbitrage funds. Of interest is that quants funds are also optimistic, with the optimism not necessarily due to the current market opportunities, but due more to less competition from other quant funds. Last year forced credit selling created unpredictable moves (both directional and magnitude) that ended up shaking out a number of less-capitalized funds that were unable to adapt quickly enough to changing market conditions. Whether the rest of 2008 is any more predictable is yet to be seen.