Alternative Perspectives: COVID-19 Expands Opportunity Set in Credit

Preview

There is a rush of new distressed funds coming to market. COVID-19 gave rise to broad-based and somewhat indiscriminate selling across asset classes and sectors. And while there has been meaningful recovery in some asset classes since the lows of March, volatility and uncertainty may persist, leading to increased dispersion and inefficiencies across markets. In other words, we may not be out of the woods just yet, and particularly so as it relates to the credit markets. Consequently, we believe a highly flexible hedged investment approach might be helpful.

At the depths of the selloff in March, leveraged loans traded down 20%, and high yield (HY) traded down over 22%. Even sectors less impacted by COVID-19, such as cable, utilities and technology, all traded off meaningfully. Meanwhile, there was a rush to perceived safe-haven assets such as US Treasuries and the dollar.

As jobless claims have hit all-time highs and helped to create a massive revenue shock for companies, many are vulnerable as nearly 15% of HY issuers lack the liquidity to meet half of their debt service payments over the next 12 months.

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Contributors

  • Managing Director Head of Credit, Event, Relative Value Franklin K2 Advisors
  • Senior Managing Director Co-Head of Investment Research & Management Franklin K2 Advisors
  • Senior Managing Director Co-Head of Investment Research & Management Franklin K2 Advisors


WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Investments in alternative investment strategies and hedge funds (collectively, “Alternative Investments”) are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Financial Derivative instruments are often used in alternative investment strategies and involve costs and can create economic leverage in the fund's portfolio which may result in significant volatility and cause the fund to participate in losses (as well as gains) in an amount that significantly exceeds the fund's initial investment. Depending on the product invested in, an investment in Alternative Investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. There can be no assurance that the investment strategies employed by K2 or the managers of the investment entities selected by K2 will be successful.

The identification of attractive investment opportunities is difficult and involves a significant degree of uncertainty. Returns generated from Alternative Investments may not adequately compensate investors for the business and financial risks assumed. An investment in Alternative Investments is subject to those market risks common to entities investing in all types of securities, including market volatility. Also, certain trading techniques employed by Alternative Investments, such as leverage and hedging, may increase the adverse impact to which an investment portfolio may be subject.

Depending on the structure of the product invested, Alternative Investments may not be required to provide investors with periodic pricing or valuation and there may be a lack of transparency as to the underlying assets. Investing in Alternative Investments may also involve tax consequences and a prospective investor should consult with a tax advisor before investing. In addition to direct as set based fees and expenses, certain Alternative Investments such as funds of hedge funds incur additional indirect fees, expenses and asset based compensation of investment funds in which these Alternative Investments invest.