Saba Capital, the New York-based hedge fund founded by Boaz Weinstein, has made big gains after its bets against junk-rated corporate credit came good in the sell-off triggered by the coronavirus outbreak.
The pandemic has shut down swaths of industry in Asia, Europe and the US, raising the prospect of a wave of corporate defaults, and pushing down the price of lower-rated corporate bonds. That has meant strong returns for hedge funds that hold bearish positions on the debt.
Three funds managed by Saba — which manages more than $2bn — have experienced year-to-date returns of between 54 per cent and 175 per cent, according to a letter sent to investors on March 16 and seen by the Financial Times. Wall Street’s S&P 500 is down 16 per cent so far this year.
“I have had the conviction . . . for a long time that investors needed to be ready for an extreme market decline,” Mr Weinstein wrote in the letter. “We believe a recession will produce a significant default rate, affecting the high-yield companies we are short far more than the investment grade companies we are long.”
Over the past 18 months, the additional yield offered by high-yield bonds over Treasuries — viewed by investors as a safe bet — has fallen, reflecting rising prices in the face of low interest rates and big liquidity injections by central banks.
But that trade has unwound in spectacular fashion over the past month as investor concerns have mounted over coronavirus. Last week, junk bold yields hit their highest level in four years as prices plummeted.
Mr Weinstein said his fund’s strategy had been to take advantage of a lack of differentiation between the cost of protection for junk bonds, whose issuers tend to be more highly leveraged, and investment-grade credit.
Last week, an index of credit-default swaps on investment-grade companies hit 140 basis points, its highest since 2011, while an equivalent index for junk-rated companies hit 688 basis points, according to data from IHS Markit.
Mr Weinstein, a former Deutsche Bank credit trader, founded Saba 11 years ago.
In the letter, Mr Weinstein said that commercial banks had been reluctant to act as market makers as the coronavirus crisis deepened, causing liquidity issues. Other big investment firms also told the FT that the high-yield market had effectively frozen.
The rapid sell-off, which has caused many of the world’s largest stock benchmarks to plunge into bear markets, has wrongfooted others. Over the weekend billionaire investor Ray Dalio, founder of Bridgewater Associates, said the world’s biggest hedge fund had suffered losses due to the sharp falls in equities, bonds, commodities and credit. Others hit by the market meltdown include the AQR Risk Parity II HV fund, which dropped 12.7 per cent last week.