BAUPOST: We’ve started buying distressed debt

The Baupost Group, the $27 billion hedge fund led by value investor Seth Klarman, has been buying distressed debt, or the bonds of companies that are in or near bankruptcy.

In an investor update, Jim Mooney, the head of the Baupost’s public investments group, said the credit market has become a “key area of focus” for the fund.

Here’s Mooney (emphasis ours):

Although the equity markets garnered most of our attention throughout the year, the credit markets have reemerged as a key area of focus. In last year’s addendum, I discussed how synchronized selling often precedes a significant decline. The October 2014 swoon to which I was referring quickly reversed and left little permanent damage. The sell-off we are experiencing today feels more ominous and has already claimed several prominent investors as victims. The fear we expressed over the last several years about the draining of liquidity from the high-yield market appears to be materializing. In conversation after conversation, dealers make it clear that they have neither the balance sheet nor the institutional mandate to absorb selling pressure. The traditional “risk” bid from Wall Street trading desks is all but gone. Further, existing holders frequently have very little appetite or, often, capacity to add to their holdings. In fact, these holders frequently are faced with their own pressure to sell into a declining market in order to satisfy redemptions. This dynamic is particularly acute in cases of ratings downgrades or deteriorating performance. Any demand for a bid on more than $1 or $2 million of bonds is likely to make the prior market price unattainable, in some cases, laughably so. The next (generally much lower) level is likely to be a bid from Baupost, or one of our competitors.

While the opportunity in credit is not yet a torrent, in the last three months, we have begun to accumulate the bonds of several companies in the energy complex as well as in other areas, including some non-energy commodities businesses. We even had a chance to play an anchor role in a refinancing transaction for an energy company after it became obvious that the deal would price more than 500 basis points wider than the underwriters had anticipated. In that case, we expect to earn a low teens return on secured paper that we believe is covered by more than two times in our downside case and even more robustly in a near-term liquidation. In the fourth quarter, we added just over 2% of partnership assets in distressed/stressed credit to the portfolio.

Baupost isn’t the only big name investor looking to put money to work in the distressed debt and energy sector. Business Insider reported last month that a number of big name investors were looking for a bottom in the oil price, and were getting ready to pile in.

In Baupost’s year-end letter dated January 20, Klarman noted that they have “ample cash reserve” and have been putting it to work lately.

Many of the hardest hit names in the equity and debt markets continue to fall. The S&P 500 Index, for example, lost a record 6% the first week in January 2016, and another 2.2% last week. The Russell 2000 Index has now plunged 23% from its peak. Consequently, our opportunity set has been expanding, and our Public Investment Group analysts in particular are as busy as they’ve been in a number of years. We’re certainly glad to have ample cash in reserve (41% of the portfolio at year-end), though we’ve been putting some of it to work recently. We feel fortunate to be in a position where we have been able to add – at increasingly steep discounts – to many of our most compelling positions.

Baupost Group has one of the best long-term investing track records around. In 2015, however, Baupost suffered its third losing year in its 33-year history.

Its public investments lost 6.7%, while its private investments gained 2.4%.

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