Theta Capital Management launches distressed credit multi-manager vehicle

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Mark de Kloe, Theta Capital Management

Hedge fund specialist Theta Capital Management has launched a new multi-manager fund vehicle for investors to access distressed credit market opportunities. Theta Capital has been waiting for the right time to capitalise on distressed markets and with Covid-19 causing such dislocation in the global economy, the firm feels now is the right time to invest with a select number of distressed managers.  

The new vehicle, Theta Distressed Credit Opportunities Pool (TDCOP), aims to generate a 12 per cent annualised return over five years and will invest in four to eight managers at any given time. 

“Last year, we looked at the markets and what appealed was the consumer credit space, in particular US home mortgages, which appeared fairly well insulated. At the same time, we were very wary of US corporate credit, particular BBB-rated paper. We thought there was some overhang there and things were fairly stretched; we didn’t know when that might snap but we wanted to position ourselves accordingly,” explains Marc de Kloe (pictured), Partner – Strategy, Investments & Operations at Theta Capital.   

Theta Capital is best known for its Legends Fund, which invests in some of the industry’s leading hedge funds including Boaz Weinstein’s Saba Capital and Izzy Englander’s Millennium Management. 

With its extensive network of manager relationships, Theta Capital is now oiling its investment gears to back some of the best distressed credit managers in anticipation of a new distressed cycle.

“We’ve been preparing ourselves for a distressed cycle as a preferred strategy but the problem is, there hasn’t been a proper distressed cycle since the GFC,” observes de Kloe. “Some large managers are fundraising for distressed funds and the types of managers we like are more mid-sized with typically USD2 to USD4billion in AUM and have a large chunk of their own money invested. But many have been returning capital the last few years and they’ve not opened up to new allocations, even after the dislocations we saw in March.  

“We think at the moment the big opportunities are in the consumer credit space, such as RMBS, partly because you had a lot of liquid ETFs and REITs in the US who became forced sellers earlier this year as they faced liquidity pressures in response to rising redemptions. All of a sudden, the price of RMBS asset went from USD100 one week to USD40 the next week.”

Structured credit is the first leg of a wider investment mandate as TDCOP seeks out trading opportunities in US corporate credit, both long and short, and distressed credit opportunities (including Emerging Markets) over the next five years. 

The house view at Theta Capital is that the Covid-driven global economic shutdown “has ignited a multi-year, multi-faceted, distressed credit cycle”.

“The start of any distressed cycle starts with a liquidity squeeze where you have forced sellers, even though the underlying assets are good; as is the case with RMBS. You can get in today at relatively attractive prices, buying from distressed or forced sellers,” says de Kloe. 

“In the CMBS space, some places like US shopping malls have become ghost towns. They might survive but even so they will likely need to restructure their finances so we see opportunities there, too – both on the structured credit and distressed credit side.” 

TDCOP will initially invest in five managers and will adjust the portfolio with two or three additional managers the further the distressed cycle develops and the opportunity set shifts. 

“Right now the opportunity is in US structured credit,” says de Kloe, “which we think will last for the next couple of years. And then we will look to shift into the corporate restructuring and distressed space.” 

There will be no more than eight managers in the portfolio to give Theta Capital’s clients (which include wealth managers and private banks as well as family offices and endowments) sufficient diversification across different strategies. “That way, we can give them the building block for a distressed portfolio, alongside long equities, long bonds etc,” says de Kloe. “Three of the five managers are running strategies in the US consumer credit space. One is a distressed manager focusing on shorting opportunities in US and Europe corporate credit, and one is investing in emerging market distressed opportunities with a heavy focus on Argentina.”   

It is hard to know the true extent to which the pandemic will impact the global economy over the next few years, with some market sectors like tourism (think airline companies) having seen their operating revenues ravaged since February; Virgin Atlantic, for example, has just had to enter into a GBP1.2 billion rescue plan to keep it buoyant for another 18 months.

What is fair to say is that a distressed credit cycle is likely to put the brakes on a 10-year equities bull run; it just remains to be seen how hard those brakes are applied.

“Between March and May we probably spoke to 60 managers and from there we built the portfolio. In the near-term, we see more opportunity in the structured consumer credit space and going short US corporate credit. We expect to see more distressed corporate credit opportunities evolve over time,” concludes de Kloe.    

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