Chou and CDS

[jollyjumper324]

The recent drop in high yield bond prices made me cast my mind back to the mid-year 2015 Chou Funds report written on August 14th:

http://www.nytimes.com/2015/12/11/business/dealbook/high-yield-fund-blocks-investor-withdrawals.html?_r=0

http://choufunds.com/pdf/2015%20semiannual%20final.pdf

 

In it, Francis Chou opines on junk bond prices:

"Junk bonds, the biggest beneficiary of easy money, should be trading at 70, not at 100 cents on a dollar with a 5.5% coupon rate."

 

He also says that he's starting to look into buying CDS:

"We are starting to look at credit default swaps (CDS). One way of assessing investors' appetite for risk is to check the prices of credit default swaps (CDS). In a CDS, one party sells credit protection and the other party buys credit protection. Put another way, one party is selling insurance and the counterparty is buying insurance against the default of a specific third party’s debt. If the protection buyer does not own debt issued by the third party, then CDS are more appropriately viewed as an investment transaction, rather than a hedging transaction, for the protection buyer notwithstanding the insurance-like features of a CDS. In most CDS, the protection buyer makes the premium payments over the life of the CDS, frequently on a quarterly basis.

We believe that CDS are starting to sell at prices that are becoming interesting. It is not as cheap as it was in 2006-2007. We are continuing to monitor CDS prices and may potentially invest in CDS in the future. We are looking at who deals in such investments and we want to examine carefully what counterparty risk we may be exposed to. The mechanics of investing in a CDS have changed somewhat from six years ago.

To make money in a CDS, you don’t need a default of the third-party’s debt. A dislocation in the economy or deterioration in the credit profile of the issuer may cause the CDS price to rise from these low levels. The negative aspect is that, like insurance, the premium paid for the protection erodes over time and may expire worthless. There is no guarantee that the Manager will make money for the Fund on any particular CDS or correctly predict an increase of value in any particular CDS."

 

With HY prices falling and spreads blowing out I hope that Francis was able to take advantage of his convictions and make some money on some CDS'. Looking forward to reading the next letter from Chou Funds. :)

[Jurgis]

Might be getting to be good time to pick HY bonds.

[merkhet]

Might be getting to be good time to pick HY bonds.

 

Or pick up some Oaktree

[Jurgis]

Might be getting to be good time to pick HY bonds.

 

Or pick up some Oaktree

 

Maybe I'd buy distressed bond fund run by Marks, however, I'm not sure I'd buy OAK.

Asset manager is not the same as the underlying funds and IMO people make a fallacy when they buy one when they think that the other may do well.

[merkhet]

Might be getting to be good time to pick HY bonds.

 

Or pick up some Oaktree

 

Maybe I'd buy distressed bond fund run by Marks, however, I'm not sure I'd buy OAK.

Asset manager is not the same as the underlying funds and IMO people make a fallacy when they buy one when they think that the other may do well.

 

Fair point.

[Jurgis]

Perhaps we should start another topic for this, but for now here it goes.

 

I own some distressed oil bonds. I am looking for more opportunities in this space, but clearly the cheapest ones are quite risky and the better quality ones are mostly expensive. I hold some CHK, DNR, X. Looked briefly at FCX, AAUKY. Probably I should spend some time on a screener to see if something interesting pops up.

 

I'd be interested to buy a good distressed bond fund, but that's the irony: Third Avenue Focused Credit fund was supposed to be such a fund. So now the risk is that the fund you buy won't survive the "volatility" of the high yield market, even though it could have come out with good return two-three years down the road. This seems to call for a set-duration special purpose hedge-like fund - which is probably what Howard Marks will run. I doubt I can get into these and the investment sizes are probably a bit too high for me.

 

Individual distressed bonds also may have issuer recap risk. Even though the issuer might be fine to pay the interest and pay them off at par at maturity in couple of years, they can look at current distressed prices and decide opportunistically to recap them here and now without paying par.

 

Anyway, I am interested in ideas, thoughts about both bonds and HY/distressed bond funds. Either on this thread or elsewhere.

[AtlCDore]

Jurgis,

 

Have you looked at closed end funds for HY debt?  The advantage is that they don't have to sell as funds are locked up.

 

In October 2008 when the convertible bond market blew up, the closed end funds did well over the following 2 years. 

 

AtlCDore

[drzola]

Is anyone considering Convertible bond hedges these days?

 

cheer

[Jurgis]

Jurgis,

 

Have you looked at closed end funds for HY debt?  The advantage is that they don't have to sell as funds are locked up.

 

In October 2008 when the convertible bond market blew up, the closed end funds did well over the following 2 years. 

 

AtlCDore

 

Thanks. SA article for future review and thinking: http://seekingalpha.com/article/3753506-high-yield-carnage-and-closed-end-funds

Tickers for search: DHF, PHK (still trading at premium?  :o ), PHT.

 

[watsa_is_a_randian_hero]

Jurgis,

 

Have you looked at closed end funds for HY debt?  The advantage is that they don't have to sell as funds are locked up.

 

In October 2008 when the convertible bond market blew up, the closed end funds did well over the following 2 years. 

 

AtlCDore

 

 

Thanks. SA article for future review and thinking: http://seekingalpha.com/article/3753506-high-yield-carnage-and-closed-end-funds

Tickers for search: DHF, PHK (still trading at premium?  :o ), PHT.

 

 

I own NHS

[Jurgis]

Browsed through Fido's corporate bond list at least B3/B-, yield >15%. It's all the usual suspects: CHK, X, some other energy, coal, steel, mining names. Nothing very interesting. Maybe ATW - I did not realize they have levered themselves so much at the top of the cycle.