HSBC has taken the decision to seriously back a stand-alone distressed debt fund, the HSBC Distressed Opportunities Fund, to the tune of $50 million in seed capital. It is to be managed as a clone of the distressed component of the original multi-strategy fund (of which it composes 40% of gross exposure), allowing investors to take advantage of the skills of the existing management team. The move represents the largest seed money commitment HSBC has made to its alternative funds range to date, and is a major vote of confidence in the portfolio managers.
A Golden opportunity
The team is led by Kim Golden, who joined HSBC in February 2004 out of T. Rowe Price, where he was a Managing Director in its Recovery Funds division. There he worked in the distressed debt space, as well as trading a broad range of financial instruments, including bonds, bank loans, trade claims, equities, and derivatives. He has also spent timeat Chemical Bank, where his work in investment banking covered merger and acquisition advisory, structured leveraged buy-outs, and where he served as one of Chemical's principal valuation experts. It was in this guise that Golden earned his stripes in the nitty-gritty of US corporate finance, on the shop floor of one of the USA's larger investment banking houses (now part of JPMorgan), a professional background that seems so essential for the making of a good distressed debt manager.
With Golden on the distressed desk in New York is Noel Hebert, a more recent recruit, who joined the firm in December last year from hedge fund Velo Capital. Hebert seems like a sound choice to back up Golden on the fund, with a grounding as a fixed income analyst and a track record as assistant portfolio manager at Velo. There he worked on high yield, convertible and distressed investment opportunities, including cash and derivatives instruments.
Prior to entering the hedge fund arena, he earned his VP stripes at Brown Brothers Harriman, analysing credit fundamentals for companies across a broad range of industries, as well as working with client company managements and rating agencies on various credit issues. He has also worked as an analyst at Moody's in the Technology, Media, and Telecom group.
The duo is being assisted by Ricky Liu, who has moved over to the team from the Hong Kong office, where he had been working on structured derivatives products, as well as helping to serve the bank's third party hedge fund client base. A graduate recruit in 2004, he joined the bank out of the University of British Columbia's Sauder School of Business.
A broad approach
"The way we do distressed debt is to take a broad approach, including stressed, excessively leveraged, and post-bankruptcy equities," says Golden of his approach. "If you restrict yourself to bankrupt companies, for example, you end up being too constrained."
Based in New York, Golden is well-positioned to keep an eye on the core part of his portfolio, namely US distressed opportunities. He is optimistic about the market, with defaults forecast to go up substantially in 200607. "Using Moody's default rate data, we can map out the time period issuance to default in CCC-rated paper," he says. "There are already a wide variety of assets out there to buy."
This fits in well with his broad-based investing approach, although he is also seeking further afield than the US for opportunities, notably in Mexico and Europe. The multi-strategy fund's distressed portfolio already contains Mexican holdings, and Golden will be looking to replicate that in the new fund. "Distressed investing in emerging markets adds to the opportunity, particularly as countries start to integrate more closely. For example, we have invested with a Mexican company with US subsidiaries. This is not simply Mexican stand-alone risk or credit. The opportunities in emerging markets are compelling."
But emerging markets aside, Golden is under no illusions as to where his expertise lies. "The core is going to be US assets," Golden says. "Distressed debt as a strategy grew up in the US, and most dealers reside here. The bulk are in New York."
In his approach to the US market, Golden will be looking at opportunities on a sector by sector basis, and recognises that some are richer in opportunities than others. At the moment data indicate that two or three sectors will be under stress, enough to make them worthy of detailed analysis. Last year was a good year for airline paper for example: "There are some credits that we like – American Airlines debentures, Continental EETCs, the whole sector has been under stress. In 2006 we are looking at the packaging sector, the manufacturing of plastics, as a consequence of the high oil and natural gas prices. There have been, and continue to be, good opportunities in packaging."Kim Golden
As for the automotive sector, Golden recognises that it could yield opportunities for the fund, although to date he has been less enthusiastic about it when compared to airlines. "We're looking at it hard, and we have had limited exposure. It seems like an easy choice on the surface, but we've got plenty of time to watch it develop. At the moment our exposure to autos and auto parts remains small."
As with the existing single and multi-strategy offerings being sold out of HSBC Alternative Investments, Golden's fund benefits from being part of the world's largest banking empire. It has the administrative support HSBC brings to the table in terms of back office, compliance, risk monitoring, and other critical operational issues, which helps to free up the investment team.
In addition, however, Golden is able to draw on HSBC's massive global credit resources. He raves about a recent offsite for senior US and European portfolio managers the bank hosted in Paris. This gave him the opportunity to sit down and exchange ideas with other HSBC managers in the European high yield and emerging markets spaces, which he found of enormous value.
Has launching a dedicated fund brought with it additional advantages? Golden doubts it. "This is a dedicated fund, but the way we will be running it will be very similar," he says. "The two funds will look very much the same. We might have a little more flexibility withthis one, but I would prefer to make them as similar as possible."
One additional advantage, however, will be capacity. "I don't think we're size-constrained because we're so broad," he says. "We could grow this fund to a billion dollars under management without any major issues." In this respect, the fund is a big departure for HSBC:it is the first of its hedge funds to have this kind of capacity, but the backing being provided for it from in-house augurs well for yet more interest externally.
Talk about billion dollar distressed debt funds may be leaving a reader with the impression that HSBC Alternative Investments is all about building giant hedge funds, investment colossi worthy of one of the world's largest banking organisations, but this is far from the truth. While HSBC's brand, balance sheet, and experience working with both private banks and institutional clients stands its hedge funds in good stead in the marketing stakes, its CEO Bill Maldonado has never subscribed to the idea of large hedge funds.
"We're not after size for the sake of it, and while we would be happy to have a fund with the potential to grow to a billion dollars, we want to build a business that is diversified in the sources of fees," he says.
Maldonado is after a scaleable investment model. His managers are remunerated on the basis of their performance, not the management fees of their funds. His view is that fund managers should feel confident that, when the time comes to close a fund, there will be no pressure to keep it open from senior management, potentially at the cost of performance. Hence, his European Alpha Fund is in the process of soft-closing at $300 million in AUM.
Another critical plank to the development of the HSBC single manager strategy has been the fact that Peter is not being robbed to pay Paul – Maldonado recruits his managers from outside the firm, and does not loot the long only desks at HSBC Halbis Partners for new talent. Such was obviously the case with Kim Golden, who came to HSBC out of T. Rowe Price. What will be interesting is whether, as the operation grows its asset base and the number of funds and strategies on offer, junior talent can be retained in-house, providing a depth of expertise that will help to win the confidence of institutional investors going forwards. There is certainly a breed of talented hedge fund managers who prefer to continue to work within the infrastructure of a larger firm, without having the distractions of the day-to-day operational issues which are part and parcel of a boutique.
Charles Robinson, who joined the business from Goldman Sachs as its marketing director, says he was attracted by the power of the platform. "For example, the Global Technology Alpha team signed on in August 2005; 30 days later, their fund was up and running," he says. "None of the associated headaches involved with setting up a hedge fund operation have to be dealt with."
"We're seeing plenty of potential managers come our way," Maldonado adds. "I must see two a week, and we have to interview 50-100 managers to find one we want to take."
Part of the process of launching new and successful funds is responding to client demand, but Maldonado also seems to be the sort of executive who is approachable, both by external managers seeking a potential seat with Team HSBC, and also those within the firm who want to kick the tyres on some of their own investment ideas. He seems to be focused on the creation of a hedge fund business that will be able to cater to investors across a broad menu of strategies. It started small, and has had its ups and downs (e.g. its ill-fated initial foray into UK market neutral), but it is continuing to accrue assets and managers in a satisfying way. By launching a distressed fund off the back of an established track record within a multi-strategy fund, Maldonado is demonstrating his ability to incubate successful strategies in-house. Oncethe numbers are there, he and Robinson can go to the market with something substantial to show to investors.