Few hedge funds in the world have the reputation of Brevan Howard, the leading global macro strategy operator. It is therefore noteworthy when a team from that firm emerges to go independent and offers investors a new strategy, particularly when the fund is up +14.9% in 2012 to end-April.

This is what Mikhael M. H. Botbol has done with MB Asset Management and the August 2011 launch of the MB Master Fund, which invests mainly in Europe in high yield and distressed debt. Joining Botbol from Brevan Howard is Eve Kopf, who is head of research, and Simon Bohbot, who is chief operating officer.

MB’s assets under management are less than $50 million, but the firm has no plans to dilute the partners’ equity by aligning with a seeder. Instead, it is offering reduced fees to multi-million dollar investors. The aim is to increase assets with these and some smaller investors before approaching institutional investors when assets hit $100 million.

Using liquidity
“What is important in my view is that our trading strategy focuses on liquidity,” says Botbol. “There are two kinds of distressed approaches: big guys doing buy and hold, and my approach which is trading in and out of positions from the long or short side. That helps me to be more liquid. Investors can redeem their money every quarter. It makes us very different from other high yield and distressed funds.”

The focus on liquidity, of course, shows that a key page has been taken from the Brevan Howard playbook. For several years, Botbol observed the trading maestro Alan Howard at close quarters, running a few hundred million dollars in high yield and distressed strategies in the now $25 billion Brevan Howard Master Fund.

Botbol’s investment decision making uses an in-house model (with Monte Carlo analysis) that is driven by fundamental data from companies, including balance sheet information and income statements. In addition to quantitative research, MB meets company executives and interviews other players in industries where it is looking to invest.

The portfolio’s high yield positions are subject to active trading with long and short positions changing as the market moves. The distressed side is primarily event driven. Leverage is limited as shown by the end-April book being 5% cash, 95% long and 36% short.

Macro view hedged
Macro analysis determines whether the Fund should be long or short. When Botbol can’t find an appropriate single name short, he will put a hedge on indices, normally using equity index futures.

High yield and distressed now operate in a much less efficient market than before the credit crunch. Proprietary trading desks at the leading investment banks, which had been the biggest players in the market, have largely dropped out. That means corporate bonds now will fall further when a company announces bad news as proprietary trading desks have been historically the first buyer of distressed bonds.

Conversely, this has occurred at a time when there are a growing number of companies in financial difficulties.

On Europe, Botbol expects the Eurozone problem to be solved, but believes it may take more than a year for it to happen. The trading strategy is avoiding macro risk right now.

“Europe is in trouble,” says Botbol. “Governments are cutting spending and companies are suffering from this. There are also cuts in retail spending. That creates a lot less consumer demand and it puts pressure on companies in Europe. With so many companies having difficulties it opens up opportunities for this strategy.”

Thomas Cook
One recent play is Thomas Cook, the package holiday operator. Bad news near the end of 2011 saw the share price fall around 70% in one day, while at the same time the bond price dropped from 85 to 30. MB’s work on the trade involved calling 30 retail outlets as well as competitors and insurers to assess the state of the business. The information derived from that and from analysing Thomas Cook’s numbers led Botbol to open a long position in the bonds, believing that the firm would be able to solve its problems. When that happened, the bonds jumped by 90%, leaving MB with a great return.

“The unique thing I bring to high yield and distressed market is a focus on liquidity,” says Botbol. “At Brevan Howard it is central to the trading perspective and we had to focus on liquidity and cut losses when required. Typically high yield and distressed investing are more long-oriented and use averaging down when a price drops. What I’m doing now is using more of the trading strategies learned at Brevan Howard to trade my book.”

Owing to concerns about liquidity, MB isn’t trading bank loans. Instead, the focus is all on bonds. Positions are kept liquid and in appropriate sizes so they can be quickly cut if needed at any given time.
MB is doing research in London with operations and trading currently being done in Tel Aviv. The fund uses a master-feeder structure based in Cayman with a feeder in Delaware for onshore US investors.
The firm is currently going through the registration process with the UK authorities. The prime broker is Bank of America Merrill Lynch.