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The Best Distressed Fund You’ve Never Heard Of

One Canadian hedge fund has made big gains on distressed companies, but says it’s still too soon to go shopping for bargains in retail. REITs, however, are another story.

Canada is not exactly known for producing standout hedge funds. But one distressed hedge fund may be among the exceptions to that.

Run by a team based out of Vancouver and headed up by Hanif Mamdani, RBC Global Asset Management’s PH&N Absolute Return Fund returned 33.6 percent in 2016, a year when the average hedge fund was up 5.44 percent, according to data tracker Hedge Fund Research’s HFRI Fund Weighted Composite Index. This year the distressed opportunity fund, which manages C$1.6 billion ($1.27 billion), was up 16.9 percent through the end of June. The fund had a ten-year annualized return of 13.3 percent through June.

With returns like that, it’s worth noting what opportunities Mamdani and his team are eyeing. Mamdani says the current environment for distressed investors is not as rich as last year’s, but a handful of sectors are offering some interesting prospects.

Last year one of the most profitable places of the market for PH&N was in energy companies. The fall in oil prices had a significant impact on many energy firms, causing bonds to plummet. PH&N swooped in and bought up the debt, often working with the companies themselves to restructure their balance sheets and provide an exit for the hedge fund investor.

This year opportunities have been harder to come by. One area that is getting particularly beat up right now is retail, especially companies that either lack a significant online presence or have a larger number of outlets in shopping malls or elsewhere. A number of distressed fund managers have said they have their eyes on the sector. But, speaking in late June, Mamdani echoed their sentiments that it is still too soon for distressed investors to find opportunities there.

“That to me is a much more difficult and complicated trade,” says Mamdani of retail. “The reason the bonds are where they are is to do with structural changes to how people shop and the impact of lease obligations on the balance sheet.”

As investor sentiment toward retail has turned almost universally negative, however, it may soon be time to dive in, he says. Many businesses have a large retail footprint that they no longer need, but still have significant outstanding lease obligations.

That said, Mamdani does not think all of retail is dead. Many of these companies, he says, “can and should survive.” For clothing retailer J. Crew Group, which is struggling with a heavy debt load and a large brick-and-mortar footprint, “there will be some painful restructuring, but J. Crew 2.0 could be a very viable business.”

As for supermarkets, online retailer’s proposed acquisition of the upscale grocery chain Whole Foods has further rocked the market. After the announcement of the deal last month, Mamdani says, “equity and bonds of supermarkets on both sides of the Atlantic have just been crushed.”

Just like with apparel, the supermarket business is having to adapt to the new, more digital, world order. “There are going to be a few companies that adapt to the new paradigm,” says Mamdani. “But a lot of marginal supermarkets probably will fall by the wayside.”

One area Mamdani says is interesting: real estate investment trusts. REITs used to trade more or less as a block, he says. Now, however, “there is much more dispersion in that sector” as the actual form of the underlying real estate is starting to matter to investors.

Mamdani says that for now his best strategy is simply patience. “We spend a lot of time thinking about how to bide our time yet still make an acceptable return while we wait,” he says. “That means looking for short-term event-driven plays, or high-coupon bonds soon to be called in low credit-risk sectors.”

Before joining RBC Global Asset Management in 1998, Mamdani spent a decade in New York, where he worked on the convertible arbitrage desks at Credit Suisse and Salomon Brothers. As for being based in Canada, he says there are advantages to being far from the hedge fund and banking epicenters of New York, Connecticut, London, and even Toronto. The distance helps him and his team be more independent in their thinking, he says — as they wait for the distressed bargain basement sales to begin.

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