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Old world value

Marc Lasry and his sister Sonia Gardner founded Avenue Capital to invest in good companies with bad balance sheets. A decade and $12 billion later, the firm is one of the world's most global distressed investors.

  • By Stephen Taub

MARC LASRY HAS A GIFT FOR RAISING money. The co-founder and managing partner of New York­based investment firm Avenue Capital Group and his wife, Cathy, frequently host fundraisers for the Democratic National Committee in their tony, 12,000-square-foot town house on the Upper East Side of Manhattan. As many as 150 people have crowded inside to cozy up to the likes of U.S. presidential candidates Al Gore and John Kerry, not to mention former president Bill Clinton, a pal of Lasry's and an invaluable drawing card.

Most guests write checks for $500 to $1,000. The Lasrys themselves donate $25,000 annually to the DNC, the maximum allowed by law.

"If you believe in something, you should be willing to put money behind it," says Lasry, who also contributes smaller sums to individual Democrats, including recently elected New York State Attorney General Andrew Cuomo, Senator Hillary Rodham Clinton and several candidates for the U.S. Senate and House of Representatives from Ohio, Minnesota and Pennsylvania. As Hillary runs for president, Lasry and his wife will be prominent supporters.

These days the 47-year-old Lasry is passionately raising money for another cause dear to his heart -- growing his business. In the past two years, he has added nearly $5 billion to Avenue's war chest, mostly from institutional investors, bringing his firm's total hedge fund and other partnership assets to $10.4 billion (the firm manages an additional $2 billion in less risky collateralized loan obligations). In October, Lasry struck a deal to sell nearly 20 percent of Avenue to investment banking giant Morgan Stanley for almost $300 million, which will enable him to raise even more from institutions that want Avenue to put up a small percentage of its own money alongside theirs when starting a new fund (see box).

One of the world's biggest investors in distressed securities, Avenue is now positioned exactly where Lasry wants it for what he expects to be a major rise in default rates and bankruptcies for companies in the U.S., Europe and parts of Asia.

"Over the next few years, there will be a massive amount of opportunities," says Lasry, sitting in his midtown Manhattan office and wearing one of his trademark sweaters -- this day, a gray cotton pullover. The office is decorated with family pictures, an antique chess set and a photo of Lasry with Bill Clinton and Nobel Peace Prize winner Nelson Mandela.

Since Lasry and his sister Sonia Gardner -- both lawyers -- launched Avenue in 1995 with less than $10 million, the firm has profited by buying deeply discounted bonds, trade claims, bank debt and other securities of what he calls "good companies with bad balance sheets" and then watching the value of those investments increase as the companies work through their troubles, often in bankruptcy court.

Lasry prides himself on being a traditional distressed-securities investor. He has kept a single-minded focus on trying to generate equitylike returns by buying senior debt instruments at a significant discount to asset value. He does not employ leverage and rarely uses derivatives. He is also not afraid to stash as much as half of his assets in cash when bond default rates are low, as he did in 2004 and 2005.

"We're very conservative," says Lasry. "Most people don't like to lose money."

For a conservative investor, Lasry has done quite well, thanks to the 2 percent management fee and 20 percent incentive fee that Avenue charges for most of its funds. In two of the past three years, Lasry has been on the ranking of the 25 highest-paid hedge fund managers in Institutional Investor's sister publication, Alpha. The $130 million he made during 2005 earned him a tie for No. 25. Unlike many managers, Lasry is refreshingly candid when he talks about the motivation that money plays in the hedge fund game.

"If you love investing, then running a fund is a great business," he says. "If you're right, you make a huge amount of money. If you're wrong, people will say, 'He used to be very good.'"

Lasry doesn't spend a lot of time ruminating about what others might think. In October he hired Chelsea Clinton, the daughter of Bill and Hillary, as an analyst for his U.S. special situations fund, working out of Avenue's New York office. "She's an extremely talented and bright individual," Lasry says of the 26-year-old, who had worked as a consultant at McKinsey & Co. since 2003 and has a master's degree in international relations from University College at the University of Oxford.

Lasry's ambitions are global. In 2004 he exported Avenue's strategy to Europe, where in addition to buying distressed securities, the firm writes loans for small companies that couldn't otherwise get financing, because that region's high-yield bond markets are less developed than those in the U.S. Avenue has almost half of its assets in its U.S. and European strategies. Most of the rest is invested in Asia, where the firm is planning to open its ninth office -- this one in Vietnam -- and has been operating since 1999. Avenue is one of the biggest Western investors in China, where new bankruptcy laws will go into effect in June, bringing the country in line with international rules for debt payments to secured creditors.

Lasry's international focus, especially in Asia, was an important reason behind Morgan Stanley's decision to buy a minority stake in Avenue last fall. "We are impressed with the number of people they have on the ground in Asia," says Yie-Hsin Hung, head of strategic acquisitions and alliances at Morgan Stanley Investment Management, the investment banking giant's money management arm.

Avenue investors agree with Morgan Stanley's thinking. "Marc's biggest differentiation is the global nature of his firm," says Marc Gamsin, president of Los Angeles­based AIG SunAmerica Alternative Investments, which is part of the retirement savings arm of insurance giant American International Group and has more than $8 billion spread across a variety of alternatives, including several Avenue funds. "He is a leader in offering international distressed funds. A lot of managers have spoken about going global, but not many have done it to the extent Marc has."

"Marc does an excellent job," notes David Bonderman, founding partner of Texas Pacific Group, a $31 billion investment firm with offices in Fort Worth, San Francisco and London that owns a small, undisclosed stake in Avenue. Bonderman gave Lasry and Gardner their start in 1989 when he hired them to manage capital for a partnership affiliated with the Robert M. Bass Group, where Bonderman was then chief operating officer.

Like a growing number of hedge fund firms today, Avenue offers products that resemble private equity funds. Lasry calls them institutional funds -- portfolios that invest parallel to Avenue's hedge funds but have seven-year lockups and are marketed exclusively to pension funds and other institutions. Avenue typically spends the first three or four years investing the money and the subsequent few years unwinding the investments. Performance is not fully calculated until a fund unwinds completely.

The private-equity-like structure is appealing to institutions because they don't need to hand over any cash until Avenue is ready to make an investment. What's more, when Lasry raised money for his most recent U.S. institutional fund, he agreed to not start charging management fees until the capital was drawn down because he didn't know when the distressed-investing cycle would improve. (Performance fees aren't charged until the fund is unwound.) This is partly why Avenue has been able to build a war chest at the nadir of the credit cycle, despite the fact that there have been few good investment opportunities. Today, Avenue has about $6.5 billion in four institutional funds, including $1.7 billion in its new, U.S.-focused Avenue Special Situations Fund IV and $3 billion in Avenue Asia Special Situations Fund IV. About 80 percent of the U.S. fund is invested.

"This is a very ethical way of doing business," says Bruce Feldman, director of alternative investments for the $29.8 billion Pennsylvania State Employees' Retirement System, which has invested money in Avenue institutional funds for four years. "For me, this is a telling illustration of Avenue's alignment of interests with the limited partners."

The loyalty of Lasry's limited partners is also telling. Sophisticated investors like PennSERS and AIG SunAmerica have stuck by Avenue despite the seemingly mediocre performance of its U.S. and European strategies. Lasry's flagship fund, Avenue Investments, which has been investing in U.S. distressed securities since October 1995, has an average annual return of 11.54 percent over its lifetime, versus the 12.51 percent return for the HFRI distressed securities index. Avenue Europe Investments has compounded at a 12.17 percent annual clip since it was started in July 2004, compared with a 13.45 percent return for the HFRI index. Only Avenue Asia Investments has managed to beat the benchmark, climbing, on average, by an annualized 14.38 percent since 1999, versus 12.89 percent for the index.

Avenue investors, however, say the numbers are misleading. They argue that most hedge fund indexes are flawed and that the returns are inflated because funds not doing well eventually go out of business or stop reporting. But even if the returns reflect reality, they say it's unfair to compare Lasry to the index, because his style of investing is less risky and less volatile than that practiced by most of today's distressed-debt investors.

Lasry concedes that Avenue's funds will likely trail the index during good years but argues that they should do better when there are fewer opportunities for investors. In 2002, for example, when global equity markets were down double digits and the distressed index was up just 5 percent, Avenue's flagship fund returned 12 percent.

"Avenue is one of the premier distressed firms in the world," says Joncarlo Mark, senior portfolio manager for the alternative-investment management program at the California Public Employees' Retirement System in Sacramento. "We like the attractive risk-adjusted returns that Marc can generate for us. Even though he is buying distressed debt, he finds opportunities at levels with limited downside."

In a typical deal Lasry might buy bank debt in a troubled company for 60 cents on the dollar and receive par in an eventual workout three years later. It's a relatively stable strategy that many longtime rivals, such as Stephen Feinberg of Cerberus Capital Management in New York, have moved away from in recent years. These days, investors like Feinberg are more interested in buying up subordinated debt and deep-discount bonds in a bid to gain control of companies in an eventual reorganization.

"I've never seen Marc involved in trying to take control of a company," says Bruce Karsh, president of investment firm Oaktree Capital Management in Los Angeles and a close friend of Lasry's. Oaktree manages $32 billion, including nearly $10 billion in distressed securities, and, unlike Avenue, offers funds that seek control of companies.

The brother-sister act at Avenue Capital is itself a rarity on Wall Street. Gardner, a partner and co-founder, is general counsel and runs the firm's 240-person business operation, which includes 115 investment professionals in 11 offices worldwide. As managing partner, Lasry oversees the firm's investments, meets with clients and raises money. Like many founders of multibillion-dollar hedge funds, he has delegated responsibility for some of the day-to-day running of his funds to a trusted senior management team.

Bruce Grossman, who was global head of the high-yield and distressed-securities research groups at UBS Securities before joining Avenue in 1998, runs the firm's U.S. strategy. Richard Furst, who was a portfolio manager at Louis Bacon's Moore Capital Group before signing on with Avenue in 2004, oversees European investments. Malcolm Robinson heads Avenue's Asia strategy from the firm's Beijing office. He joined in 1999 from Richmond Parly Investment Co., a Hong Kong­based firm that invests in private and public equity and the distressed-debt obligations of Asian companies.

"Marc has built a great firm in a very thoughtful way," says AIG SunAmerica's Gamsin. "He is good at building teams and attracting management, which has enabled him to move through the investment cycle and allocate capital."

Lasry and Gardner complement one another. Lasry is the gregarious, more optimistic big-picture guy with loads of energy who loves schmoozing. "His appetite for being with people is insatiable," says the reserved and detail-oriented Gardner, 44, who is very comfortable letting her older brother play the more public role at Avenue. "I have no interest in being in the limelight," she says, stressing that this is the first time she has agreed to sit down to a lengthy interview. "I'm much happier managing the firm."

Lasry has an eclectic mix of interests, ranging from basketball to chess to perhaps his prize possession -- a collection of more than 2,000 comic books, including the first issues of Superman and Batman. Like most successful hedge fund managers, Lasry has his share of toys, including a black Ferrari he plans to garage at the 17-room house in Westport, Connecticut, that he bought in 2005 for $14.7 million and that he is having renovated. But investors say Lasry is remarkably down-to-earth. His natural friendliness and calm way of speaking further boost his credibility.

"His soothing style fits well with making institutional investors comfortable," says James Berens, managing director of Irvine, California­based Pacific Alternative Asset Management Co., which manages $7 billion in funds of hedge funds and is currently invested in Avenue's European strategy.

Nonetheless, Lasry is fiercely competitive, whether playing cards, basketball or tennis. He likes to win and delights in setting up tournaments to declare a champion, even betting on an otherwise friendly Ping-Pong game. "If he beat me for 100 bucks, he would be thrilled," Oaktree's Karsh jokes. "He'll keep me up until 2:00 in the morning playing gin. He loves to compete." Lasry likes to host winner-take-all card games in his town house, where the stakes can get as high as $20,000. He's especially good at poker and gin. "I have a rule," says Texas Pacific's Bonderman. "Never play cards with Marc for money."

WHEN MARC LASRY JOINED COWEN & CO. IN 1987 as co-director of the Wall Street firm's bankruptcy and corporate reorganization department, the business plan called for him to hire a lawyer. At the time, investing in distressed securities was a relatively arcane strategy practiced by few, who kept their contacts close to the vest. Lasry wanted someone he could trust to help run the trade claims department but who would not subsequently leave with Cowen's secrets. His solution: to hire his sister, who had just graduated from the Benjamin N. Cardozo School of Law at Yeshiva University in New York.

"Back then people thought this was a very proprietary type of business," explains Gardner. "I figured I would try it and see if I liked it. The timing was perfect." She enjoyed the work, and the siblings have remained a team.

Lasry and Gardner were born in Marrakech, Morocco, where their family had lived for several generations. They moved with their parents to a two-bedroom apartment in downtown Hartford, Connecticut, when he was seven and she was four, sharing a bedroom with their younger sister, Ruth. (Ruth, now 42 and also a lawyer, works as a bank debt trader at Avenue.) Their father, Moise Lasry, was a computer programmer for the state of Connecticut; their mother, Elise, taught French at Renbrook School, a private day school in West Hartford, which the Lasry children attended through ninth grade.

"We were always close as a family," Lasry recalls. "When you grow up sharing a room, you are either close or hate each other."

All three Lasry children attended Clark University in Worcester, Massachusetts, on scholarships. Lasry was a junior when he met his future wife, Cathy Cohen, then a freshman and a friend of Gardner's. Lasry and Cohen dated, broke up and later reconciled with the help of Gardner. She would tip off Lasry about her friend's whereabouts, enabling him to bump into Cohen and her new boyfriend, who eventually gave up. Cohen went crying to Gardner, who told her brother to come over quickly. Marc and Cathy Lasry have been married for 23 years.

Lasry graduated from Clark in 1981 with a BA in history; three years later he received a JD from New York Law School. His corporate law professor recommended him to clerk for Edward Ryan, then chief bankruptcy judge for the Southern District of New York. After his clerkship Lasry practiced for a year at New York­based Angel & Frankel, which specializes in bankruptcies. He soon realized he was more interested in business than in law.

In 1986 he got a job at R.D. Smith (now Smith Vasilou Management), a small New York brokerage, serving as director of the private debt department, buying trade claims from creditors. The year at R.D. Smith jump-started Lasry's Wall Street career, enabling his move to Cowen, where he eventually managed $50 million in partners' capital, investing in distressed securities.

In 1989, Lasry and Gardner left Cowen to launch Amroc Investments, which was affiliated with Acadia Partners, an investment partnership that included the Robert M. Bass Group (now known as Keystone). Lasry and another partner, Phillip Schaefer, were given $75 million to invest in trade claims, bank debt and senior bonds, while Gardner managed the firm, serving as senior managing director and general counsel. They all reported to Bonderman, then chief operating officer for the Basses.

This was around the time that junk bond pioneer Michael Milken resigned from Drexel Burnham Lambert after being indicted by a federal grand jury for securities fraud. One of Milken's legacies is that he enabled scores of companies that had been shut out of the capital markets because they didn't have investment-grade credit ratings to raise money in the public bond markets. Milken's fall and a crackdown by banking regulators on highly leveraged transactions caused many shaky companies with low junk bond credit ratings to plunge into deep financial trouble, resulting in their bonds' dropping into distressed territory (commonly defined as trading at yields of 1,000 basis points or more above the yield on Treasury securities).

The burgeoning supply of distressed and bankrupt securities created a big opportunity for investors like Lasry. In 1990 he and Gardner took the Amroc name and set up their own firm, also called Amroc Investments, managing about $5 million of their own money.

Once a company filed for bankruptcy, Lasry would get a list of the creditors and painstakingly contact each one directly. He would buy either the bank debt or trade claims and then quickly sell most of them to other investors, making the spread between what he paid for the securities and what he received when he sold them. He was good at it, compounding returns in excess of 50 percent annually for the first six years, albeit on a small capital base, according to people familiar with the operation.

"A lot of it was being in the right place at the right time," Lasry acknowledges. "We were buying debt of troubled companies at huge discounts. Not many people understood this at the time, and not many were doing it."

In 1995, Lasry and Gardner decided to get into the hedge fund business, creating Avenue Capital Group and launching Avenue Investments, a domestic partnership set up initially to manage the firm's own capital as well as money from family and friends. In 1997, Lasry added an offshore version of the fund, Avenue International, and in 1998 he created Avenue Special Situations, a limited partnership that heralded his new strategy of offering institutional funds.

Some of the biggest investors in that new fund were the principals of Texas Pacific Group -- Bonderman, James Coulter and William Price. "Marc's relationship with Texas Pacific Group was a strong endorsement," says CalPERS's Mark, who has invested in five Avenue funds, including a recent commitment of $400 million to the firm's latest Asian offering.

As Lasry focused more on growing Avenue and the hedge fund business, he realized that he didn't have as much time to devote to Amroc. He also knew that the big investment banks moving into the business of trading bank debt had an edge because they had far more capital and resources than Amroc with its two dozen employees. So in 2001 he made the difficult decision to all but shut down the firm, which was very profitable and had a huge database of contacts. It also controlled about 20 to 30 percent of the distressed-bank-debt market and 75 percent of the trade claims market.

Lasry retained the Amroc name, well known in the vendor community, solely to source trade claims for the benefit of Avenue funds. "We wanted to focus all of our activities on Avenue, which we thought going forward would provide the biggest growth and the largest success," he says.

"He took a big chance giving up Amroc," says AIG SunAmerica's Gamsin. "He knew he had to walk away from a fabulously successful brokerage. He bet the farm, but he wanted to get into fund management."

AT THE END OF EVERY AUGUST SINCE THE EARLY 1990s, Marc and Cathy Lasry have taken their kids for a week to Sea Island, Georgia, a luxurious resort about 80 miles south of Savannah that offers miles of private beach as well as boating, fishing, horseback riding, golf and tennis. There they vacation with the families of two of Lasry's longtime friends, Oaktree's Karsh and Jay Wintrob, an executive at AIG's retirement services group in Los Angeles.

A few years ago Lasry created what he, Karsh and Wintrob refer to as the Mosquito Classic. There is golf, played on one of Sea Island's three championship courses, at which Los Angeles residents Karsh and Wintrob excel. Lasry, self-admittedly a terrible golfer, gets his chance to gloat during tennis. The winner is crowned after the bingo-night finale, which serves as a neutral tiebreaker. The competition is good-natured but spirited, says Karsh, who won last year's Mosquito Classic, taking home the prize, a five-foot-tall trophy Lasry picked out because it was suitably tacky.

"They train for months and send fattening foods to one another," says Cathy Lasry, smiling. Her husband last won the trophy in 2005.

Although he loves to go head-to-head at games like tennis, chess or cards, investing is the ultimate competition for Lasry. And he says there's no better place for it than at a hedge fund. "In this business, if you're not doing well, people don't invest with you," he explains. "To me that's logical. Guys are paying you 2 and 20 not because they like you but because you're a good investor."

Distressed-debt investing is a painstaking process. It involves buying the securities of troubled companies teetering on the edge of bankruptcy or actually in it. The companies themselves aren't necessarily bad; many have simply taken on too much leverage and are unable to make their payments. Distressed-debt investors must identify and analyze the securities to determine the likelihood that the company that issued them will eventually make good on its obligations.

By its nature, distressed-debt investing is cyclical. There are fewer opportunities when corporate default rates are low, as they have been during the past three years. For firms like Avenue that focus on senior debt, which is more likely to get repaid in the event of a bankruptcy, the investment opportunities can be even harder to come by. That's one reason why distressed-debt hedge funds like Chatham, New Jersey­based Appaloosa Management have moved down the capital ladder looking for value, buying emerging-markets debt, subordinated bonds and even the equity of beaten-down companies. Although the returns from such a strategy can be higher than those of more traditional distressed-debt investing, so is the volatility.

The prospects for all distressed investors should improve during the next few years if predictions of a drop in corporate credit quality come true. Global Insight, a New York­based financial forecasting firm, expects U.S. corporate bankruptcies to rise 17 percent this year, to roughly 36,700. It foresees an economic slowdown, rising interest rates and relatively high energy and commodity prices, all of which hurt profits.

"Usually, there is a lag between the stress factors and bankruptcies," explains Mark Killion, head of world industry services at Global Insight.

New York­based credit rating giant Standard & Poor's is equally gloomy. It is forecasting that the default rate for junk bonds will more than double this year, to 3 percent. Although that's still below the historical average default rate of 4.7 percent, it would be significantly higher than the record low of 1.2 percent set near the end of last year.

At Avenue, Lasry has been talking about a turn in the credit cycle since 2005, expecting that the U.S. economy would slow as the Federal Reserve Board continued to raise interest rates and the housing bubble burst. Lasry admits that he was early -- the Fed hikes have had little effect on long-term rates, and the housing market has managed to avoid a major collapse -- but he and his senior portfolio managers are confident that the U.S. economy is slowing and that corporate defaults will rise.

"Starting last spring there has been more visibility from the Fed that the economy would slow but not deteriorate into recession," says Avenue's U.S. strategy chief Grossman. "That's good for our business."

Grossman, 43, oversees about $3.7 billion in assets, including the original Avenue Investments fund, now at $1.4 billion. An Institutional Investor magazine­ranked research analyst during his days at Lehman Brothers (he was No. 3 in Paper & Forest Products in 1997), he is experienced at following cyclical companies and industries.

He and his 26-person team start by formulating a macro view of the economy and then identify the industries most likely to be affected by it over the next six to 12 months. The process helps them narrow their universe of more than 1,000 securities, some of which are found through Amroc, to determine which companies the analysts should research. "We have an information edge through our long-standing relationship with vendors and bank lenders," says Lasry.

Avenue's U.S. portfolios typically hold 25 to 30 positions, investing in different parts of the capital structure, mostly public debt securities, bank debt, trade claims and equities. "Each layer of the capital structure carries different risks," says Grossman, who has a BA in economics from Tufts University in Medford, Massachusetts. "Assessing those risks is more an art than a science." Liquidity risk -- the potential inability to get out of a position because a security is thinly traded -- is of particular concern because Avenue runs a fairly concentrated portfolio. In the U.S. the firm mitigates that risk by sticking to large- and midcap companies.

Avenue's investment approach has led the firm to several downtrodden industries, including autos and airlines. Avenue began aggressively investing in Delta Air Lines shortly after it filed for bankruptcy in September 2005, buying up debt secured by the Atlanta-based company's aircrafts. But it wasn't until early last year, when Grossman and Lasry became more confident about the airline's prospects, that Avenue began buying the company's unsecured claims, which became one of the firm's biggest positions. Specifically, Avenue invested $350 million in Delta's debt, paying 20 to 30 cents on the dollar. "We bought it at or close to its liquidation value," Lasry says. Last fall the bonds surged to more than 50 cents on the dollar when US Airways Group unexpectedly made a bid for Delta. Avenue heavily cut back its holdings at the beginning of this year when the bonds rose to more than 70 cents on the dollar, but Delta is still an important position for the firm.

In the auto sector Avenue loaded up on the bonds of General Motors Corp. and General Motors Acceptance Corp. in 2006, as well as on bonds issued by auto-parts maker Delphi Corp. It has since sold most of its Delphi and GMAC positions. Avenue also owns the bonds of Ford Motor Co., which Grossman says is well capitalized after its recent $18 billion financing deal to fund its turnaround. Although Grossman is bearish on the auto sector in general, he is confident that GM and Ford will be able to solve their labor problems. "GM and Ford have the resources to fund the buyouts of their employees," he explains. "The math of that is very compelling."

Like other distressed investors, such as Cerberus and Oaktree, Avenue sometimes gets directly involved in a restructuring by seeking representation on creditors' committees. However, Grossman asserts: "It's time-consuming. It's not a good use of our resources." Lasry adds that once on a committee, an investor is generally restricted from altering his position because he would be receiving material, nonpublic information. So Avenue also seeks to get on so-called ad hoc committees of creditors, which try to influence the outcome of reorganizations without the restrictions that come with sitting on the creditors' committee. Last year Lasry helped create the Delta Ad Hoc Secured Aircraft Committee and the Delta Ad Hoc Unsecured Claims Committee to ensure that Avenue's interests are protected.

"We didn't want to be on the official creditors' committee because we wanted to keep increasing our position," he notes.

Avenue's European strategy is steered by Furst, 43, who before joining the firm managed about $1 billion of U.S. and European distressed and high-yield securities for Moore Capital in New York. Furst has a BS in economics from the Wharton School of the University of Pennsylvania and an MBA from the Kellogg School of Management at Northwestern University. He got his start on Wall Street in 1986 as an analyst in the mergers, acquisitions and restructuring group at Salomon Brothers in New York.

"Furst is very complementary to Lasry," says Paamco's Berens. "He is introspective. He loves running money and is well networked. We like the European strategy because it is well managed and not too large."

Avenue's strategy in Europe is a little different from that in the U.S., says Furst, largely because the high-yield-debt market is not as mature on the Continent as in the U.S. As a result, most small and middle-market companies there have had to rely on their local banks for financing. That was fine until the Basel II accord, which creates more stringent capital requirements for banks in Group of Ten countries, including France, Germany and the U.K.

"In Germany the local banks were subsidized by the government to lend money to middle-market companies at low rates and not worry whether they were good loans on a risk-adjusted basis," explains Furst, who is based in New York but travels to Europe at least once a month. "Now they must make sure they are good loans. So banks are not lending as much to these companies."

Cash-strapped businesses are turning to firms like Avenue to shore up balance sheets, refinance bank debt and provide growth or acquisition capital. Furst and his 15-person team specialize in lending to companies with less than $500 million in revenues. They find them by talking to banks and local financial advisory firms that do M&A, restructurings or debt refinancing in jurisdictions where Avenue deems the legal system to be particularly strong, including Ireland, Scandinavia, the U.K. and the Benelux countries -- Belgium, the Netherlands and Luxembourg. Furst says the firm likes owning debt in Germany, because there are more opportunities to restructure.

In the U.K., for example, Avenue owns bank loans in Focus, a do-it-yourself retailer that is feeling pressure from big Home Depot­like competitors. Furst is confident that if the company files for insolvency and liquidates, there is enough asset coverage between the inventories, accounts receivables and value of its store leases. Avenue is also currently making middle-market loans in Germany, including an investment in D+S Europe, a Hamburg-based call center and transaction-processing company that recently went through a successful turnaround and now wants to grow.

Furst and his team generally avoid investing in Eastern Europe, France, Italy and Spain because of what they see as a lack of predictability in the bankruptcy process. "It is very unclear whose interests are being prioritized," says Furst, referring to the various constituencies -- employees, suppliers and investors -- that could lay claim to a company's assets in bankruptcy. "The senior debt could be subordinate to employee claims," notes Lasry. "In France the system is geared toward helping the workers."

Malcolm Robinson, 40, runs the firm's Asian strategy. Lasry hired the Wharton MBA in 1999 as Avenue was entering the Asian distressed market with its first hedge fund, Avenue Asia Investments. The decision, shortly after the 1997 Asian debt crisis, was seen by many investors as extremely risky. But Robinson, who had experienced the crisis firsthand as a hedge fund manager at Richmont Parly Investment Co. in Hong Kong, agreed with Lasry's assessment that Asian debt was too cheap to ignore. In 2001, Avenue launched an offshore version of the hedge fund, as well as two Asian institutional funds. By the end of 2006, the firm had $5 billion invested in Asia, spread among several institutional funds and two hedge funds, making Avenue one of the biggest hedge fund investors in the region.

"Marc was in Asia early and stepped up to become one of the largest investors there," says AIG SunAmerica's Gamsin. "He built the business in a very thoughtful way. Distressed investing can be very cyclical, and he decided to go international when there were great opportunities."

Asia is Avenue's biggest challenge and one of its brightest opportunities. The firm has about 70 employees in the region, including 55 investment professionals operating from offices in Bangkok, Beijing, Hong Kong, Jakarta, Manila, New Delhi, Shanghai and Singapore. "There are many different languages, cultures and legal systems," says Robinson, who is based in Beijing but spends at least half his time on the road. "Just getting money in and out of the countries is difficult."

Lasry says one of the greatest appeals of investing in Asia is that the number of distressed opportunities in the region is growing by 3 percent a year even as the economies are growing strongly -- in China's case by close to 10 percent annually. "What happens when GDP growth slows to 1 percent?" he adds.

Avenue's investment strategy in Asia is very different from the approaches it takes in the U.S. and Europe and varies within the region from country to country. In India and Indonesia, for example, Avenue is more likely to buy the debt of individual companies. In the Philippines the firm buys pools of loans that have been bundled together, as well as single assets. Most of the debt is in the form of secured bank loans.

In China, Avenue buys concentrated pools of nonperforming corporate loans, many of which were extended to companies by government mandate before new risk control measures were put into place. In 2006 the Chinese government put $20 billion of such loans up for auction. Avenue bought $1 billion of the $4 billion in loans that were actually sold, paying 20 to 40 cents on the dollar for its share of the pool.

The Chinese corporate loan pools differ by region, industry, business and the type of bank selling them. Robinson and his staff of local lawyers and investment professionals research them by poring over the financials and industry data and speaking to competitors, suppliers and customers. "It's very labor intensive," stresses Robinson, who says that the valuation of the Chinese yuan is just one of many factors that he considers.

In June new laws will go into effect in China, bringing the country's bankruptcy system closer to that of the U.S. Chinese companies will no longer be required to liquidate but instead will be able to reorganize and restructure.

"You will see a massive amount of restructurings at the corporate level in China in the next five years," says Robinson. "We will be in the middle of that."

For Lasry, China is just one part -- albeit an important one -- of his plan to deploy the $10.4 billion war chest he has built at Avenue. He is quick to point out, however, that bringing in new assets, even for him, isn't always easy. "The way to raise money is having good returns," he says. "If you don't have good performance, you couldn't do what we do."


Morgan Stanley: A deal well done

For Avenue Capital Group co-founder and managing partner Marc Lasry, the decision to sell nearly 20 percent of his firm to Morgan Stanley last fall was an easy one. He was looking for a partner that shared his belief in the increasingly global opportunities for distressed investing and that was willing to provide the capital -- almost $300 million -- to help him take advantage of them.

For Morgan Stanley, the investment in Avenue is part of a corporate decision by CEO John Mack to build a bigger presence in alternatives. Morgan Stanley has long been a leader in providing prime brokerage services to hedge funds, but historically, its own hedge fund offerings have been limited.

The alliance with Avenue was the first of a flurry of deals by Morgan Stanley last fall, including its reported $300 million purchase of a 19 percent stake in London's Lansdowne Partners and its outright acquisition of Greenwich, Connecticut­based FrontPoint Partners. Morgan Stanley reportedly paid $400 million for FrontPoint, which has $5.5 billion in assets under management, enabling the investment bank to quickly build the foundation for a multistrategy fund platform. The deals give a much-needed boost to the bank's $478 billion money management arm, Morgan Stanley Investment Management.

Morgan Stanley's investment in Avenue values Lasry's firm, which manages more than $12 billion, at roughly $1.5 billion. Yie-Hsin Hung, head of strategic acquisitions and alliances at MSIM, says the valuation is based on several factors, including Avenue's assets; earnings before interest, taxes, depreciation and amortization; future cash flows; and potential opportunities.

"The deal is successful for both Morgan Stanley and us," says Avenue co-founder Sonia Gardner (Lasry's sister), who as the firm's general counsel was closely involved in the deal. "We wanted a top-quality partner, but we also wanted to keep control."

Lasry's interest in Morgan Stanley goes beyond the bank's ability to package and sell his products. The money he gets will make it easier to raise additional institutional funds. That's because each time Avenue launches a new fund, pension funds, insurance companies and other institutional investors expect the partners to put in at least 2.5 percent of the money.

"Blue-chip institutions want to see the general partner put up a substantial amount of capital," explains Hung. "Our alliance enables Lasry to expand his business. The proceeds are being invested in upcoming funds." -- S.T.