Ever since the unexpected gating and liquidation of Third Avenue's credit fund in early December, there has been a jump in comparable credit money managers, both of the mutual and hedge fund variety, such as Claren Road and Stone Lion Capital, who have decided they'd rather hand in the keys and repay their investors (at a loss) than try to eek out alpha in an environment where, as Richard Breslow put it earlier, "it feels like the algos are hooked up to Tinder."
It is also clear that as long as both IG and HY continue to bleed, the liquidations will continue: just this Monday in his latest fire and brimstone sermon, Jeff Gundlach told Reuters that more "credit fund bankruptcies are coming." Sure enough they are, and as HF Alert reported today, the latest hedge fund to liquidate is London-based Warwick Capital, which was founded in 2010 by former Polygon executives Ian Burgess and Alfredo Mattera and which according to its website had $900 million in AUM most recently.
As HFA writes, the London firm began liquidating its Warwick European Distressed & Special Situations Credit Fund in May after investors submitted redemption requests amounting to 90% of the fund’s assets, and yet, nearly a year later limited partners have yet to get all of their money back, or even a majority of it.
Because something unexpected happened: "the problem" as HFA writes, is that "the fund’s remaining assets — encompassing debt and equity positions in Fitness First, New Gulf Resources, Oasis Holdings and Punch Taverns — are too illiquid to be sold right away."
This is what the fund said:
“In the final quarter of 2015, the funds experienced a substantial increase in volatility in the credit markets, primarily due to market concerns over global growth, the collapse in oil and other commodity prices and the illiquidity experienced by certain credit funds,” Warwick director Ralph Woodford wrote in a Feb. 5 letter to investors. “As a consequence, there was little or no liquidity in the markets for the fund’s remaining positions. Where liquidity was available, there was dramatic widening of the bid-offer spreads, meaning that it was not possible to sell these assets at what we considered to be their fair price.”
Actually, what HFA says is the problem is not the problem at all, because there is always a buyer for any bond - even bankrupt ones - at the right, low enough price. The real problem is that Warwick Capital had marked these bonds at ridiculously high levels and had refused to mark them lower to follow the declining overall market. As a result, Warwick's LPs have been given flawed information about the true value of their holdings, which are based on bond prices which may never be seen again.
The result: another redemption gate, in the vein of Third Avenue:
"the bottom line: For now, limited partners will receive cash payments equal to just 57% of the fund’s net asset value on Dec. 31. The remaining assets will be transferred to a special-purpose vehicle dubbed Realising Fund, which will be unwound as market conditions permit."
In short, a modest 10-20% correction in equity prices from all time highs, and suddenly nobody can possibly find buyers due to massive deltas between marks and markets.
Adding insult to injury, investors will pay fees equal to 1.25% of assets and 20% of profits on their stakes in Realising Fund.
Yes: paying 1.25% and 20% to be gated!
Finally, what is perhaps most disturbing is that like in the case of many other liquidating credit funds, the NAV of Warwick's European Distressed & Special Situations Credit Fund fell only 5.3% in 2014 and presumably continued to drop in 2015, but hardly too much if the management team was using such bettered-up marks that it can't possibly find a willing buyer anywhere close to its marks.
As HFA concludes, "how much money remains in the Warwick vehicle is unclear. Warwick pegged the fund’s assets at $340 million last May. But at the time, investors representing perhaps 30% of the fund’s capital expressed interest in transferring their money to Warwick European Credit Opportunities Fund, a private equity-like vehicle that locks up capital for at least four years."
Or that may be just more fabrications by the fund's management team in hopes of buying some more time, time which will force central banks into reflating asset values once again, and Warwick will luck out and can sell at higher prices.
It may not be so lucky.
And so, as another hedge fund gates, we wonder, as we did back in December, just how many other funds are artificially inflating marks on largely OTC instruments like junk bonds, to avoid a panic among the LPs and prevent a redemption scramble; one thing is certain - the longer junk and IG bond prices drift lower, the greater the concerns of LPs around the entire asset management world, until one day the massively pent up redemption flood is unleashed.
It is only then that we will truly see what a bidless bond market looks like, and incidentally that is the catalyst Jeffrey Gundlach has been waiting for to start buying.