Comprehensive Ira Sohn Notes (Part 1/2)

Yesterday, Distressed Debt Investing attended the Ira Sohn Conference. We were updating from the conference live at @DDInvesting - hopefully you were following along. We hope this will be some of the more comprehensive notes out there in regards to the 2011 Ira Sohn Conference. Enjoy!

(Note: After writing this monster, I split it into two as it was getting aggressively long)

Erez Kalir, Sabretooth Capital - "Economic Death as a Special Situation"

• For those not familiar, Sabretooth Capital was formed by Erez Kalir and Craig Perry. Perry used to work at King Street Capital, followed by CSFB's credit prop group, and then starting a prop distressed trading effort at Swiss Re. Kalir worked at Eton Park and then a Julian Robertson seeded 'Tiger Cub'. Eventually Julian himself seeded the two with $65M in 2009.
• Sabretooth's portfolio, in my opinion, looks very little like most Tiger Cubs' ... which makes sense given the pedigree of the founders: Distressed / Event Driven funds. Here is their 3/31 holdings as reported in their 13F:

• “Economic Death as a Special Situation” was the title of the presentation. Economic death is broader than you think. General theme was that in dealing with situations that seem to have a binary outcome small changes in probabilities can mean large changes in expected value. Cited 3 Examples
• MBIA – Thinks rumors of its demise are greatly exaggerated. Advocates going long equity, selling 2 year subsidiary CDS and selling 5 year parent CDS. Think challenges to separation (good co/bad co) will fail, and in reality no one incentivized to force MBIA into receivership due to the second order effects it would cause. Further, market not giving them credit for $49bn in commutations. Erez noted Ackman’s open source model is dated, and was flawed because it didn’t take into account the present value of the CF streams. In the "Good bank", muni risk is not that bad. At today’s price, market is pricing the Company at 1/3rd of Adjusted BV. Depending on the outcomes, book value is $5-$20/share. Think upside is 100-200% and downside 30%, and the Company has the right leadership under Jay Brown. Given the possibility of being wrong, however, size your position accordingly
• Argentina. Sabretooth is involved in Argentina's E&P sector. Argentina, on the whole, suffers from the biggest sovreign default in 2002. Has a history of politicians making the wrong bets, using the wrong models. CDS spreads sill twice as wide as rest of LatAm ex Venezuela and in Erez’s opinion way too high. The reason for the tilt to the Argentinian E&P sector: Argentina has proven resources and a very robust energy infrastructure. In addition, Argentina has become a net importer of energy for the first time requiring significant energy investment for self reliance. The stocks he advocates are CWV CN, BOE CN, MVN CN, RPT CN and YPF
• Hedging Economic Death as it relates to the US Financial System. When countries's GDP falls below interest rates, the term "Doom Loop" should be thrown around. Thinks owning gold is flawed as risk of confiscation is high. Has actually happened in the US before, and don’t think that storing it in Switzerland is a panacea, as US Gov’t sought out foreign gold for confiscation back then as well (He noted rumors Paulson has done this). Thinks shorting Tsys (as his mentor, Julian Robertson is doing) is flawed as well – just a legal construct, the Fed can pin the long bond @ a certain yield. Thinks Buffets strategy of buying high quality stocks of dominant franchises with pricing power (e.g J&J, Coke, Amex) also flawed - in hyper inflation everything gets crushed. Advocated for owning farm-land outside of the US because its a "replenishing asset" that wins in a secular growth theme as well.

Dinakar Singh, TPG-Axon

• Dinakar Singh formerly ran the Principal Strategies Department at Goldman Sachs before starting TPG-Axon. His letters to investors are some of the best out there. I remember one he wrote in late 2008 that was absolutely remarkable. From speaking to a number of people there, they do not limit themselves to long-short equity - and will play in a variety of asset classes.
• "Beta trade is over." We are in a stock-picker’s market. Valuations and margins recovering, but when the stimuli is pulled away we get to see what the real economy looks like. Look for companies with structural growth and separately, companies that are undergoing internal restructuring. He wants to buy stocks when margins and valuations are already at cyclical/secular peaks (i.e. truly improving stories)
• ORKLA (ORK NO). Norwegian conglomerate. Thinks upside is 65-80 (30-60%). Overcapitalized. Change is underway. 3 Key segments: premier consumer staples biz, legacy alumni-related biz, and high quality investment portfolio. “Bell has rung” – separation of businesses is on the horizon, will look to return money to shareholders. Major shareholder Canica. Trading at 9/10 PE; 1x Book, 5% yield, and has a good balance sheet. In general, Europe was slower to cut costs in this most recent downturn, so more upside from here. In addition, 22% shareholder is fed up with performance and is now on the board.
• Zhongpin (HOGS); US-listed, Chinese pork processor. In the last 6 months there has been significant underperformance of Asia stock versus US. Chinese P/Es are below that of the S&P. HOGS is a good example. Basically now the growth-in-Asia stories are on the clearance aisle. The industry in which HOGS participates is consolidating (50-80% of capacity is coming out of the market by 2015). HOGS has inflation risk to it, but has the ability to pass that on to the Chinese consumers. Margins will be sustainable, as the Chinese government, which is sensitive to price increases to the end consumer, is even more sensitive to rural Chinese, and will always choose farmer over urban dweller. Buying it today 7-8x earnings and will be 4-5x in a couple of years
• Spring Nextel. Basically thinks it is super-cheap. The company has both low margins and a low valuation which will make returns explosive to the upside if things turn around. US cell market is attractive and being #3 in tri-opolgy ain’t bad. Will get chance to buy cheap assets because of forced divestitures on ATT/Tmobile (also T Mobile is their weakest competitor). Also they are fixing their networks and will have the opportunity to pursue a number of good JV deals due to consolidation in the market. There is upside here as Sprint's strong network is an attractive acquisition candidate for CTL, AMX or CMCSK. Stock currently trades at 5x EBITDA. Should trade at 6.0x-7.5x implying a value of ~$8.50 to ~$14.00/share.

Jeff Aronson, Centerbridge Partners - "CIT Group: An Event Waiting to Happen"

• Jeff Aronson is the Managing Partner of Centerbridge Partners. Centerbridge will be family to regular Distressed Debt Investing readers as they are quite active in the distressed space. They have played in cases such as Champion Enterprises, BKUNA, Wamu, Istar, Extended Stay, Dana, and many others. Before Centerbridge, Aronson was a Partner at Angelo Gordon.
• Centerbridge manages $14bn. Aronson noted they are not traditional stockpickers. With that said, they have been buying CIT, a post-reorg equity, of late. They started buying the pre-Chapter 11 bonds and have been buying since.
• Think stock’s intrinsic value today is $59; $45 3/31/11 BV plus $7 in future accretion from fresh start accounting (FSA) write-down, plus $7 in NPV of $2.1bn of DTA which they have taken a valuation allowance on gets them to $59. Will reverse the VA after they lower their cost of funding and start making more money. Using a 10% discount rate assumption in PV calc. So, cheap on an as is basis versus $41 share price.
• Thinks value if they acquire a deposit-funded institution, or vice-versa is ~$64-65. Value creation comes from marrying higher yield assets at CIT (8% vs, 4.6% for commercial banks) with cheap funding (7.2% cost for CIT versus 1.0% for banks). Thinks stand-along 2012 EPS is $1.76, can pick up another $3.03 by putting the 60% of their assets that are bank eligible (Corp, Vendor, Trade) in a bank, plus $1.04 in operating synergies gets you to Adj. 2012 EPS of $5.83. At 10x comp multiple get $58 stock plus $7 in NPV of DTA = $65 stock. If instead is the acquirer, thinks they could pay up 15% for VLY, combine the two, and at 1.1x BV = $64 stock.
• Listed US Bankcorp, WF, HSBC, and TD Bank as potential acquirors of CIT.
• His concluding comments were short and to the point: At 0.7x book value, and a normalizing funding environment, CIT is completely misunderstood by the market.

Robert Howard, KKR Equity Strategies

• In 2011, Robert Howard joined KKR to build out its public market equity initiative. Most recently he was Global Chief Operating Officer of Goldman Sachs and head of Principal Strategies Americas equities / credit division.
• KKR Equity Strategies looks for situations that are not well understood by the market (he cited lack of history as a main culprit) that "fly under the radar"
• Pitched WABCO (WBC), a global supplier of electronic and mechanical components to the commercial vehicle industry. Spin-off with a long history (invented ABS brakes). Play on cyclical recovery in Europe and US truck production, tightening safety and emission requirements and EM growth. The company also has a dominant market share in China and India. $100 share PT. The CEO is eating his own cooking, owning $200M of economic exposure
• Second pitch was HSNI. Howard sees 40% of upside here. The company trades a little less than 6.0x, which is well below the retail universe that the street usually compares the company to. The company is under levered AND overcapitalized and could pay a $950M dividend. Margins here are well below HSNI's larger competitor QVC and a consolidation makes sense. In fact QVC's parent, Liberty Media Interactive, owns 32% of HSNI. 65-90% upside in a merger.

Phil Falcone, Harbinger Capital Partners

• As expected, Falcone started off the presentation giving an overview of Lightsquared. While equity investors cannot play it (yet), there is debt out there. The 12% Term Loan trades at 102-103 as of today. Thesis is 50% increase in data form 2009 to 2014, Not enough spectrum in the mkt. He is acquiring spectrum and has a terrestrial network with a satellite overlay. All about "building the pipe"
• Falcone then went on to discuss one of their larger holdings Crosstex Energy (XTXI)
• XTXI is one of the only publicly traded General Partner interests in a C Corp structure. Crosstex owns 100% of the GP interest and 32% of a publicly traded entity XTEX (Crosstex Energy LP) and 100% of the distribution rights. There are no corporate level income taxes at the LP.
• The publicly traded entity is expected to increase its distribution by 30% which, because of leverage, could increased the GP distribution 3x higher than that
• Falcone sees at least a double to a 2.5x return on this position

Jim Chanos, Kynikos Associates - "Does Solar + Wind = Hot Air?"

• Before crushing alternative energy, Kynikos founder, Jim Chanos went on about how he was "NOT" going to talk about a particular country in Asia that he is short. The country turned out to be Japan. He is bearish on China as well (of course) and India (didn't want to piss off a billion people like he did last year)
• Bearish on Alternative Energy; Solar + Wind = Hot Air. Unreliable baseload power, geographically limited sources of power. Intermittent power generation creates significant issues. Not the job growth provider the politicians like Obama want you to believe it is – Installation, not Innovation. Low R&D, putting people to work in the construction industry basically. Environmental benefits are questionable: marginal impact on CO2, NIMBY, noise pollution, wildlife impact.
• Wind is 50% more expensive than natural gas and solar is even more expensive. In addition, we have a ton of coal.
• Short Vestas Wind Systems (VWS DC ). Accounting is gimmicky (that's how they first found it), pulling revenues forward and deferring costs. Have changed auditors = red flag. Low ROIC, and increased competition in both US and China. $600M of cash has burned in the last 6 months.
• Solar mkt fundamentals are deteriorating. Feed-in tariff policy is not sustainable particularly in Spain and Italy. Capacity growth is relentless, driven by easy credit in China (solar cell production capacity increasing 30-50% while installations are down 40-90%).
• Short First Solar (FSLR) – Uses think film technology instead of next generation poly technology. The company is burning cash this year. Management has been selling stock - Chanos LOVES when management sells stock. New management team is new to the solar business.

Stay tuned tomorrow for the rest of the post!

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Quick Reminder

I will be at Ira Sohn tomorrow, running a live update (@DDInvesting) and will have notes tomorrow / Thursday evening. Looking forward to it!

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Reminder: Ira Sohn Investment Contest due this Friday

I've gotten a number of emails asking about the Ira Sohn Conference and Competition I discussed here last week. We will be at the conference taking notes and with live updates via Twitter (@DDInvesting).

With that said, I wanted to remind everyone that the Ira Sohn Investment Contest submissions are due by Friday at 5PM. EVERYONE should be entering this ($100 for entries, $25 for students). Dust off an old piece if you must - the chance to speak at this conference is remarkable to say the least. Truly an honor. Really hoping to see one of us on that stage next Wednesday.

Again, here is the website for the contest entries: Ira Sohn Investment Contest

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Favorite Quotes from Q1 Hedge Fund Letters: Passport, Kleinheinz Capita, and Omega

One of the most fascinating aspects of the investment business is manager commentary in the form of hedge fund letters. Sometimes these letters take the form of an aggressive rant, or a "teach-in" session of some strategy the fund is employing (see: Michael Burry @ Scion), or simply a commentary on what's keeping the hedge fund manager up at night. I try to read as many of these letters as possible (hint: send me more letters). I also believe in a post-Madoff world, increased disclosure of underlying investments can generate investment ideas for your own portfolio.

Over the past few months, I've received a number of letters from readers. After the litany of 13Fs coming out today, I thought it would be productive to pull out a sentence of two from a number of prominent hedge fund managers' letter that I particularly found insightful. I have split this post into two individual posts with the second one coming later in the week.

Kleinheinz Capital Partners, a legend fund in the hedge community (26.1% annualized returns over 182 months...you can read more about them here) wrote:

"In summary, while the near-term case for uranium equities has been significantly weakened as investors take a wait-and-see approach, we believe that in the long-term nuclear power will provide as essential component of the world's energy consumption. Therefore, the Fukushima accident is unlikely to cut short the nuclear power growth story the way Chernobyl did twenty-five years ago, because even in the worst case scenario Fukushima would remain a narrowly localized problem with limited radiation beyond the immediate area surrounding the plant. Additionally, twenty-five years ago, growth in nuclear power was driven mostly by societies in Western Europe and North America, while future growth is expected to come from emerging markets such as China, which has a more centralized decision making process and a very large population with rapidly growing needs for electricity. China, Russia, India, and South Korea account for about 75% of the projected nuclear build-out and those countries have a constructive view on nuclear power."

I spoke with a number of brilliant analysts after the Fukushima accident and the smarter ones of the group started doing their work on the various uranium producers. If you look at the charts of many of these companies, they've traded down hard to the point of a significant discount to NAV (the spot market for the actual underlying commodity is actually fairly tight right now). Names include Berkeley, Denison, Cameco, ERA, Extract, Paladin Energy, Ur-Energy, Uranium Energy, and Uranium One. I think here you go for a low cost producer with an unlevered balance sheet trading at or below NAV.

Omega Advisors, founded by "The Doctor" Leon Cooperman, wrote in his quarterly letter:

"Equity-market valuation is attractive. However, valuation by itself does not bring higher share prices. We are all aware of, and have experienced, value traps. There almost always needs to be a catalyst to activate market undervaluation. We are constructive on U.S. shares because we believe that there are several important, significant, and long-lasting catalysts to activate share undervaluation. These catalysts include:

• A self-sustaining U.S. economic expansion that should last at least as long as the average post-war expansion of 60 months.
• An economic and inflation cycle characterized by a low level of volatility.
• A very sweet profit cycle.
• A significant allocation shift to equities from fixed income by individual and institutional investors."

I always have enjoyed Leon Cooperman's commentary both in his quarterly / annual letters and his appearances and conferences and on CNBC. The letters particular are stocked with charts and graphs that really back the fund's investment positioning. While I am not as bullish as Omega on the overall public equities markets (I believe that profit margins are characteristically too high and even with sales growth fueled by an economic expansions, profit growth will be less than analysts' estimates), I 100% agree with point 4 above. I saw a statistics of the amount of equities, as a % of net worth that people under 40 have, and it's staggeringly low. Further, once inflation rears its ugly heads, fixed income investors will realize that past performance, i.e. a 25 year bond bull market, does not guarantee future returns.

Passport Capital, led by John Burbank, had a fascinating disclosure on the purchase of a Chinese Renminbi (RMB) non-deliverable forward contract:

"We believe that the RMB will continue to appreciate at a mid to high single-digit rate each year for the foreseeable future. To maintain Beijing's target for growth, acceptable levels of inflation, and to prevent an excessive correction of home prices, we believe China must develop independent monetary policy. Over the long run and as evidenced by their recently released five-year plan, China intends to rebalance its economy from export to consumption. This should drastically reduce China's trade surplus, as suggested by Yi Gang of the People's Bank of China in October 2010. Gradual appreciation of the RMB helps China move judiciously in that direction."

The letter goes on to note that the fund estimates that the break-even for the position is 8% from entry over the next two years and a 11% move (5% for two years...or the pre-crisis average growth rate) would net Passport a 2x reward with further upside.

This sort of trade as well as another fascinating one disclosed in the letter (adding aggressively to their Saudi portfolio during late February), as well as other commentary from John Burbank and his team that these guys understand value in a global context and position the fund to capture the upside while minimizing the downside. I learn more about the global economy each time I read one of Passport's letters.

Later in the week we will post the second part of the series of Q1 hedge fund letters. If you have any letters you would like to share, please send them to hunter [at] distressed-debt-investing.com

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Ira Sohn Conference and Competition

On May 25th, 2011 the legendary Ira Sohn Conference will take place at the Lincoln Center with an amazing lineup of speakers. In my humble opinion, this year's slate of presenters is arguably the high quality in the history of this fantastic event. The 2011 speakers include:

• Bill Ackman
• Jeff Aronson
• Eike Batista
• Jim Chanos
• David Einhorn
• Steve Eisman
• Dr. Marc Faber
• Philip Falcone
• Steve Feinberg
• Joel Greenblatt
• Jeffrey Gundlach
• Mark Hart III
• Robert Howard
• Carl Icahn
• Erez Kalir
• Peter May
• Dinakar Singh
• And comments from Michael Price and Ken Langone

The Ira Sohn Research Conference Foundation's mission is the treatment and cure of pediatric cancer and other childhood diseases. Ira Sohn, from who the foundation takes its name, was diagnosed with cancer in 1989 at the age of 24. He succumbed to cancer four years later. In 1995, Doug Hirsch (Seneca Capital), Lance Laifer, Daniel Nir (Gracie Capital), and Sohn's mother Judith Sohn created the Ira Sohn Research Conference Foundation, a miraculous organization that has invested over $20M in research to fight cancer and fund pediatric care. For more information, please check out their brochure.

Maybe even more exciting than the actual conference: This year, the first ever Ira Sohn Investment Contest will be taking place. Here are some details:

• Participants submit their best investment idea (long or short) with a market cap over $1 billion
• The winner will be selected by a panel of judges for the "most compelling investment idea with a one-year horizon
• The judges (wait for it...): Michael Price, Bill Ackman, David Einhorn, Joel Greenblatt, and Seth Klarman!
• The winner of the contest will present the investment idea, in a ten minute presentation at the Ira Sohn Conference...talk about exposure!
• The entry fee is $100 ($25 for students), fully tax deductible

Detailed rules can be found here: Ira Sohn Investment Contest Official Rules

I, for one, have already started thinking about an investment (s) to present to the judges. I am excited about the opportunity to have some of the most elite portfolio managers in the world look at, ponder on, and debate an original investment idea of mine. EVERYONE should be applying - not only because it's a world-class cause, but because if you win, and you are up there presenting your investment idea, my hunch is things are going to look pretty good in your professional career going forward no matter whether you are still in school, raising capital for a fund, already managing a book, etc

For more details about the Ira Sohn Conference, please visit the conference webpage: http://www.irasohnconference.com/ ... Distressed Debt Investing will be there taking notes conference notes, and dare I say it, tweeting in real time all the action. Hope to see you there.

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Distressed Debt Investing Twitter and LinkedIn Pages

I've resisted for quite some time, yet for reasons I will announce shortly, I've decided to set up a Twitter Page: @DDInvesting

In addition, many of you know I set up a LinkedIn Group for Distressed Debt Investing. It is a way for readers and other members of the distressed debt and high yield market to connect with one another. You can find the group here: http://www.linkedin.com/groups?mostPopular=&gid=2604443 (I hope I did that right!)

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Notes from Chicago Booth's Annual Distressed Investing and Restructuring Conference

We were fortunate enough to have the organizers of Chicago Booth's 6th Annual Distressed Investing and Restructuring Conference take notes for us. Enjoy!

MORNING KEYNOTE:

Howard Marks, Chairman, Oaktree Capital Management

• Dean Harry Davis, who taught Howard Marks, introduces Marks with a discussion about the importance of Art and Study and how those themes run through Marks’s career.
• Marks gives an overview of the distressed investing space and the current cycle. He notes that while thousands of people can do similar analysis the difference lies in the art of interpretation.
• Marks walks through the history of each distressed debt cycle, noting that each cycle is similar to past cycles: unwise extension of credit combines with economic weakness to offer plentiful opportunities in the distressed debt space.
• The cyclical pattern is the same with tight post-recession credit conditions leading to solid credit quality, which then leads to strong returns, which then pushes more money into the space allowing for poor quality issuance, which eventually produces high defaults and a period of risk aversion.
• The second half of the talk was a case study of Favorite Brands with Marks explaining how to analyze the capital structure and why Oaktree bought at every level of the capital stack.
• In terms of fund management while having an ability to take positions in large size trades gives an access to unique opportunities, having a lot of assets under management is not always a good thing in terms of efficiency and client management. Quality of investments is the key.
• He also noted that an investor must make conservative assumptions, but not so conservative that it prohibits putting money to work.
• Prospective Commercial Real Estate opportunities will depend on whether financial institutions face the reality of the buildings' prices going down from their original levels and how regulators treat loans.
• Basel II will require European investors to face value drops and this may lead to distressed investment opportunities there.

Legal Panel

Moderator: Donald Bernstein, Davis Polk & Wardwell LLP

Panelists:

Douglas Baird, University of Chicago Law School

Ashley Keller, Bartlit Beck Herman Palenchar & Scott

Damian Schaible, Davis Polk & Wardwell LLP

Christopher Sontchi, US Bankruptcy Judge, District of Deleware

• Chapter 11 was designed to provide legal mechanisms to restructure companies but more recently has been used more by the investors than management. Panel discussed how the Chapter 11 process has been transformed with regular players who use it as a way to source investments.
• Discussion of reorganizations versus 363 sales. At times, reorganizations are the best solution as a 363 asset sale at a certain period in time may not provide the best price. Yet, the reorganization process does not consider the fact that debt is being traded and there are no clear-cut rules on how the court should deal with investors having different incentives and positions in various parts of the capital structure.
• In recent reorganizations, there has been increased importance of "gifting" where senior creditors give junior creditors some value to be able to come to an agreement.
• Credit bidding has become an important trend and it provides a good option in situations of market failure (example of Delphi where the only bid was 15% of the DIP financing amount). Discussion of whether Philly News will be precedent setting.
• The role of CDS protection holders in the restructuring space has become an important topic. Their incentives differ from other distressed investors because of the ability to get paid when CDS is triggered by a credit event such as bankruptcy.
• The revival of capital markets activity with covenant-lite loans and PIK-toggle loans is coming back in vogue. This should lead to plenty of bankruptcy work.
• There seems to be a lot of loan amendment activity, as well, which may indicate more distressed opportunities down the road.
• Issues with deal sourcing in the current environment due to high demand from distressed investors and new players in the space.
• A great number of current activities in the space are from hedge funds which lead to prolonged periods of negotiations when it comes to handing over the keys to the company.
• Another side of the coin here is that should credit markets freeze, we are to expect a severe drop similar to Q2 2008.

Private Equity Panel

Moderator: Darin Facer, AlixPartners

Panelists:

Duncan Bourne, Wynnchurch Capital

Ron Glass, GlassRatner Advisory & Capital Group LLC

Paul Halpern, Versa Capital Management

Michael Oleshansky, Industrial Opportunities Partners

• Some panelists thought that the downturn would have gotten a lot worse before getting better
• One panelist noted that they never expected creditors to be as patient as they have been (relating to the many amendments and extensions)
• It was also mentioned that some investors thought that interest rates would have faced more upward pressure by now
• The panel also discussed the importance of implementing operational changes in the portfolio companies The panel spoke about ways they are sourcing deal flow and specific sectors / industries they are looking at.
• Current environment is also a good one for monetizing private equity investments due to active capital markets.

Investment Banking Panel

Moderator: Nat Gregory, Professor, University of Chicago Booth School of Business

Panelists:

Dan Aronson, Lazard

Mona Baruah, Rothschild

Jeffery Finger, Miller Buckfire

Andrew Turnbull, Houlihan Lokey

• Much of the discussion centered on the question, “Is the recent distressed cycle done?” Panelists contrasted the low-level of deal-flow today versus the hectic period of 2008/2009
• Lack of deal-flow mainly attributed to the improvement in the global economy, the prevalence of covenant-lite loans during the recent credit boom, and the flexibility of debt holders
• In light of decreased activity in the space, panelists mentioned that some banks are pushing their related capital markets platform (specifically, negotiating amend & extends and sourcing new capital for struggling companies)
• Panelists predicted that the high level of covenant amendments might result in another distressed cycle in the 2013-2015 timeframe (when a maturity wall of ~$600bn will come due)
• Many companies (despite having pushed out their maturities) will still be underwater and will eventually have difficulty refinancing sizeable issues
• Panelists also discussed the popular topic of distressed municipalities and the general consensus was that many municipalities are facing real distress
• Panel worried about how fast credit spreads have tightened, how quickly banking activity has returned to near 2007 levels. The financing business cycle has been compressed by massive U.S. stimulus programs, leaving open the possibility of a fairly quick return of frothiness in underwriting, then to another credit crunch.

Distressed Investing Panel

Moderator: David Small, Grosvenor Capital Management

Panelists:

Eric Baer, Chicago Fundemental Investment Partners

David Miller, Elliott Associates

David Trucano, Centerbridge Partners, LP

Michael Watchorn, PIMCO

• Panel began with each investor discussing strategy and talking through an investment. Names discussed included Quebecor World, Delphi, Tribune and an unnamed finance company.
• Panel then turned to the current location in the distressed cycle. They worried about how fast credit spreads have tightened and how liquidity returned so quickly. Panel is generally cautious on fixed income assets and particularly sovereign debt.
• They turned attention to the shift to the increasing sophistication of investors in bankruptcies and how the smaller sophisticated claim holders can obtain higher returns.
• The panel turned to sourcing opportunities. It was emphasized that in determining new opportunities investors should look for businesses owned by unnatural owners.
• Panelists agreed on the companies facing commodity pressure (both agricultural and oil) will face hard times in the next two years.
• Another source of opportunity will likely be Europe due to both fiscal crises and changing financial regulations.
• Panelists discussed whether it is better for young investors to be generalists or specialists, with the panel divided on which is best. One consistent theme was repetition and muscle memory and an emphasis on being part of lots of investments.

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Aegis Funds - High Yield Commentary

A few months ago, we featured the team from the Aegis Funds in our emerging manager interview series. The team is out with their Quarterly Letter (embedded below), and as usual, it's fantastic. Here are some of my takeaways:

• The Aegis High Yield Fund outperformed by 100 bps for the quarter. This might not seem remarkable, except when you realize their duration is 2.7 versus 4.6 for the Barclays HY Very Liquid Index
• Great quote: "Currently, the Federal Reserve is in the process of completing a renewed $600 billion program of debt monetization through money printing, known as QE2, which has now resulted in a near tripling of the monetary base since early 2009. The enormous surge in liquidity from this questionable economic policy has forced short-term interest rates to extraordinarily low levels, driving all manners of investors into risk assets to avoid the painful, slow erosion of purchasing power when holding cash or treasury bills with yields under the rate of inflation. In this low-rate environment, high yield bonds have certainly proven to be a popular asset class with investors. The first quarter of 2011 was no exception, with Credit Suisse estimating high yield fund flows of $5.4 billion."
• Aegis believes the amount of excess reserves held at the Fed will ultimately result in inflation if bank turn the lending spigot on
• Fantastic quote on Washington (a point I 100% agree on): "While the Federal Government continues on track to spend more than $1.5 trillion more than it receives this year, politicians recently declared a shutdown-averting victory with a $38 billion “compromise” cut in the $3.8 trillion federal budget. While the Washington Post hailed the “Biggest Cuts in U.S. History,” anyone with basic math proficiency can understand the intellectual incoherence of touting a one percent cut in a federal budget in this fashion, particularly given that the federal budget has increased by an incredible 40 percent since 2007. The current level of government spending is clearly unsustainable."
• Letter notes the recent move up in pricing for basically everything and the Fed's lackluster response
• Another point I 100% agree on - and probably worth of a future post: " Government inflation statistics themselves are also suspect, having been subject over the years to changes in calculation methodology, which now include modifications such as hedonic adjustments and substitution effects, all of which appear to moderate the reported rate of inflation. Reported inflation would have hit an annual rate of 9.6 percent in February, had the reporting methodologies remained consistent with those in place prior to 1980, according to the Shadow Government Statistics newsletter."
• The aforementioned points are the reason why the fund has kept its duration so low
• In addition to keeping duration low they are buying floating instruments, buying underlying investments that will benefit in a raising rate environment, buying foreign corporates and converts
• Favorite quote, and one of the reasons I have been putting less and less money to work: "When credit spreads are low and the yield curve steep with short term rates near zero, fixed income funds have increased incentive to borrow money at ultra-low short rates to finance longer-duration bond purchases to “enhance” yield. In this context, it is somewhat disconcerting to note that reported margin debt has now increased to $310 billion in February, up a significant 7.2 percent from January and well up from its $200 billion post-crash low in early 2009.
• Largest Purchase for the fund: Reddy Ice 11.25% of 2015
• Playing higher up in the cap structure: 71% of fund in Senior Secured issues or unsecured bonds with nothing ahead of them in the cap structure

For more information about the Aegis High Yield Fund, please visit: "http://www.aegisfunds.com/highyieldfund/"

Ahyfx q12011 Letter

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