GCA Credit Opportunities Fund: Global Credit Advisers

Global Credit Advisers, which invests in high yield and distressed single name corporate credits, has generated annualised returns of almost 40% since inception in October 2008 with one down month.

Global Credit Advisers (GCA) has emerged as one of the top performing credit managers in the hedge fund industry since it was established in late 2008.

GCA’s investment team, led by founder and chief investment officer Steve Hornstein, has expertly navigated the twists and turns of the US economic recovery, combining deft macro calls and deep fundamental research with sharp trading skills to generate strong returns for investors.

The GCA Credit Opportunities Fund invests in high yield and distressed single name corporate credits, employing a long/short trading strategy. The fund has generated annualised returns of almost 40% since inception in October 2008 with only one down month.

The strong performance, underscored by a gain of over 67% in 2009, has attracted significant interest from investors. GCA’s assets under management have grown to over $250 million from less than $12 million at launch in spite of the difficult capital raising environment for start-ups.

In many respects GCA is an unlikely success story. It was founded at the height of the financial meltdown by a team of portfolio managers and traders from Sailfish Capital Partners and Stonegate Capital Management, two hedge funds that closed their doors amid the market turmoil in 2008.

Hornstein was formerly a minority partner at Sailfish, a multi-strategy credit hedge fund, where he launched and ran its leveraged finance portfolio. Sailfish liquidated its positions and returned money to investors in early 2008 after its flagship fund registered a negative return in 2007.

Prior to joining Sailfish in 2006, Hornstein was a partner at long/short credit hedge fund Pinewood Capital and Imperial Capital, an investment bank specialising in high yield and distressed debt. He started his career at the investment bank Donaldson, Lufkin and Jenrette where he spent 18 years and became head of high yield and institutional corporate bond trading.

John Fusek, a co-founder and director of research at GCA, and trader Josh Hariton also previously worked with Hornstein at Sailfish Capital Partners.

The senior management team at GCA includes chief operating officer and director of risk management Brian Hessel, senior credit analyst Daniel Charleston and chief compliance officer Timothy Finn. All three previously worked together at Stonegate Capital Management, a long/short credit hedge fund that was wound up in 2008. Stonegate’s returns held up through the market downturn but it shut down due to difficulties raising capital in a challenging environment for credit funds.

Hornstein speaks positively about his time at Sailfish despite its sudden demise, noting he was given the independence to build an investment team and launch and run a trading strategy. He says the biggest lesson to be learned from the collapse of Sailfish and other hedge funds at this time is the need to minimise and manage leverage carefully.

“Leverage has not historically played a big role in high yield trading but it was the main reason a lot of hedge funds got into trouble in 2007 and 2008,” says Hornstein. GCA employs minimal leverage and focuses on maximising returns through careful security selection, he stresses.

Hornstein was eager to get back on the field after Sailfish shut its doors in early 2008. The markets were chaotic and volatile but Hornstein’s experience told him the environment was a good one for GCA’s long/short credit trading strategy. “Our strategy has a significant trading component, so volatility is a plus,” he says.

Raising external capital was almost impossible, but Hornstein decided to launch the fund regardless, reasoning that it was a good time to establish a track record. “We really wanted to get back into the markets. The trading opportunities were too good to pass up,” he says.

The GCA Credit Opportunities Fund launched in October 2008, a few short weeks after the collapse of Lehman Brothers. It was a gutsy move but one that paid off handsomely. The fund registered positive returns in each of its first three months, finishing 2008 up 13.02%.

Hornstein and his team have been posting impressive returns ever since. The GCA Credit Opportunities Fund enjoyed a banner year in 2009 gaining over 67% and was up 18.22% at the end of October 2010.

Hornstein attributes the fund’s strong performance to GCA’s investment process. This combines top-down macro analysis with bottom-up fundamental credit research and active trading.

The portfolio is built around a number of sector themes which reflect the investment team’s assessment of various macro factors such as interest rates, fund flows, commodity price moves and changes in government policy.

The macro view determines sector selection and also influences the directional bias of the fund and the sizing of individual positions. “We try and understand the likely outcomes of a whole range of different sector themes and then express those views through single name credits,” Hornstein explains.

For instance, GCA started selling the credits of independent power producers for the short side of its portfolio on the basis they would suffer from the continued slide in natural gas prices. Hornstein also purchased healthcare companies in early 2010. He reasoned that the expansion of insurance coverage under the Obama administration’s healthcare reforms would create increased demand for services, more than compensating for lower prices.

Security selection is based on bottom-up fundamental credit research. “Once we have our themes, the next step is to drill down into the capital structures of companies in the sectors we like or don’t like to identify the securities that offer the best risk/reward for the long and short portfolios,” says Hornstein.

The fund is relatively diversified, targeting around 75-85 positions in a range of different sectors across its long and short books. Notably, GCA is committed to maintaining a robust portfolio of short ideas in both up and down markets.

“The short book is not there to be an insurance policy against our long positions. We try to make it a profit centre for the fund,” says Hornstein. GCA is careful about managing its short exposure, he adds. The short portfolio tends to consist of smaller positions spread across a greater number of names.

Shorts were a significant contributor to GCAs returns through the end of 2008 and in the first quarter of 2009. Hornstein shorted companies in the technology, chemicals, retail and consumer discretionary sectors, focusing on levered credits at the bottom of the capital structure of companies that were on the verge of breaching debt covenants.

The short portfolio has been a relatively small contributor to GCA’s returns over the past 18 months given the lengthy and substantial rally in credit markets. “We have continued to maintain a healthy portfolio of short ideas but this has been weighted to be a smaller percentage of the overall fund, reflecting our view of the macro environment,” says Hornstein.

GCA was not caught by surprise when credit markets began to rally in March 2009. “We were in the markets. We could see the liquidity coming back in,” says Hornstein. GCA quickly reduced the size of its short book and began purchasing the credits of strong companies in favourable sectors that would also benefit from the return of liquidity to the marketplace.

GCA’s returns in 2009 and 2010 have come from a series of well timed bets on the recovery of various industry sectors. One of Hornstein’s most satisfying trades was going long the credits of auto suppliers once the US government orchestrated its bailout of GM and Chrysler. “The government basically came in and removed the headline risk in the trade,” says Hornstein.

By this point most of the big auto suppliers had already gone through restructurings and cleaned up their balance sheets. “Considering the rationalisation in the sector, the low interest rates and the stimulus programmes, we felt many of these companies were well positioned on the upside.”

And so it proved. The US government’s ‘cash for clunkers’ programme helped stabilise car sales in 2009 and several auto suppliers returned to profitability after making job cuts to rationalise their businesses for lower production volumes.

GCA was also long chemical companies, having previously shorted the sector, and pursued a number of commodity based themes in the energy and food processing industries.

Hornstein’s healthcare bet also contributed significantly to returns in 2010. GCA exited some of these positions recently as the team believed valuations had become stretched. The fund is now getting back into select healthcare names. Hornstein cites GCA’s ability to trade around positions actively in this way as one of its competitive advantages.

“There is a lot of trading experience at the firm. We don’t have an exit price in mind when we enter a trade but if we believe a position is getting too expensive, we will sell. We continuously debate the relative value of every position in the portfolio,” explains Hornstein.

Going into 2011 Hornstein continues to favour many of the themes that have done well for GCA over the past two years. He sees more value in healthcare and continues to hold positions in car suppliers, some of whom he believes will work themselves back to investment grade in the next 6-18 months. “The balance sheets in the auto supplier sector are relatively strong, cash flows are good and the cyclical dynamics of replacement vehicles are still attractive,” he says.

Hornstein also likes the energy sector. GCA is long some land based exploration and production companies, especially those that are weighted to oil.

The investment team is closely monitoring corporate activity with a view to putting on more special situations trades in 2011. High yield issuance hit record levels in 2010 as levered companies took advantage of the favourable market conditions to refinance debt maturing between 2011 and 2014. Hornstein believes there is more to come.

“Good companies have refinanced much of their maturing debt but there is still more to do to get short maturities off the balance sheet. Bad companies always struggle but the capital markets have been accommodative and we think that will continue in 2011,” he says.

GCA has already profited from a number of event driven positions in names that have refinanced, but it has only participated in about half a dozen bankruptcies to date. The default rate in 2010 has been “virtually non existent from a historical perspective” and opportunities for traditional distressed plays have been few and far between.

“We think of distressed as an opportunistic strategy. It could get more interesting in 2011 when we expect default rates to pick up to between 2.5% and 3.5%,” comments Hornstein.

Hornstein is confident GCA can maintain its positive performance in 2011 although he is quick to stress the investment team is very conscious of headline risks and macro headwinds. One of his main concerns is the increase in mergers and acquisitions which poses an inherent risk to GCA’s short portfolio.

“If high yield names are acquired by investment grade companies, their bonds could rally substantially in a short space of time. That’s the type of scenario that we are always looking to avoid,” Hornstein explains.

He says GCA’s returns will ultimately be driven by disciplined adherence to its investment process. “We basically call the same play regardless of the market environment. We want to be long the themes, sectors and companies we like and short those we don’t. We will position the portfolio and size trades to reflect macro conditions. That’s not going to change,” he states.

Given GCA’s returns to date, investors will be happy with more of the same.

 

Fund facts
Full name of fund:	GCA Credit Opportunities Fund
Portfolio manager:	Steve Hornstein
Investment/management company:	Global Credit Advisers
Contact information:	www.globalcreditadvisers.com
Launch date:	October 2008
Assets under management:	$250 million
Annualised returns:	39.64%
Total return since inception:	124.14%
Strategy:	long/short credit
Prime broker:	JP Morgan
Administrator:	Butterfield Fulcrum Group
Auditor:	Rothstein Kass
Law firms:	Carter Ledyard (US), Maples & Calder (Cayman Islands)
Domicile:	US & Cayman Islands
Management fee:	2%
Performance fee:	20%
Minimum investment:	$1 million
Redemption period:	quarterly with 60 days notice
Lock-up:	none, 3% redemption fee in first 12 months