Earlier this year Solus Alternative Asset Management in New York reported to clients that it had raised $1.1 billion for its two funds that invest in late-stage bankruptcy claims, including those against Lehman Brothers, the estate of Bernard Madoff, MF Global and Hostess subsidiary Interstate Bakeries Corp.
With those two funds now fully deployed, Solus plans to complete its capital closing on two new funds in October or November, according to people familiar with the firm. The Solus Recovery Fund III and the Solus Recovery Strategies Fund will also invest in late-stage bankruptcy litigation-related claims.
Christopher Pucillo, president, CIO and founder of the $3.3 billion alternative-asset firm, declined to comment, but sources say Solus expects to have capital commitments of more than $200 million for the new funds. The Solus Recovery Strategies Fund seeks to offer investors more liquidity than the firm’s existing funds, with a two-year lockup period rather than its usual three years.
Trade claims such as those offered by Solus have developed into a business worth more than $40 billion. Late-stage bankruptcy claims in particular have gained a strong following among investors during the past couple of years. Part of their attraction is that in a climate in which high yields are hard to find, these claims offer a debt instrument with a relatively high and virtually certain payoff — even if the payoff takes several years. The claims, which may be against corporations, banks, government agencies or individuals, are far enough along in bankruptcy or litigation proceedings that an investor can count on a cash distribution as well as a timeline for the distribution, although there is always a slight risk of a judge finding unexpected reasons to delay the payouts.
Sam Katzman, chief investment officer at Constellation Wealth Advisors, a $4.4 billion multifamily office in New York, sees late-stage bankruptcy claims as something of an antidote to low yield in a time of what he calls “financial repression due to Federal Reserve policy.” Someday the Fed will wind down its quantitative easing program and interest rates will rise, but Katzman says bankruptcy claims will have to offer even higher rates. Besides, he says, tapering will only add to the supply of claims.
“One of the unintended consequences of QE is that a lot of companies are borrowing money that shouldn’t be,” says Katzman. “It’s unfortunate for those that get themselves into trouble, but when rates go up, there will be some new opportunities.”
At Gapstow Capital Partners, a $1 billion fund of hedge funds in New York that began allocating to funds that invest in bankruptcy and liquidation claims this year, senior investment analyst Manish Valecha likes the fact that such claims are not dependent on market performance. “Most of the recovery value has already been determined,” he says.
A fund manager can also find various levels of liquidity, hence the possibility for funds that can promise early payouts. That is thanks in part to very large and actively traded claims, such as those against Lehman Brothers. But the liquidity can also vary depending on the capital structure of the claims. “In the case of MF Global, for example, you have claims from bonds that the firm backed, bank debt and customer claims,” says Valecha. The bonds will be the most liquid of these claims, while the payouts for customer claims are likely to take longer.
Many hedge fund firms invest in late-stage bankruptcy claims, including New York–based Paulson & Co. and San Francisco’s Farallon Capital Management. Fewer have funds dedicated to bankruptcy or liquidation claims, however. In addition to Solus and Greenwich, Connecticut–based Contrarian Capital, those that have specific bankruptcy or liquidation funds include Serengeti Asset Management and distressed debt firm Stone Lion Capital Partners, both based in New York.
Solus launched its first late-stage bankruptcy fund in the summer of 2012 and its second that fall. The Solus Recovery Fund I is up about 10 percent this year through August. The Solus Recovery Fund II rose 5.5 percent during the same period. The firm’s 11-year-old flagship Sola Fund, up 19.5 percent this year through August, is a large investor in the over-the-counter shares of MGM Holdings. The entertainment studio, which emerged from bankruptcy in 2010, is expected to launch an initial public offering or be acquired in the near future.
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