Over the last few months, we have profiled a number of managers sub $250 million of assets that I have come to meet through various channels. I met Vladimir Jelisavcic over 5 years ago when he was co-portfolio manager at Longacre. He has always impressed me with his incredible analytical abilities and knowledge of the trade claims market where he is regarded as one of the most prominent players out there. This is an incredible interview. For more information on Bowery, you can visit their website here: http://www.boweryim.com/
Could you please give us a brief run down on your background?
I received my BS from NYU in 1987 and my JD from the University of Iowa in 1993. After graduating from law school, I began working at Bear Stearns trading distressed claims and loans where I became a Vice President. In 1998, I left Bear to found Longacre Fund Management with 2 partners, also from Bear. We ran Longacre from 1998 to 2012, where I served as co-portfolio manager, building assets from $1 million to $2.7 billion. In 2012, when my partners and I decided to return capital to Longacre investors, I founded a new firm called Bowery Investment Management where I continue to manage the Opportunity Strategy. In all, I have been in the distressed debt investment business for 20 years.
How has the investment strategy for Bowery evolved over time, or how is it different from previous iterations?
Longacre’s strategy was a fundamental, bottom-up, value-driven approach to distressed debt investing. We could invest up and down the capital structure in bank debt, bonds, trade claims and some reorganized or leveraged equities. By mandate we could invest up to 20% of the capital managed in trade claims. The Bowery Opportunity Strategy takes a similar approach to distressed debt investing but with a greater focus on niche assets. The Bowery Strategy allows us to invest in less liquid assets where we think there are better return opportunities. We focus on overlooked or underfollowed capital structures, smaller companies and issuances, and can invest up to 50% of our capital in trade claims. Bowery also focuses more heavily on risk management and volatility control than did Longacre, taking a systematic, top-down approach to hedging.
Vlad, you are well known in the distressed space as an expert in analyzing and investing in claims. Can you talk about how that market is changing and where you see it going in the future?
Trade claims are one of the purest forms of distressed debt investing and a natural byproduct of the bankruptcy cycle. During and immediately following the financial crisis, we saw an abundance of claims available for purchase at attractive prices, as creditors desperately needed liquidity. Now, with default rates at an all-time low, the claims market is less robust than it was 4 or 5 years ago and many of the largest bankruptcies (Lehman, Madoff, etc.) are finally distributing what assets remain in their respective estates. That being said, there are still plenty of opportunities to purchase claims if you know where to look. Large companies such as American Airlines, MF Global and Eastman Kodak have all filed for Chapter 11 within the last two years. A number of smaller companies have recently filed or soon will file, which will further improve supply. Moreover, having an in-house sourcing team, as Bowery does, allows us to locate untapped creditors and smaller counterparties which our counterparties cannot. While the popularity of claims investing continues to rise among hedge funds, most transact in the largest “on-the-run” cases like Lehman, unwilling (or unable) to devote the time and resources to smaller cases. When interest rates rise, so should the number of new bankruptcies, which will give firms with experience buying claims, like Bowery, an edge in finding attractive opportunities.
You launched the Opportunity Strategy very near the end of the crisis period of 2009. Can you talk about investing then versus the current market environment?
2009 represented a historic market dislocation, and there was an unprecedented amount of distressed assets available for bargain prices. We didn’t have to look very hard to find attractive investment opportunities. Now, the opportunity paradigm has shifted as US companies’ corporate balance sheets are strong and persistent monetary policy intervention suppresses interest rates. Distressed capital is concentrated in the same few troubled names (Lehman, TXU, etc.), but there are plenty of smaller companies in distress, as well. In order to differentiate ourselves from other investment managers (and old Longacre), we focus on mid-market companies whose capital structures are too small for many of our distressed debt peers to build meaningful positions. This requires us to be more creative in sourcing opportunities, but this is what distinguishes the Bowery team. We especially like counter-consensus themes, such as old-media, European financials and shipping. Since we consider ourselves process experts, we can apply the same fundamental analysis to a company worth $100 million or $10 billion. Our method in 2009 versus now is the same, we just cast a wider net now, focus on the underfollowed names, and are more cognizant of the political and macroeconomic landscape.
Bowery has $125 million in assets under management yet it has invested in many of the well-known names targeted by megafunds and still managed to outperform the DJ-CS Distressed HF Index. What are the advantages and/or difficulties a smaller investment manager has compared with larger managers?
Over the last 5 years, assets in the distressed debt space have become ever more concentrated. The large investment managers have gotten larger and the largest have gotten super-sized. There are certainly advantages to this for these managers—scale, pricing power, coverage, perceived safety. But, this has also hindered their ability to access some of the most attractive opportunities in the form of smaller companies or issuances. In such cases, the large managers can’t source enough product to create a meaningful position in their portfolios that will “move the needle,” or in doing so they will move the market on the way in and out. This leaves many opportunities undiscovered which of course works to our benefit as a smaller player since it allows us to source a significant amount of product for our portfolio at an attractive price. Not only do these opportunities enhance returns, but they allow us to differentiate our book from those of our peers. A great example of this is the Tribune bankruptcy. Most distressed debt managers bought securities of the holding company, which there were plenty of. Bowery bought the trade claims of the operating companies of which there were only $80mm outstanding, inaccessible (or irrelevant) to larger managers. We started buying the claims at 40 cents on the dollar and received a par recovery
.
Can you talk about your investment process? How does an idea go from being a potential investment to become a portfolio holding?
Our investment process is a time consuming and rigorous approach, but one which has historically generated significant alpha. The process starts with the idea generation phase. Ideas are derived from weekly team meetings, buy and sell side relationships, news runs and bankruptcy filings, all viewed through a macroeconomic and thematic lens. We focus on finding unique, underfollowed opportunities with significant asymmetric return potential. We rely on our extensive industry contacts and market experience to source and vet only the best opportunities. Next we perform a deep, fundamental research analysis of the company, financials and industry in conjunction with discussions with management teams, other analysts and knowledgeable industry contacts. We then select the most compelling opportunities with what we perceive to be the highest risk-adjusted return potential. We evaluate possible catalysts and exit strategies in selecting the appropriate securities in the context of overall market fundamentals. Finally we determine the appropriate size of each position taking liquidity and technicals into consideration. The portfolio is monitored in real-time and positions are hedged, adjusted and traded around on an ongoing basis.
Nearly all of Bowery’s major investments have been in U.S.-based situations. Would you consider more global opportunities? How do you view the opportunity set in Europe?
We are very opportunistic, so while the portfolio has historically skewed towards North American opportunities, we are also active in Western Europe. We don’t do a whole lot of investing outside of these two regions because those are where we best understand bankruptcy case law. At the close of March 2013 we were 80% net long; 56% in North America and 24% in Europe. This significant European weighting is reflective of the current market environment in which fundamentals of American companies are relatively strong compared to those of European ones. I expect the opportunity set in Europe to remain attractive for the near term until sovereign debt issues are fully resolved and austerity measures absorbed. Nonetheless, we are never at a loss in finding unique opportunities domestically.
With so many people having differing opinions, we'd like to hear your thoughts on the credit markets today. Is high yield in a bubble right now?
I am not sure I would call the high yield market a bubble, but it is certainly overbought. The average yield on speculative grade bonds fell below 6% for the first time ever in recent months, and spreads are at historic lows. Treasury rates can only go up from here. This will tighten spreads even further before risk premiums undoubtedly rise, and the high yield market cools off. When and to what extent this happens is more difficult to say but a correction is likely.
How do you manage your book? Claims generally have a lower liquidity profile than on the run credit? How do you balance illiquid vs liquid?
Our strategy is constructed to match the duration of our book so we are not forced to sell out of a position prematurely and take a haircut. The strategy accommodates the less liquid trade claims part of the portfolio which can be up to 50% of capital (35% in claims at the end of March). We invest the rest of the book in more liquid distressed bonds and bank debt which generates a significant amount of alpha, but also provides liquidity and diversification away from claims. Furthermore, most of our claims portfolio is invested in liquidations where the distributions are in the form of cash, so there is little market risk associated with this type of exposure. The main risk of a claims position is process and time risk (that the bankruptcy will drag on for longer than expected), but we factor this probability weighting into the price we bid for a claim. In the case where a claim position results in reorganized equity, we may short sell an equity index, or buy a put on an individual name as a hedge. Away from our claims exposure, we characterize and hedge our portfolio in a number of buckets, from equity like risk (ex- unsecured bonds) to lower beta credit risk (ex- secured bank debt) and will express hedges using various indices like the HYG, LQD, and JNK. Our book is constantly monitored in real-time by our head of risk management, and our smaller size allows us to be dynamic in adjusting hedges up and down as necessary.
Can you describe a specific situation where you have passed on a compelling idea because you couldn’t get comfortable with the risks?
One of the most popular shorts in the distressed space in recent months has been JC Penney (JCP). In fact, as of April 15, 36.8% of JCP’s equity float was short. New CEO Ron Johnson failed to transform the chain from a coupon-driven discount retailer to a higher-end, boutique shopping destination. Meanwhile, competitors such as Macy’s and Kohl’s continue to outperform. JCP was burning through cash, but also held unencumbered assets, like real estate, which could potentially be used to secure new financing. This was enough to make us wary of an investment from the short side. Sure enough, within the last week JCP secured a $1.75B financing package from Goldman Sachs, boosting the stock and buying the company time to get back on the right track.
Can you talk about an investment you find particularly compelling today that fits into Bowery's strategy?
We are very bullish on our first lien bank debt holding in R.H. Donnelley (RHD). The investment fits our strategy for a number of reasons. First, the company is a yellow-pages business, and as most people know, print media is out of favor with the advent of smart phones, tablets and digital publications. As I mentioned, we like counter-consensus themes. Secondly, there is only $750mm of the bank debt outstanding, trading today at about 72 cents on the dollar, half of which is held by long term holders. So, there is only about $375mm face value of float. As I also mentioned, we like smaller issuances. So, what is there to like about this company besides the fact that it fits into our investment criteria? First, while print businesses are in secular decline, the rate at which RHD’s business is shrinking has moderated. Second, with little overhead or fixed cost, the business produces an abundant amount of free cash flow which goes to first lien bank debt holders. Thirdly, RHD is “bundling” a digital component with its print renewal offers where the digital component will continue to grow and generate even more free cash flow. Finally, RHD’s parent company, Dex One, recently merged with Supermedia, a competitor, which provided a number of business synergies to reduce costs at both firms. But most importantly, the merger provides tax benefits to RHD which will benefit its creditors. We initiated the position in February 2012 at 39, and the bank debt now trades in the low-70’s. We expect it to be worth par by the end of 2014.
*Disclosure: Bowery is a client of Reorg Research