Bonds of Blood

Bonds of Blood
By MICHAEL SHARI | MORE ARTICLES BY AUTHOR

Distressed-debt specialist NZC Guggenheim has put up top performance numbers over the last three years. Why portfolio manager Todd Boehly thinks 2012 will be another "grind."


Before putting up the seed money for Todd Boehly's opportunistic credit fund in the midst of 2008's financial crisis, a tough-minded investor told Boehly he wanted assurance that if it didn't work, the portfolio manager was going "to live with it not working." So the leveraged-finance specialist put the first initials of his three sons, Nick, Zach and Clay, in the name of the fund.
Boehly and his young sons haven't had much reason to distance themselves from the NZCG Guggenheim Fund so far. Launched from a separate account Boehly was running at Guggenheim, the fund has been among the top performers in the U.S. over the last three years. Today totaling $1.45 billion, NZCG was up 65.61% in 2009's recovery and 24.09% in 2010, according to Morningstar. It finished sixth (under the name NZC Guggenheim Total Return Strategy) in Barron's Hedge Fund 100 last year. In a poor year for hedge-fund returns, the fund gained 11.21%, net of fees, in 2011.
The long-time Credit Suisse professional, 38 years old, defines his approach as "identifying good companies that deserve to exist." He starts by avoiding ones that are capital-intensive. Then he and the senior members of his team―Steve Sautel, Mike Damaso, Tony Minella and Adrian Duffy―determine a company's enterprise value, which is the sum of its debt and equity, minus its cash. They put particular emphasis on cash flow and how a company likes to spend it. The group also assesses sales prices of comparable companies, and what they think the company could earn.
"Once you identify good companies, you look at various securities in their capital structure and you identify where the best odds are," says Boehly.
THE FUND IS PART OF Guggenheim Partners, a privately held firm that generates most of its revenue from managing $125 billion in assets in hedge funds, mutual funds and separate accounts. Owned partly by Peter Lawson-Johnston, the fifth-generation scion of Meyer Guggenheim, the company started out a dozen years ago managing the money of the Guggenheim Foundation, which now represents a small minority of its total assets.
Using a classic deep-value strategy, Boehly buys debt of companies whose fundamentals he likes, but that others believe to be at high risk. Then he waits patiently for the market to realize that any problems aren't specific to the company and to drive up the debt prices. Even if the issuer defaults, NZCG is content to convert its debt to equity and wait for the stock price to rise.
Backed by a 90-person credit-research team that includes a 15-person legal team, NZCG covers more than 1,000 companies and has the flexibility to invest across any company's capital structure in any industry. Boehly prefers bank loans because their covenants keep companies to their payment schedules. In particular, he favors senior-secured loans because they're less volatile, offer relatively long maturities of five or seven years, and stand at the top of the issuer's capital structure, where he can get his money back first if anything goes wrong. But the fund also buys debtor-in-possession financings, middle-market loans and, further down the capital structure, second-lien loans, high-yield bonds and private mezzanine debt. NZCG will buy equity, though not in a short sale.
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David Yellen for Barron's
Boehly's high-performing debt fund first finds distressed outfits he likes, then selects the capital position he wants."Right now we are comfortable, on a nice company, with [a yield of] somewhere between 8.5% and 10.5%," he says.
Boehly's goal is to generate a return of 600 to 800 basis points (a basis point is one-hundredth of a percentage point) over the Barclay's U.S. Corporate High Yield Index, which was up 5.3% in 2011. To achieve this, he doesn't depend entirely on the $1 billion that investors have put into NZCG. Like many leveraged financial funds, it borrowed money, utilizing $450 million via a 12-year loan, which expanded the total investable assets to $1.45 billion.
He explains that NZCG has added $150 million in equity from its coffers to the $450 million, which allows it to invest another $600 million in all. The loan doesn't have any "triggers" permitting the lender to call the loan, so Boehly doesn't have to worry about marking the assets to market daily. NZCG also is able to distribute to its investors the difference between what it makes on the $600 million in investments and its interest expense, which is low because of the generally low level of rates. In all, he says, this can make for a total gain of nearly 20%.
NZCG'S INVESTMENTS ARE SPREAD across industries from ketchup to paper clips. In November 2008, the fund bought a bond issued by H.J. Heinz (HNZ) with a low investment grade of BBB at a yield-to-maturity of 11.5%―and sold it just nine months later, in August 2009, for a return of nearly 60%. The team had determined that Heinz was a good bet because it was about one-third less leveraged than the typical issuer of a high-yield bond.
The fund raked in a return of about 50% on a five-year Staples (SPLS) bond that it bought in January 2009 and sold just four months later, in May 2009. The team was drawn to Staples because, although the retailer's debt was double its Ebitda, it still had almost $1 billion in free cash flow annually, and its stock was trading at about eight times earnings.
NZCG has also done well with first-lien loans, which give it priority over other lenders in the event of default. It scored a 30% return on first-lien debt issued by privately held Renal Advantage, an end-stage renal dialysis provider that proved stable in the last recession; NZCG bought the debt in October 2008 and sold in June 2010.
It raked in a 65% jackpot on Allied Capital (AFC), a business-development corporation whose debt it started purchasing in May 2009 for about 45 cents on the dollar and sold in April 2011. The team was confident because its investment was covered three times over by the value of the company's assets.
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David Yellen for Barron's
Boehly (center front) with team (l-r): Adrian Duffy, Steve Sautel and Tony Minella.THE "ACHILLES HEEL" of distressed-debt strategies, as Boehly puts it, is that bonds and loans "are liquid when we don't need them to be liquid." In other words, they tend to get sold in huge amounts all at once in times of stress, like late last summer. Last year's returns would have been higher if not for a drop of 7.66% from Aug. 1 to Sept. 30, half a percentage point more than the Barclay's index, when Europe's sovereign-debt crisis plunged the global fixed-income markets into their worst turmoil since the collapse of Lehman Brothers in 2008. Of course, NZCG used the turmoil to pick up assets on the cheap.
He expects more of the same in the year to come. "My expectation is that 2012 is going to be a lot like 2011," he says. "It will be a grind. There isn't a lot of growth out there."
But this is a fund that smacks of confidence. It does not charge performance fees unless Boehly delivers a return of 8% in a given year. And then it charges a range of 10% to 20% depending on how good the performance was. The management fee is low by hedge-fund standards, at just 1.5% of assets under management. But investors must be equally confident, as the fund has a long lock-in period of three years before they are allowed to withdraw their money, and are required to give 90 days notice. And they are expected to put up $10 million each.
After all, Boehly has put his sons' initials on the bargain.