Wasserstein eyes debt dislocation | StoneX

^{By Hugh Leask}

As Wasserstein Debt Opportunities (WDO) celebrates a decade in business, the New York-based leveraged loan and high-yield credit investment manager is aiming to capitalize on what it sees as a ‘home-run, high-alpha’ opportunity stemming from pricing inefficiency across its target market.

Launched in May 2013 by president and chief investment officer Rajay Bagaria, Wasserstein’s fund trades high-yield bonds and leveraged loans with a specific focus on mainly private equity-backed, domestically oriented smaller-cap corporate issuers that tend to have broadly diversified businesses.

“These are GDP-type businesses - building products, specialty chemicals companies, essential business services, and so on,” said Bagaria, adding this focus is both a play on the current “domestic renaissance” as well as the strong dollar.

“A lot of supply chains are moving back in-house today, and so we’re now seeing many smaller-cap, domestically oriented businesses doing quite well,” he told Alternatives Watch in a recent interview.

A nimble approach

Bagaria launched Wasserstein Debt Opportunities with backing from Wasserstein & Co., the family office of the late Bruce Wasserstein, which spun out of boutique merchant bank Wasserstein Perella in 2001 after its acquisition by Dresdner Bank.

Prior to that, Bagaria had spent more than eight years at Apollo Global Management, where he led more than $3 billion in public and private high-yield assets spanning loans, bonds, private debt, restructurings and distressed assets, investing across the cycle. He later became a partner at Apollo and a member of its investment committee.

A high-yield investment specialist with more than 20 years’ experience, Bagaria began his career at Goldman Sachs in 2000 as an analyst within its principal investment unit, focusing primarily on private debt investing where the bank had managed a large mezzanine fund running several billion dollars.

While other strategies tend to be concentrated either in long-only fixed-rate debt or long-only leveraged loans, Bagaria takes a more nimble approach to both markets. Here, WDO oscillates between the two sectors based on relative value or the prevailing rate outlook, allowing it to be more agnostic towards yield while less sensitive towards rates, and ultimately taking gains from price inefficiencies.

“It’s the off-the-run, less-liquid market segments, that offer high absolute return, with more opportunistic sourcing, and relative value-focused against bonds and loans,” Bagaria said of Wasserstein’s investment universe. “There are a lot of par players, and there are a lot of distressed players. We’re in the middle, buying stressed debt that’s still performing.”

Gaining an edge

Noting how the average high-yield issuance has soared from a “few hundred million” 15 years ago to some $800 million today, Bagaria explained how this market evolution has expanded the range of investment ideas and themes within the fund’s scope, as smaller-sized issuers and more complex situations become increasingly overlooked by larger investment managers.

“The two major secular themes we see are the growth of the asset class - in terms of the size of issuers, and the funds that buy high-yield debt - as well as the complexity of certain situations,” he said.

“Regarding the growth of the asset class, this is indicative of what has happened in the asset management industry more widely,” he added. “A lot of the smaller names have been weeded out, passive funds have taken share from active ones, and the alternative managers have gotten so large that they are no longer constructive in the smaller issues.”

As passive funds have taken market share from active funds and now need to put “significant dollars” to work, and alternative managers have outgrown their traditional capacity size, this has created more opportunities for larger issuers to raise more debt. At the same time, more issuances are coming from private, 144A participants, where credit documentation and protections are less standardized.

All of which means that high-yield has become a trickier asset class in which to invest, according to Bagaria, which in turn is serving up more complex and unique investment opportunities. “Bigger sizes, more complexity, less regularity - that forms the thesis of our vehicle,” he added.

Continuing on this theme, he said: “The bigger funds have layers of decision-making - investment committees, memos, and so on - and the offering could go in hours. But if you’re a smaller, more nimble manager with a deep expertise in these names and a head start, you can move faster and clear risk at more opportunistic prices.

“If we can focus on the smaller issuers that are less coveted and less in-focus among these bigger managers and bigger hedge funds, and then also focus on complex situations that are difficult for new investors to buy because it requires active managerial mindsets, flexible thinking and deep expertise, then we have an edge.

“These situations are much harder for some groups to figure out, or to source, and it gives us an opportunity to play in a slightly different sandbox that has a natural advantage. Smaller issues have more absolute return, and if we can also do our job through due diligence and sourcing, we can add alpha to that.”

Ringing the bell

This approach has helped Wasserstein generate around 12% net IRR in the 10 years since its launch, outperforming not only the main benchmark high-yield bond index, but also the S&P 500 and the Russell 2000 US small-cap index.

Bagaria declined to comment on the fund’s performance or specific returns, citing SEC marketing rules. However, he noted: “What’s remarkable is that we have done all of this simply by investing in high yield - that speaks to the breadth of the market. Most people like to look high yield as a one directional bet. But we have proven that there are actually lots of different pockets of opportunity within this broad $3 trillion dollar asset class.”

Casting an eye over the prevailing market landscape at 2023’s midway point, Bagaria said the opportunity set in the leveraged loan market is “front and center” of WDO’s agenda right now. Specifically, the strategy aims to delve more into leveraged loans and, later on, pull back and sell higher-priced debt, and begin buying bonds that are more dislocated.

“We are spending most of our time on leveraged loans today,” Bagaria remarked. “It’s incredible to be able to buy top-of-the-capital-structure first-lien debt with 15% unlevered yields at a 20-points price discount. In three decades, there’s only been one opportunity like this before, and that was in the Global Financial Crisis.

“So whether you’re right or wrong within the absolute best entry point, you’re not going to lose money buying the asset class at these levels. In six to 12 months, this leveraged loan opportunity will prove to be an absolute home run.”

He added: “There are a lot of people that are trying to time high yield on spreads, but having been in the market for more than two decades and made a lot of money in distressed cycles, we’re ringing the bell right now.”

Turning to the firm’s client mix, Wasserstein’s strategy has typically found favor with more medium term-oriented money, Bagaria said, describing how the fund has constrained its growth – it currently manages about $450 million in assets – in order to maintain the right amount of capital.

“Being in off-the-run markets requires some patience, and so that doesn’t often line up well with fast capital looking to make a quick bet, in contrast to endowments, foundations, and family offices that like and understand the volatility and understand the buying opportunity,” he said. “For all of our existing investors who have added to us we really haven’t lost money. We have a good track record of keeping our clients and we want to keep it at a reasonable size where the outcomes are very significant for everyone involved.”

Ultimately, the WDO strategy provides a “high alpha component” in an investment portfolio, according to Bagaria. He noted that demand for the fund is rising among groups that do not need 100% of their exposure in a short-duration of BBB bund. Rather, he explained, they are content to “put 10% in us and they can take a portfolio yielding 6% and make it 7.5% or 8%”.

“The groups that partner with us are really looking to move the ball forward with their portfolios. Many consider us a high-impact allocation - high absolute returns for medium-term capital – and they understand that we tend to have our best results during periods of dislocation.”

_{This article, “Wasserstein eyes debt dislocation,” was originally published on July 5, 2023 on Alternatives Watch and is republished here with permission from BMV Digital, Inc.}