Hedge funds are increasingly selling credit-default protection on bank loans to corporates in emerging markets as a way of gaining exposure to this high-yielding debt. Emerging-market sovereign debt has always been attractive to hedge funds but as the sector has become crowded the squeeze on yields has prompted funds to look at emerging-market corporate debt and local-currency issues.
Dealers report that they can now originate emerging-market corporate loans and swap the risk via credit-default swaps and total-return swaps with emerging-market focused hedge funds. The advent of standardized documents on loan-only CDS has brought more hedge funds into this type of swap. Firms are also issuing debt securities via private placements and hedging these via credit-linked notes, again sold to hedge funds.
According to a hedge fund salesman at a U.S. investment bank, special situation and distressed debt funds have been out in front with this strategy. They tend to have offices in these countries and carry out extensive due diligence on the companies before selling protection on the loans made by banks. Hedge funds are not making the loans themselves because banks often already have relationships with these corporates.
Ashmore Investment Management was cited as a fund that may have entered this type of swap. Officials at Ashmore did not return calls.
Most activity has focused on Eastern Europe, with corporations in Belarus, Kazakhstan and Ukraine recently receiving financing via both private foreign loans and private-placement deals. Financials and commodity-heavy companies have seen the largest inflows while telecoms, consumer goods and real estate development firms have also had deals structured this way. Names of corporates could not be determined.
For the banks involved, the benefits of not having to syndicate these loans for risk management has upped their underwriting profits.
Hedge funds in turn are keen on ramping up emerging market debt portfolios because traditional institutional investors are more and more interested in buying into these high-yielding strategies. Gary Kleiman, founder of emerging market advisory firm, Kleiman International Consultants in Washington, D.C., explained there has been a slowdown in yields for sovereign debt and as a result money managers have invested more into emerging-market hedge funds among other alternatives. "Investors have been moving out the learning curve as well as the credit curve," Kleiman said. "This is the next logical progression."
