Credit Opportunities Funds
Credit opportunity fund is another type of pooled assets vehicle through which a professional manager multiplies investor's money through investing in special credit opportunities.
Credit opportunity fund has been a very popular type of opportunities fund in the recent times. The reason is that the credit market trends and the unprecedented moves of the credit rates. Moreover, the equity markets have lost huge percentage of their value since the beginning of the financial crisis.
As a result, the credit market has had an attractive risk/return profile for 2009 compared to other asset classes, allowing fund credit opportunities fund to develop. Credit opportunity funds have been the largest and fastest-growing segment within the market-value collateralized debt obligation sector.
The credit opportunities fund is designed to generate a high level of current income (when compared to Treasury bonds) consistent with preserving capital and maintaining liquidity by investing primarily in high-grade classes of debt securities and of money market instruments.
The credit opportunities fund aims to generate alpha (excess returns) for its investors through strategies that involve taking active positions across the credit curve. This differentiates credit opportunities fund from other funds currently available on the market and therefore offer an ideal diversification tool for investors.
Credit opportunity fund is typically restricted to investing primarily in liquid credit assets and employs only a moderate degree of leverage. Semi-liquid assets, meaning assets that cannot be marked more frequently than on a monthly basis, are generally limited to certain percentage of the credit opportunities fund's net asset value.
There are two main investment styles that are applied by credit opportunity funds: event-driven and income-oriented. Event-driven strategies involve investments, long or short, in the securities of corporations undergoing significant change (e.g., spin-offs, mergers, liquidations, bankruptcies). Event-driven credit opportunity fund tends to have lower allocations to bank loans and greater allocations to high-yield bonds and special situations.
The current liquidity crisis has caused a great dislocation in the credit market and created a favorable environment for credit opportunity fund. It allowed credit opportunity fund's managers to exploit the gap between the premium on credit obligations and the cost of buying protection against default payment of an issuer (credit default swap or CDS).
This situation is called "negative basis trade", whereby a credit opportunities fund is using arbitrage strategy, as it at the same time buys a bond and the CDS corresponding to protect it from risk of default by the same issuer.
Then, a "buy and hold" strategy since then they can benefit from tightening of the yield spread between the bond and the CDS.
In general, credit opportunity fund issues several classes of shares that differ according to their lock-up period. Credit opportunity fund allows for equity redemptions after a lock-up period that is also subject to certain restrictions, such as restriction on the percentage of capital that can be withdrawn in a single period (e.g. limit of redemptions to 25 per cent per year).
Who should invest in a credit opportunity fund?
Investors that believe that a markets will remain chaotic and that there are further possibilities to profit from the dislocations of the credit rates. Some experts say that the "negative basis" trade, which often is the main source of income for a credit opportunities fund is slowly disappearing.
However, there are many who claim that the situation allowing to benefit from investments performed on the yield curve will always be present, regardless of the prevailing market conditions. Credit opportunities fund is recommended for investors with mid- to long- term investment horizon with a medium risk profile.