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Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization, Second Edition by Janet M. Tavakoli

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CHAPTER 16
Credit Funds

CREDIT HEDGE FUNDS

Limited purpose finance corporations (LPFCs) and convertible bond funds have been in existence for decades. While these funds deal with credit, for the purposes of this section, I do not consider them credit hedge funds and focus instead on more recent funds that aggressively make bets on credit across many sectors. Aggressive credit hedge funds are a more recent product having sprung into existence a few years into this century. As of this writing, these funds are based in London, the United States, and Switzerland: venues that are friendlier to this activity.
Funds that trade only in correlation are also viewed as credit hedge funds. Funds that invest in tranches of CDOs levering the position are also viewed as credit hedge funds. I would not consider convertible arbitrage funds as credit hedge funds for the purposes of this section, but Magnetar, a leveraged structured credit fund, would be viewed as a credit hedge fund.
Many funds have limited mandates, employ little leverage, and invest cash in high-yield and emerging market debt. Other credit hedge funds often have a broad mandate ranging from cross-currency transactions on credits to credit plays within the same sector—for example, trading Citibank versus JPMorgan Chase. Often these funds use total return swaps to engage in leveraged structured credit transactions. As we saw with single-tranche transactions, hedge funds may engage in correlation trades, going long the equity ...

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