Blue Mountain Credit Alternatives Fund sent its first-quarter letter to investors recently. The fund was down 3.93% net for Class S and 3.81% net for Class L. Fund management blamed “a combination of idiosyncratic, unrelated events and the underperformance of the Systematic Equity Strategy” for the disappointing returns. However, the fund did better in April with a 2.16% net gain for Class S and 2.2% gain for Class L. Blue Mountain is now down 1.85% and 1.69% for the two classes respectively, year to date.
CLO Equity loans remain biggest holding
The fund’s management highlighted two positions in their Q1 letter, which was reviewed by ValueWalk. Blue Mountain’s biggest position is still CLO Equity, of which nearly all is in deals managed by the fund. Even though the issuance environment was more challenging for the company, the fund completed two new issues in the U.S. and Europe during Q1.
For the collateral on the fund's loans, the team boosted exposure to names they have more conviction in and slashed exposure to those whose risk/ reward profiles appeared more "marginal." They hit most of their targets for boosting the fund's average loan spread during the selloff during the fourth quarter. However, they still managed to shift further into loans with lower prices and wider spreads.
They added that their CLO loans are more defensively positions compared to peers at an average asset spread of 336 basis points versus the median of 345 basis points among peers.
Global Lending Services was the biggest change
The Blue Mountain team boosted their allocation to the subprime auto loan originator Global Lending Services. The fund began a majority equity stake in the company in 2013 and started a loan purchasing program with the company a little over a year ago. The equity part of this position represents about 65% of Blue Mountain's exposure to the firm. An equity market-up boosted the value of the position during Q1.
The fund's management said GLS has been successfully executing its strategy, and its earnings have been better than their expectations. The Blue Mountain team hedged the fund's exposure to GLS to protect against weakness in the consumer credit and auto sectors by shorting a number of auto finance and manufacturing credits.
Credit market rally
After Q4's selloff, the credit markets rallied in Q1, and the Blue Mountain team sees plenty of opportunities that will fit with their relative value strategies. They noted that strong periods of risk-on and risk-off sentiment are good for risk taking via relative value because other investors are selling or buying assets "more indiscriminately." They also pointed out that the high-yield credit spread dispersion jumped during the fourth quarter and has remained high since then.
During the first quarter, lower-quality credits tended to underperform their index betas. The fund's management sees some strong short opportunities after the Q1 rally. They are still monitoring wider spread longs and "situational opportunities" in which they believe their investment theses are unique.
Leveraged loans lagged high-yield bonds so far this year, mostly due to flows. They noted that mutual funds focused on loans have saw major outflows over the last six months, driven by the Fed pivot to a dovish view of interest rates, which slashed interest in floating rate credit. Retail investors preferred high-yield bonds instead.
The Blue Mountain team is now looking into additional loan opportunities for their Fundamental Credit strategy and CLO portfolios.
Top and bottom performers
The fund's Distressed and Special Situations strategy underperformed mostly due to three positions. One was its CDS credit position in Windstream, which subtracted 1.25% gross after a legal ruling that went against it, resulting in its bankruptcy. Blue Mountain exited the position.
The fund's long position in Pacific Gas & Electric (PG&E) also worked against it during Q1. The position was down 0.73% gross in January after the company announced plans to file for bankruptcy. PG&E has since regained some of its declines due to positive market reactions to attempts at improving its governance structure. The company has been a thorn in Blue Mountain's side for quite some time.
Long second-lien holdings in One Call also detracted from Blue Mountain's Q1 returns. Management said a number of disappointing data indicated that enterprise-level integration was lacking. The company also lacked levered free cash flow, and future liquidity concerns were possible. Due to these issues and turnover in the company's management, the Blue Mountain team exited the position.
The fund's Systematic Equity strategy underperformed due to weakness in the medium- and short-term U.S. large cap models. The strongest contributor during Q1 was the fund's Fixed Income strategy, driven by strength in Agency Mortgages and Municipal Bonds.
This article first appeared on ValueWalk Premium