King Street Capital Gains As Lehman Brothers Lives

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King Street Capital Management produced a return of 1.93% gross for investors for three months ended September 30, 2016. After the fees, the fund returned 1.6% net. Unaudited net gains for the nine months ended September 30 are 3.02% according to the fund’s third quarter letter to investors, a copy of which has been reviewed by ValueWalk.

King Street, the large and notoriously secretive credit hedge fund founded in 1995 by Brian J. Higgins and Francis Biondi, profited in the third quarter from its long bets on stressed/distressed credit. Directional long bets on these types of credit earned the fund 1.72% net for the period. Equity long bets cost the fund 0.04%, and short bets cost 0.06% for a net return of -0.1%. Overall long directional bets earned 2.2% for the fund. Short bets cost 0.3%, and overall net profits before hedges were 1.92%. Hedges cost the fund 0.06% and other factors detracted 0.26% from net performance for an overall return of 1.6% net for the period.

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Q3 2016 Hedge Fund Letters

For the first nine months of the year, King Street’s directional credit bets earned the fund 4.1% (4.69% on the long side and 0.59% on the short side) hedges cost 0.08% and other costs detracted 0.99% from overall performance for a total return of 3.02% net.

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King Street profited in the quarter from many positions, but the largest gains came from investments in monoline-wrapped securities and mortgage structured credit. As noted above, distressed positions also paid off handsomely for the fund. A position in the former bankrupt and now interesting NOL play (Syncora – Large Investor Sends Board Letter, Activist Rumblings In The Small Cap Universe) yielded results as the company completed a series of restructuring transactions including an initial distribution to Syncora’s surplus notes.

Syncora is expected to make additional distributions to these notes shortly. Like most distressed credit funds, King Street racked up some gains in the quarter from positions in Lehman Brothers debt. King Street benefited from both a distribution on distressed debt that came in above expectations but also from the monetization of Lehman’s stake in Formula One through a transaction with Liberty Media.

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One position performed well outside of the distressed and bankrupt sector is a new position the fund initiated earlier this year in Sprint debt. King Street notes that the company continues to progress on its turnaround, backed by an improving network and impressive customer acquisition trends. Sprint’s strong earnings and subscriber growth metrics helped drive performance of the bonds.

King Street also discusses the environment in the wider credit sector within its third-quarter letter to investors. The hedge fund notes that asset prices are apparently ignoring potential political risks, and the lack of meaningful yields in the developed world are pushing investors into credits with no other options. Yields are negative on over $10 trillion of sovereign and corporate debt globally, and as a result, “If markets sense that central banks are going to begin tempering their intervention, we expect bouts of volatility to become increasingly common.”

Against this backdrop, King Street remains disciplined. The fund notes that as we are early in the credit cycle, it is best to avoid flawed or subscale businesses with distressed capital structures or weak assets. On the short side, King Street expects to see weakness in particular healthcare, retail, legacy TMT and consumer products businesses as they get drawn into secular or cyclical downdrafts. On the long side, the fund like energy, telecommunications, old media, and certain emerging market credits. In addition, King Street’s managers see opportunities in the European financial sector, particularly those businesses that continue to work through their asset quality issues.

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