Hedge Funds Pounce on Debt Amid Turmoil

Unfazed, Some Take
Advantage of Reluctance
To Buy Loans, Bonds

By GREGORY ZUCKERMAN, HENNY SENDER and ALISTAIR MACDONALD
July 28, 2007; Page B1

The turmoil in the credit markets is beginning to wound some high-profile hedge-fund managers -- but it's prompting others to swoop in and snap up some beaten-down assets.

Sowood Capital Management, a hedge-fund firm founded by a manager who had helped run Harvard University's endowment, has sustained significant bond losses lately. The firm is down about 10% so far this year.

DEBT DILEMMAS

• Scorecard: How credit-market tremors have affected junk bonds, LBOs and hedge funds

• Complete Coverage

The firm, which trades both stocks and bonds, has sold various positions, including merger-related shares, to raise cash to deal with continuing difficulties in the credit markets and to raise money for potential margin calls from its lenders.

A number of hedge funds have profited by anticipating the difficulties in the housing market. But others made money in recent years through holdings of riskier debt, and now these managers are seeing their securities drop in value. At the same time, their investors want to get out of the funds and lenders are demanding more collateral, forcing additional sales.

Some financial pros sitting on cash are looking to take advantage of the situation. Wall Street's Goldman Sachs Group Inc. is launching a $20 billion fund to invest in corporate debt. The fund was expected to amount to $12 billion but has been expanded to take advantage of the turmoil in the market, according to people familiar with the matter.

"It may be fortuitous, but the timing is superb as it relates to the markets," says John Danhakl, a partner with Los Angeles-based private equity firm Leonard Green & Co. LP.

A Goldman spokesman declined to comment.

Hedge funds such as TPG Axon and GSO Capital Partners, which had kept some of their powder dry, were among those pouncing on debt of companies whose bonds have traded down amid a massive supply of debt, according to people close to the matter. They also are offering to help private-equity firms finance deals that the banks are unwilling to underwrite, these people add.

These funds are taking advantage of a sudden unwillingness on the part of investors to continue to buy loans and other products that have financed buyout deals.

Funds such as TPG Axon and GSO are approaching the banks and offering to take both loans and bonds off their hands -- at a sizeable discount, attracted both by the discount and the generous yield. Several hedge funds, for example, bought huge chunks of junior slices of the debt of Dollar General at 87 cents on the dollar, which amounts to a 17.5% yield.

Kohlberg Kravis Roberts & Co. won the retailer in an auction which saw Bain Capital, Blackstone Group and TPG all drop out as the price rose. Investors are especially nervous about Dollar General because of the debt load and because there is general concern about retailers vulnerable to a slowdown in consumer spending.

Hedge funds are discovering that their ability to borrow money to bet on the markets is drying up because the banks themselves are under pressure, left with commitments to fund deals as investors retreat. In many cases, brokers are calling hedge funds and asking them to post more collateral as the value of their holdings plummets.

At least one hedge fund is unfazed by the new environment. AQR Capital Management LLC, based in Greenwich, Conn., plans to file registration documents for an initial public offering of shares on Monday intended to raise $500 million, according to a person familiar with the matter. The deal is being handled by Goldman, Lehman Brothers Holdings Inc. and Credit Suisse Group's investment banking unit, this person said.

Run by a group of former executives from Goldman's asset-management division's quantitative-research team, including Clifford Asness, AQR, with roughly $35 billion under management, is one of the world's largest hedge funds. The firm was founded in 1998 and has had top-notch returns.

Fund managers on Friday were eagerly trying to determine which of their colleagues were feeling the pain from the market's drop. So far, Sowood seemed to be one of the only prominent names affected. Sowood has met the margin calls and isn't closing down, according to a person familiar with the matter. Sowood doesn't face any potential redemptions from its investors until the end of 2008.

At Sowood, the person close to the matter says the hedge fund is down about 10% this year, with most of those losses coming in the past two months.

Sowood was launched with fanfare by Jeffrey Larson, who has one of the most-impressive pedigrees in the hedge-fund world. Mr. Larson was among a group of managers who picked investments for Harvard Management Co., which remains an investor in the firm.

--Kate Kelly, Anousha Sakoui and Kate Haywood contributed to this article.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com, Henny Sender at henny.sender@wsj.com and Alistair MacDonald at alistair.macdonald@wsj.com