Diameter Is Credit’s Hottest Hedge Fund For One Reason: Speed
(Bloomberg) -- There’s no real secret to the success of Diameter Capital Partners, one of the hottest hedge funds in credit investing. Ask co-founders Scott Goodwin and Jonathan Lewinsohn and they’ll tell you it all boils down to a simple maxim: “Know the names.”
Names is their way of describing the tens of thousands of individual securities in the global bond and loan markets. Know means understanding them all well enough to make decisions faster than anyone else.
“Speed of capital is really what matters,” Lewinsohn, 42, said in a Bloomberg “Front Row” interview. “You don’t have time anymore in this environment to sit for weeks and think about it.”
In credit, the historically slow business of evaluating price against the risk of default, that speed can be disruptive. Diameter’s $6.4 billion hedge fund has bested most of its peers with annualized returns of 13% and minimal volatility since its start on Sept. 1, 2017. This year, the fund is up 9.5% through August, or 14.6% on an annualized basis. Assets across all the firm’s strategies have swelled to more than $9 billion.
Goodwin draws parallels with Chase Coleman’s Tiger Global Management, whose willingness to bid aggressively and close on deals quickly has shaken up the clubby world of venture capital. Doug Ostrover and Marc Lipschultz have similarly rattled the business of non-bank lending at Blue Owl Capital Inc.
“Because we have a proactive process where the research is done up front and we know the names, we can respond in seconds,” Goodwin, 41, said.
Market Speed Accelerating
One reason for the emphasis on speed: Markets move so much faster now. After the Lehman Brothers bankruptcy of 2008, it took 18 months for the corporate bond market to recover. In 2020, investment-grade spreads bounced back to pre-pandemic levels in a third of the time.
It’s also why Diameter is returning a tenth of the capital in its hedge fund to clients by year-end. With so few borrowers in financial distress, the kinds of juicy trades that can drive returns are rare. Instead, the firm is left to bet on decidedly less sexy outcomes, such as a probable upgrade of Netflix Inc. bonds.
Diameter told clients yesterday about the capital return and also that the management fee on its hedge fund is rising slightly.
“The most important thing we’ve taken from seeing failures elsewhere, or periods of failure amid successes, is getting sizing wrong,” Lewinsohn said. “People want to be really relevant: ‘I’m the biggest creditor, I’m in control of this process.’ And that’s great if it works. If it doesn’t work, you’re stuck and you can’t change your mind.”
Lewinsohn and Goodwin met while working at Anchorage Capital Group and hatched the idea for Diameter over meetings at Bubby’s, a comfort-food restaurant in Manhattan’s Tribeca neighborhood. By combining the trading expertise that Goodwin had built at Citigroup Inc. with the research skills Lewinsohn, a Yale Law School graduate, had honed as a clerk for Richard Posner at the U.S. Court of Appeals, they figured the firm could be more nimble than the typical distressed-debt player.
In addition to the hedge fund, Diameter now manages almost $2 billion of structured-credit assets, including $900 million of collateralized loan obligations, or CLOs. A long-only dislocation fund raised in 2020 has since returned 91%.
The Next Act
Goodwin and Lewinsohn plan to expand even further --- into private credit as lenders to buyout deals, into European CLOs and into structured credit with another long-only vehicle. Goodwin predicts that within a few years Diameter may be managing $30 billion.
“What I’m excited about, what we’re so excited about, is knowing more names,” Lewinsohn said. “Last year, in March, we didn’t want to be in distressed yet. We didn’t want to be looking yet at cruise lines and hotels. We wanted to be buying loans and we didn’t know enough loan names.”
There’s another quality that separates Diameter from the credit hedge fund crowd: its tight relationship with Wall Street.
Lewinsohn recalled an episode from the depths of the pandemic panic in March 2020. Goodwin, he said, was proactively calling dealers to advertise what Diameter wanted to buy. Soon, a bank offered him $500 million of loans that a troubled mutual fund had to sell immediately. The price, about 85 cents on the dollar, was a steep discount to what the loans were worth at the time.
Many investors see bank trading desks as adversaries. Kevin Ulrich and Tony Davis, the co-founders of Anchorage, think differently and schooled Goodwin and Lewinsohn to treat banks as partners.
“What we’ve done here is try to put that model on steroids to some extent and be really transparent with the banks, share our research with them at times, try to make them smarter,” Goodwin said. “They know that they can call Diameter on names we know well, and they’re not getting the junior analysts, they’re not getting the junior trader. They’re getting me or Jon.”
Diameter recently subleased space on the 29th floor of a tower in Hudson Yards, the gleaming new development on Manhattan’s West Side. A commanding view into New Jersey only reinforces the self-assured aura of accomplishment. Adds Lewinsohn, “I don’t think there is a lack of ego at the top of this firm.”
So the challenge is not letting the confidence morph into arrogance.
“It’s very easy to get complacent, particularly when you’ve had a little success. We’re happy with things so far, but it’s been almost no time. This is a very hard industry,” he said. “At some point we’ll stub our toe.”
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