Victor Khosla Warns Distressed-Debt Hedge Funds Are Losing Their Edge
(Bloomberg) -- Victor Khosla has a message for his peers in the world of distressed-debt investing: You’re losing your edge.
Buying up beaten-down bonds and loans to take control of troubled companies is supposed to be strategic -- not to mention secretive. Yet some creditors are all too willing to team up in the courtroom. Others are quick to flip their stakes, rather than make a longer-term investment in the companies they helped restructure. And just about all distressed buyers lean on Wall Street to execute their trades.
If Goldman Sachs Group Inc., JPMorgan Chase & Co. or Morgan Stanley knows what cards you’re holding, Khosla asks, who else does?
“That’s not a great way to have a competitive advantage,” Khosla, who manages $17.5 billion as founder and chief investment officer of Strategic Value Partners, said in a Bloomberg “Front Row” interview. “Our entire industry is reliant on Wall Street as an intermediary feeding them.”
Khosla, 63, once ran a proprietary-trading desk at Merrill Lynch in the 1990s. Now he prides himself on bypassing broker-dealers when possible, instead tapping a network of lenders and creditors in the U.S. and Europe.
“We go through the Goldman Sachs trading desk, but we also call the banks and the loan funds,” he said. “We get to it faster and we get to it directly, without an intermediary.”
Khosla has seen first-hand how the industry has evolved -- and how it hasn’t -- over the past two decades. He founded SVP in 2001 after stints at Cerberus Capital Management and Moore Capital Management, starting out as a classic distressed-debt hedge fund trading bonds and loans.
As SVP increasingly took control of businesses by swapping debt for equity, he began hiring executives with operating expertise. Today, SVP is the majority shareholder in 10 companies that collectively employ some 15,000 people, accounting for about 40% of its assets. They include Vita Group, a mattress foam manufacturer based in the U.K., and Omnimax International, a maker of rooftop drains and gutters near Atlanta.
Few competitors care enough about what happens to companies they end up controlling, Khosla said. They acquire debt, restructure it (usually into equity) and flip it as quickly as possible with little regard for employees, suppliers or clients.
He called out some of his largest peers -- Oaktree Capital Management, Centerbridge Partners, Avenue Capital Management, GoldenTree Asset Management and Diameter Capital Partners -- but emphasized that his concerns extend to almost the whole industry.
“Ninety-five percent plus of the distressed business is paper investing, paper trading,” Khosla said. “We’re trying to fix businesses which were broken, in bankruptcy. We’re improving the way they run.”
His approach has yielded results. SVP’s returns, averaging 15% a year through four flagship funds, are among the industry’s best and most consistent.
Meanwhile, clients keep giving Khosla more money. Greenwich, Connecticut-based SVP just raised $5 billion for its largest fund yet. Assets under management have more than doubled in three years.
While the amount of bonds trading at distressed levels has tumbled from nearly $1 trillion last year, Khosla rejects the popular notion that pandemic relief programs and monetary stimulus have starved debt buyers of opportunities. SVP has invested $8 billion since the start of 2020 and Khosla wants to put another $4 billion to work in the next 12 months.
“We’re not buying stuff at 90 cents” on the dollar, he said. “Our average purchase price is 70-odd cents. We’re mostly focused on deals which are going to restructure and default right now.”
For now, SVP steered clear of airlines and instead spent $1 billion on debt backed by aircraft. It also bought 33% of Swissport International, an airport cargo handler, previously owned by distressed Chinese conglomerate HNA Group Co.
Khosla is battling in bankruptcy court for control of Washington Prime Group LP, an owner of 100 U.S. malls.
“The next cycle is not going to be that 11-year recovery like you saw from 2008 to 2020 -- it’s going to be faster,” Khosla said. When the next downturn happens, “it’s actually going to be deeper, because some of the things which needed to get fixed in this cycle never got fixed.”
Because they profit from misery and misfortune, distressed-debt investors are often vilified as vultures or locusts. Khosla jokes that by raising $5 billion, much of it from pension funds, he must now be “socially acceptable.”
In the courtroom, however, it’s a different story. Khosla has a reputation for hardball tactics when his gambits are on the line. He frowns on creditors who work together to share research and cut deals of mutual benefit.
And he’d remind his peers that distressed-debt investing is a competition -- one he intends to win.
“We are not their friends,” Khosla said. “We are not a pack hunter. We do our own work. We have our own point of view about how we approach it.”
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