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5 Hidden Investment Opportunities for 2008
Jan Alexander
01/01/2008
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Every year holds some new lessons for investors, and
2008 begins with several hard-earned pearls of wisdom: You should not believe
every AAA debt rating you see; real estate prices do not keep rising forever;
the golden age of private equity is over; and euro-denominated assets are an
important hedge against the incredible shrinking U.S. dollar. Now begins a year
of sobriety in which investors must beware the excesses that easy credit
wrought. Worth polled a half-dozen wealth advisors and fund
managers to uncover the best investment opportunities and strategies for a time
when the global economy faces a downturn and, with a presidential election on
the radar, the low-tax era is quite likely nearing an end.
 Jump Aboard the Distressed-Debt Bandwagon
1. What: Unpaid
subprime mortgage obligations and debt issues from corporations in bankruptcy.
Why: The lending
crisis is expected to hit more mortgage and related industries that will need leverage to reorganize or
liquidate.
How: Invest through hedge funds
that specialize in distressed debt.
Pricing is tricky, but some of
the best-known leveraged-buyout investors are sure there will be plenty of manna
from distressed debt. For example, Wilbur Ross has said the subprime market both
in the United States and abroad will be the new focus for his New York–based
private equity firm, W.L. Ross & Co., and he agreed in August to invest $50
mil-lion in the bankrupt American Home Mortgage Investment.
Defaults from the subprime crisis are just beginning to
reverberate into related industries, including homebuilding, back-office loan
processing and retailing. "It’s a bit early in the cycle," notes Jeff Erdman, a
private wealth advisor with Merrill Lynch in Greenwich, Conn. "We’ve just
started hiring hedge fund managers who specialize in that area. I think the
opportunities will be all over the place."
Defaults from the subprime crisis are just beginning to reverberate into related industries, including home-building, back-office loan processing and retailing. |
Katalin Kutasi, a principal and portfolio manager who
specializes in distressed and high-income investments at Kellner DiLeo &
Co., a hedge fund management firm in New York, foresees a chain reaction from
subprime mortgage defaults. "A lot of distressed paper, whether it’s distressed
corporates or distressed mortgages, is going to come under pressure," she says.
One indication of this is the large volume of adjustable-rate mortgage (ARM)
resets: Roughly $300 billion in both prime and subprime ARMs is scheduled to
reset by the end of 2011, according to data from Banc of America Securities.
"That, I think, is going to dwarf much of the subprime problem," Kutasi says.
Like Ross, Kutasi expects to see a great deal of distressed
debt coming from Europe. "Leveraged loans and high yields, loosening strictures
on the buyers, all of the structural issues that led to weakening credit
standards were also present in the European high-yield market over the past
year," she says. "So I think you’re going to see the same kind of fallout in the
European market."
In the corporate sector, there are rumblings of a 1980s-style
junk-bond fest. Figures from JPMorgan show that in the first half of 2007,
before new lending effectively shut down, more than 32 percent of new corporate
loans went to companies with the lowest debt ratings. The prior record was 20.9
percent for all of 2006. History shows that the default rate for such borrowers
is 37 percent over three years.
The Blackstone Group announced a plan to escalate its buying of
debt securities on the grounds that the returns would be better than those from
equity in the same companies. Kutasi, who concentrates on mid- and small-market
corporate debt, believes that limited financing options will make 2008 a tough
year for companies in that range, which means good times ahead for
distressed-debt holders. U.S. companies with ratings of B or below failed to
make interest payments on $4.5 billion worth of debt in the first eight months
of 2007. Standard & Poor’s estimates that low-grade corporate defaults could
be as high as $35 billion this year. "Some of the fallout is in consumer
discretionary spending, and that will lead to some corporate debt among
large-caps, too," Kutasi says.
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