Six years after launching the Somerset Special Opportunities Fund at Babson Capital, Robert Feingold still sees plenty of them available. The $400 million fund employs an event-driven strategy focused on small- and mid-cap securities, which Feingold says are routinely mispriced—a fact that positions the fund well for the next market cycle.
Feingold joined Boston-based Babson in 2000 from Triumph Capital. Babson manages more than $180 billion, and Feingold's own fund has a capacity of $1 billion. FINalternatives Senior Reporter Mary Campbell recently spoke with Feingold about his strategy, his target investor and his view of the current market.
When was the Somerset Special Opportunities Fund founded and what opportunity was it intended to capitalize on?
We launched a dedicated vehicle in 2007, but we had been managing the strategy in another form since 2004. The opportunity was—and still is—to take advantage of mispriced securities in the small- to mid-cap space. Specifically, we found that small- and mid-cap companies that have meaningful debt on their balance sheets are routinely misunderstood by equity investors and often fall beneath the radar of larger debt investors. Many equity analysts are uncomfortable evaluating events surrounding debt. They avoid companies with issues like covenant violations, debt refinancing hurdles and depressed EPS caused by higher interest burden. We see these issues as areas of potential opportunity. Given our team’s deep credit expertise, and the ability to invest anywhere in the capital structure, we are able to capitalize on these opportunities. We love this niche because our diligent research process allows us to have an edge in terms of identifying overlooked and misunderstood situations.
How would you describe the strategy?
We define the strategy as long/short event-driven, because for each investment we have identified a catalyst or several catalysts that we believe will drive returns. We invest opportunistically across the capital structure and take a bottom-up fundamental approach. Depending on where we are in the cycle and where the best opportunities reside, we will invest in stressed/distressed corporate bonds and loans, equity, post re-organization equity, or we will be both long and short in the same company’s capital structure if an arbitrage opportunity exists. We do not employ merger arbitrage strategies. What really defines the strategy is that we focus on small- to mid-cap companies with leveraged balance sheets.
Who is your target investor?
Our target investors are sophisticated institutions or family offices looking for a long, stable relationship with their managers. We seek like-minded investors who appreciate the stability and resources of a firm like Babson Capital but are still looking to add alpha to their portfolios.
How would you characterize the current market?
The Russell 2000 Index is up over 150% since it troughed in March of 2009. This rally has had two key elements to it: First, it was partially a relief rally as we came away from the abyss. Second, it was partially a beta rally, driven by unprecedented intervention from the Fed. Both of these drivers have largely played themselves out. The next return driver will be individual company performance. This type of a market will favor good stock pickers. Consequently, the current market is set up very well for event-focused investors.
We have identified several themes that we will look to exploit over the next 12 to 18 months. One major theme is refinancing activity. The low cost of borrowing and availability of credit is enabling companies to aggressively refinance expensive debt and drive EPS growth. We have been exploiting this theme over the past 18 months and because different debt vintages continue to become callable, this opportunity will persist for at least the next 18 months. Refinancing itself can be a catalyst but often leads to other events such as M&A and shareholder-friendly actions, which are current themes of ours as well.
We expect M&A activity to be robust for several reasons including: the low cost of capital, high cash balances on corporate balance sheets, and the unwillingness of corporations to pursue organic growth through green-field development. Many corporations believe that growth through acquisitions is less risky because the sales are already there. Additionally, we think the recent run-up in equity prices could lead to more M&A as corporate boards will be more willing to sell at these “more reasonable” levels. This willingness of corporate boards to entertain offers will also be welcomed by the private equity community which has an enormous amount of dry powder and a credit market that is ready and waiting to finance their deals.