In Depth

Q&A: Brownstone Tackles Credit Market

Jan 19 2009 | 8:25am ET

There were more losers than winners in the hedge fund universe last year as funds grappled with a deteriorating credit market and a global equity sell-off. One firm that bucked the trend with its strong performance was Brownstone Asset Management, a long/short credit hedge fund.

FINalternatives recently spoke with co-founder Oren Cohen in the firm’s New York office about its strategy and how it generates alpha in up and down markets.

FINalternatives: How do you play the credit market as a firm?

Cohen: Our sense is that a majority of credit managers tend to be long bias, and we recognize that at different points in the cycle, you have to be directionally agnostic and people shouldn’t have to time their entry into credit. We have an inherent belief that cycles tend to repeat themselves as excesses build up in the economy on the way up, and then you have a down cycle based on the deflating of a lot of those excesses.
 
We don’t use leverage in the strategy and we try to generate pure alpha where we’re outperforming benchmarks with lower-than-market risks. Every trade in our book must have analyzable catalysts for significant moves in the security—up or down—over a period of time. We also have target entry and exit prices and that distinguishes us from other credit managers who focus more on the coupon and less on the total return of the trade.
 
FINalternatives: According to public data, the Brownstone Catalyst fund gained 6.95% last year when most funds were down, and that was one of your less profitable years. How were you able to make money?  

Cohen: The main factor was our understanding in 2007 that the economy had peaked, high yield spreads had tightened to historic levels, and there was no place to go but down.
 
We swung the portfolio net short in the third quarter of 2007 and we focused in on the theme of a consumer-led recession in terms of how it would play out in retail, home building and consumer products. Another thing we’re proud of is recognizing that the gaming industry in 2007 was very susceptible to a consumer-led recession. There was a predominant view in previous cycles that gaming was recession proof and we analyzed the sector and said, ‘It’s different this time’ because of the buildup of casino jurisdictions throughout the country in 35 different states and the over-reliance these days on hospitality revenues versus pure gaming.
 
FINalternatives: Where do you see the credit market heading in 2009?

Cohen: We’re seeing value in the market today. We think there are downsides to bonds, but there might be enough of an offset with the actual current cash yield to justify making long investments today ahead of a bottoming in the economy. But that is on a case-by-case basis. We don’t believe that it’s time to throw money at a high yield index. It’s a stock picker’s market and you have to be able to pick the survivors.
 
FINalternatives: With over 20 years experience in the financial markets at institutions like Bear Stearns and Merrill Lynch, you’ve been through different credit cycles. How does this cycle compare to past ones?

Cohen: We’ve been through some bad times before, but from my perspective, this is a much deeper downturn because it’s on the heels of a very powerful bull run that started in 1982. It’s had various ups and downs, but the downturns have been much more focused. After 25 years of excess, there’s just tremendous leverage that’s been put into the system, so we’re talking about a much more significant downturn than I’ve ever seen in my professional life.
 
FINalternatives: So far, the fund hasn’t had a losing year since it started trading in July 2004 and you’re managing a little over $300 million. Are the pension funds knocking on your doors yet?

Cohen: We haven’t had a lot of conversations with pension funds yet. Now that we’ve had a four-and-a-half year track record and we’re over $300 with a consistent approach, it’s hard for me to understand why this isn’t a fairly ideal stream of returns for pension funds.

We think we should be a lot bigger. We started very small with under $30 million and we’ve been very patient. Doug [Lowey] and I wanted to build something for the long term with a very focused strategy. We turned the corner in 2006, getting the fund over $200 million, and we grew it in 2007 and 2008. We’ve never seen as much interest in our fund as we’ve seen in the last three or four months.


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