Hedge funds are highly exposed to GM debt: bankers
Tue May 10, 2005 01:20 PM ET
By Gerard Wynn
LONDON, May 10 (Reuters) - Hedge funds have been building up stakes on the European debt of the U.S. auto firm General Motors (GM.N: Quote, Profile, Research) over the past six months, risking losses in a highly volatile situation, fund managers and bankers said.
These risks came to the fore on Tuesday with talk of massive losses on debt instruments called CDOs (collateralised debt obligations), hugely popular among hedge funds. The talk was sparked by last week's downgrade by ratings agency Standard and Poor's of debt issued by automakers General Motors and Ford.
"A lot of hedge funds are playing in GM," said a distressed debt trader at one investment bank.
The S&P downgrade affected 23 billion euros ($29.52 billion) of European debt in GM (GM.N: Quote, Profile, Research) and Ford (F.N: Quote, Profile, Research) .
Hedge funds and distressed debt specialists are likely buyers of GM debt that original investors are now selling in advance of expected further downgrades, Citigroup said in a research note last week.
But funds looking for GM bargains were in danger of finding false protection in hedging strategies, analysts said.
"There have been a lot of smart ideas around for the past six months, but a lot of people have lost a lot of money," said one investment bank analyst.
In the meantime, some non-hedge fund investors have retreated to safer ground.
"The last GM trade we did was in March," said Branko Jevtic, head of capital structure arbitrage at DrKW portfolio management. "The market is becoming extremely volatile in the entire autos sector."
PROFIT STRATEGIES
Hedge funds invest in CDO's to get a better return than in the regular bond market because they offer higher interest rates. Ford and GM debt have been included in a lot of CDO structures because they trade at wider spreads than similarly rated credits.
Hedge funds also use so-called arbitrage bets, where they bet on several outcomes to increase the chance of being right. And the different arbitrage positions they have taken in GM has highlighted the unpredictability of the situation.
For example, one popular GM deal has been to sell the parent company's bonds -- betting on a fall -- and buy the debt of GMAC, the financing arm -- betting on a rise -- because the fortunes of these entities are expected to diverge.
Analysts are increasingly expecting GMAC to get a better rating than its parent company.
But one hedge fund took the opposite view to the GM-GMAC trade, on Tuesday, highlighting the uncertain outlook.
"Most arb (strategies) are positioned for a widening of GM and GMAC. We believe that their spreads may converge," said Louis Gargour, predicting that GM may sell GMAC assets, and then draw its finance unit in closer.
"A significant proportion of GMAC's assets are non-core -- such as its mortgage business -- and we estimate by selling some of their non core assets they could raise 10 to 20 billion euros."
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