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Summary

  • ACP is a closed-end fund run by distressed investing pro Jeffrey J. Gary.
  • Past performance has been good, but two rights offerings require active management.
  • Expenses are high, but less than most hedge funds.

Avenue Capital Group is a pioneer in distressed credit investing that was founded in 1995 by Mark Lasry and Sonia Gardner. It manages about $14 Billion in total and invests in the public and private debt and equity of distressed companies across a variety of industries. Most of their clients are institutional or accredited investors.

In January, 2011 Avenue started a closed-end fund that is available to retail investors- Avenue Income Credit Strategy (NYSE:ACP). It is a global credit, non-diversified fund that uses risk management through variable shorting and hedging strategies. At one point in 2013, they were short the LQD Corporate bond ETF.

The fund's portfolio manager is Jeffrey J. Gary, who was hired away from Third Avenue Management. I had a good experience investing in Third Avenue's TFCIX mutual fund when it was first issued. This fund was previously run by Jeff Gary, and I always enjoyed reading his annual shareholder reports. He is highly experienced in distressed investing. (By the way, I still like his old fund TFCIX for investors who want a lower expense investment with no leverage. It's YTD performance is around 11.5%.)

Closed-end funds have performed quite well lately, but it is harder to find bargains like we had in late 2013. I like ACP as an investment in many ways, but would also like to point out some potential negative features:

- The management fee of 1.25% on managed assets is quite high. The 1.25% rate not only applies to common assets, but also to assets acquired using leverage.

- A firm like Avenue Capital Group runs other hedge funds which directly benefit from excess performance. There is a risk that they may cherry pick some of the best ideas for their hedge funds and place some of their less successful illiquid loans into the closed-end fund.

- ACP has already done two dilutive rights offerings where they sold shares well below NAV. This has been harmful to a passive buy and hold investor who wasn't paying attention. That said, rights offerings can be very beneficial for opportunistic active investors who may get trading opportunities to buy rights cheaply.

On the positive side, the leverage cost of 1.10% is fairly good for a distressed fund. Because of the rights offerings dilution, the past performance given on Morningstar is understated. An opportunistic investor who actively traded the rights could have seen much better performance. This would vary based on several factors including commission costs, market timing etc.

Avenue Income Credit Strategy

Investment Objective: The fund seeks to provide a high level of current income as a primary objective with capital appreciation as a secondary objective.

Total Net Assets: 347 Million

Total Common Assets: 252 Million

Baseline Expense ratio= 2.21%

Leverage: 28%

Annual Cost Of Leverage: 1.10% (est.)

Discount= -7.16%

Annual Distribution Rate (market price) = 8.04%

Portfolio Allocation: Fixed Versus Floating

Fixed Rate

76%

Floating Rate

17%

Cash

7%

Security Type (as of March 31, 2014)

Senior Secured Bonds

42%

Senior Unsecured Bonds

31%

Loans

17%

Cash

7%

Junior Subordinated Bonds

5%

Government Debt

<1%

Equity/ETF Short

-3%

Portfolio Quality (as of March 31, 2014)

BBB

4%

BB

7%

B

41%

CCC

34%

CC

1%

NR

6%

Cash

7%

Investment Performance: NAV Return as of 6/27/2014)

Note: Longer term performance is understated because of dilution in NAV from two rights offerings. Individual investor results should have been better depending on how the rights offering was navigated.

YTD+7.39%

1-Year+19.51%

3-Year+10.36% annualized

ACP is currently trading at a discount to NAV of -7.16% compared to the 52-week average discount of -6.90%. Here are some Z-statistics for the discount to NAV:

  • 2-year Z-statistic = -0.82 (2-year avg= -4.72%)
  • 1-year Z-Statistic = -0.15 (1 year avg= -6.90%)
  • 6-month Z-Statistic = -0.30 (6 month avg= -6.94%)
  • 3-month Z-statistic = +0.35 (3 month avg= -7.32%)

Source: cefanalyzer

Using these Z-statistics, the current discount to NAV is about one standard deviation below the mean over the last two years, and slightly below the mean for the last six and twelve months. The discount is slightly above the mean over the last three months.

ACP has average trading liquidity and trades about 50,000 shares a day. Overall, I think ACP is a reasonable way to participate in distressed investing with a well respected pro - Jeff Gary. But it is only appropriate for active investors who follow their investments closely, since it is possible there will be more rights offerings in the future.

Source: Avenue Income Credit Strategy: Distressed Credit Investing At A Discount