Distressed debt hedge funds to shine in 2008

By Laurence Fletcher

LONDON (Reuters) - A predicted golden age for distressed debt hedge funds has so far failed to materialise in spite of the global credit crisis, but 2008 should be their year.

"You ain't seen nothing yet ... It's going to be huge," said one funds of hedge funds executive who declined to be named. "The tea leaves are not difficult to read."

After the start of the credit crisis this summer caused by the U.S. subprime meltdown, and after subsequent turbulence in equity and bond markets, a number of funds of hedge funds have again turned to distressed investing, a cyclical strategy that tends to do well when times are tough for everyone else.

Distressed funds look to buy the discounted bonds, loans or other debt of firms that have defaulted on debt payments or are set to enter bankruptcy or financial restructuring and bet they can weather the storm and earn strong returns from a turnaround.

Given that a prolonged period of ample liquidity and easy borrowing conditions is over and many banks are stuck with debt they are keen to get rid of, distressed funds, which have had slim pickings in recent years, should be coming into their own.

The problem is that these opportunities have so far failed to emerge -- in part because corporate defaults remain so low.

According to Moody's Investor Service, the global "junk" bond default rate was at a 26-year low of 1 percent in November.

"As it stands, it's a bit precipitous to suggest there are lots of opportunities," said Tim Gascoigne, a fund of hedge funds manager at HSBC Alternative Investments.