(Bloomberg) — Hedge fund manager Dan Gropper was short AMC Entertainment Holdings Inc. when the Redditors began their moon launch of the movie theater chain.
Just six months into running a new fund, he decided he wouldn’t be going down like that.
Gropper, who had managed money at Aurelius Capital Management and Fortress Investment Group before starting Carronade Capital Management, covered 20% of his short on Jan. 26, when AMC closed under $5, and the rest a day later, as the stock soared to $20.
AMC wasn’t even a directional short bet for Carronade, a multi-strategy credit fund that now runs $300 million. It shorted the stock as a hedge on an investment in AMC’s second-lien debt, which had been trading at deeply distressed levels. Gropper started buying the bonds at around 20 cents on the dollar, said a person familiar with the matter.
It turned out to be one of his best bets yet. The bonds have surged four-fold since Gropper acquired them, helping his fund notch a 23% gain during its first 12 months and 10% this year through June, the person familiar said. The returns came despite the timing of Carronade’s launch, which missed much of the long-awaited but brief window of distressed opportunities that many credit funds seized on.
Read more: Fortress Backs Distressed Debt Fund Launched by Aurelius Alums
Yet if Carronade hadn’t quickly unwound its AMC hedges, it could have been a very different outcome.
“We made the decision to cover the rest of our short position in the face of the run-up to insulate the portfolio from a large, unbounded technical downdraft,” Gropper wrote in a Feb. 17 investor letter, one of several seen by Bloomberg. “Had it not been for the Robinhood platform (and others) enforcing buy limits on AMC stock, we will never know to what level the stock could have traded.”
The unpredictable nature of the stock market today has made it harder for funds that engage in capital-structure arbitrage to hedge massive, multi-pronged bets. With equities susceptible to the whims of exuberant day traders, some have had to rethink the strategy.
Read more: Reddit Traders Are Upending the World of Credit Investing, Too
After exiting the short, Carronade opted to keep its bond bet, hoping AMC would take advantage of the rally by selling shares to stockpile extra cash. It did just that, raising $1.25 billion in the second quarter alone. The fund added to its position as the notes sold off this month, the person said.
Paul Caminiti, a spokesman for Carronade, declined to comment.
Carronade’s double-digit return in the first six months of the year is twice as high as the average credit hedge fund, which gained just 5% in the first half of 2021, according to Bloomberg hedge fund indexes.
Toward the beginning of the Covid-19 pandemic, hedge funds loaded up on companies pummeled by government lockdowns and social-distancing guidelines, according to industry consultant PivotalPath. As tech stocks soared, with millions of people shifting to remote work, hedge funds rotated into beaten-down entertainment and travel stocks, wagering on an eventual return to normal.
A bet on the debt of Hertz Global Holdings Inc. — another company crushed early in the pandemic only to become beloved by retail traders — also helped Carronade’s returns.
The hedge fund first bought Hertz’s European debt last July, when it traded in the mid-80s. Gropper’s thesis was that holders of those notes would have first dibs on the car-rental company’s operations in the region — which comprised more than 20% of its business, the letters said. The fund also acquired unsecured debt and stock and hedged the position by using options to short shares of rival Avis Budget Group Inc.
Hertz, which emerged from bankruptcy last month, repaid the bonds held by Carronade. The hedge fund opted not to claim additional interest on its unsecured debt in exchange for the right to acquire privately-placed reorganized stock at $10 a share. That could result in an additional windfall as those shares now trade above that price.
Carronade also made money buying convertible bonds of cannabis company Tilray Inc. while shorting the stock, and buying the beaten-up bonds of Canada’s largest movie-theater chain, Cineplex Inc., hedged by a short on Cinemark Holdings Inc., the person said.
(Updates with trends in capital-structure arbitrage in eighth paragraph.)
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