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Oct. 23 (Bloomberg) -- Hedge funds such as Maglan Capital LP and MeehanCombs LP are helping fuel a rally in Puerto Rico debt, signaling that investors who have the most appetite for risk expect the worst may be over for the commonwealth’s bonds.
As yields on obligations of the struggling U.S. territory soared to records in recent weeks, David Tawil, 38, co-founder of New York-based Maglan Capital, has been buying. The purchases mark the first foray into municipal debt for the fund, which typically focuses on distressed U.S. companies. The moves add demand to the $3.7 trillion municipal market at a time of record withdrawals by individuals.
A four-month slide in Puerto Rico securities, along with Governor Alejandro Garcia Padilla’s steps to turn around a shrinking economy and end budget gaps, have lured hedge funds and buyers of distressed munis, Tawil said. The former bankruptcy lawyer bought after taking a pass on debt of two bankrupt localities, Detroit and Alabama’s Jefferson County.
“Over the next two years, the government should be able to make progress in their plans,” said Tawil. His $60 million fund has earned 31 percent this year through Aug. 31, according to the firm. That’s more than triple the gains of Chicago-based Hedge Fund Research Inc.’s distressed-debt index.
“They will do a lot of fundamental changes; they will be seen as a reforming story, so that debt should trade up substantially,” Tawil said.
The outlook for Puerto Rico’s finances and its debt has significance beyond the shores of the Caribbean island. More than three-quarters of U.S. muni mutual funds hold its securities, which are tax-exempt in all U.S. states, according to Morningstar Inc.
Tawil and MeehanCombs were among more than 2,000 participants in an Oct. 15 webcast in which Puerto Rico officials updated investors on the island’s finances in a bid to stabilize the $70 billion market for its debt. That load has doubled since 2004, according to the Government Development Bank, or GDB, which handles the island’s capital-market transactions and sponsored the call.
Puerto Rico bonds have rebounded since the call. Their 2.1 percent gain Oct. 17 was the biggest since 2008, Standard & Poor’s data show. The debt has still lost 16.8 percent in 2013, the worst performance since at least 1999, on concern that a contracting economy would tax its ability to repay the bonds.
The past week’s gains pushed yields on some debt to a two- month low.
Tax-exempt general obligations maturing in July 2041 traded yesterday with an average yield of 7.86 percent, the lowest since Aug. 27, data compiled by Bloomberg show. The 3.53 percentage-point spread above benchmark munis was also the least since August. Yields exceeded 9 percent last month, the highest since their March 2012 issue. That’s a taxable equivalent of about 15 percent for top earners.
Hedge-fund buying is “a good thing,” said Daniel Solender, who manages $16.5 billion as director of munis at Lord Abbett & Co. in Jersey City, New Jersey. “It would mean that they see value, that they see something positive out of it.”
Greenwich, Connecticut-based MeehanCombs, which manages $130 million, has been buying Puerto Rico since August, said Eli Combs, its president.
“While there are clearly some economic challenges, we don’t think they’re going to have to restructure anytime soon,” Combs said in an interview.
Its Puerto Rico holdings include general obligations and sales-tax debt, he said.
Other participants in last week’s webcast included New York-based Arrowgrass Capital Partners (US) LP, whose parent company manages $3.5 billion of alternative investments; and MatlinPatterson Global Advisers LLC, a New York alternative- asset manager.
Nick Lord, spokesman for Arrowgrass, declined to comment. MatlinPatterson representatives didn’t immediately respond to a message left with an operator.
Marathon Asset Management LP, with $10 billion of assets, has also been buying Puerto Rico debt, Bruce Richards, the company’s chief executive officer, said Oct. 7 during a Wall Street Journal-sponsored conference.
The managers’ interest coincides with a stampede out of muni mutual funds by individuals, who hold about 70 percent of the local-debt market. Investors have yanked $55 billion in the past 21 weeks, the most ever, Lipper US Fund Flows data show.
Some of the mutual funds that suffered the most as Puerto Rico bonds slid the past four months are seeing rebounds, and the recovery may lure back others, Matt Fabian, managing director of Concord, Massachusetts-based research firm Municipal Market Advisors, said in an Oct. 21 report.
The net asset value of the Oppenheimer Rochester National Municipals fund, which has almost 8 percent of its $5.5 billion in Puerto Rico, rose last week for the first time since September, to $6.67 per share, data compiled by Bloomberg show. The value fell to $6.50 per share last month, the lowest since April 2011.
The downside to hedge funds’ adding Puerto Rico is that those investors may not hold the debt for as long as traditional muni buyers, said Richard Larkin, director of credit analysis for Fairfield, Connecticut-based Herbert J. Sims Co.
“They’re providing liquidity to people who are scared to death,” Larkin said.
Tawil of Maglan said his fund keeps investments for an average of two years. He has been buying Puerto Rico debt backed by sales-tax revenue, water and sewer bonds, and securities of the highway authority.
“I plan to hand this baton off at some point to somebody else,” Tawil said. “But right now I’m taking the baton at a pretty precarious point for the commonwealth.”
An index that measures Puerto Rico’s economy fell 5.4 percent in August from a year earlier, the steepest plunge since 2010, according to GDB data.
Garcia Padilla, 42, who took office in January, wants to end recurring deficits by the fiscal year beginning July 1, 2015. His budget for this year uses $750 million of deficit financing, the lowest amount since at least 2009, according to the GDB.
The governor, a member of the Popular Democratic Party, has boosted the retirement age and increased public-worker contributions to help sustain a pension system with a funding level lower than any U.S. state.
“This administration has implemented a number of very significant actions since January to strengthen Puerto Rico’s fiscal situation,” interim GDB President Jose Pagan said in an e-mailed statement. “We will maintain an ongoing dialog with the investment community to ensure a clear understanding of our plan, our progress and our improving prospects.”
Commonwealth officials expect to issue as much as $1.2 billion of sales-tax debt by Dec. 31 to balance budgets. If borrowing costs are too high, the commonwealth has enough funds to hold off through June 30, GDB officials said during the webcast.
Elsewhere in the market, localities nationwide are selling about $8.1 billion in long-term debt this week, the most since July. They’re issuing with yields near a one-week low.
The interest rate on AAA 10-year munis is 2.8 percent, Bloomberg data show. That compares with 2.51 percent on similar- maturity Treasuries.
The ratio of the yields, a gauge of relative value, is about 112 percent, compared with an average of 94 percent since 2001. The higher the figure, the cheaper munis are compared with federal debt.
--With assistance from Katherine Burton and Saijel Kishan in New York. Editors: Mark Tannenbaum, Mark Schoifet