Reddit traders are upending the world of credit investing, too

It was the type of master stroke that could make a Wall Street career. Jason Mudrick’s financing of AMC Entertainment Holdings Inc. at the height of the pandemic netted his hedge fund hundreds of millions of dollars in just a few months.

Then, in the blink of an eye, it was gone. Options contracts meant to hedge the bullish wager went haywire as retail traders flocked to AMC’s stock, pushing shares to once unimaginable heights and costing Mudrick Capital Management all of its gains — and more.

Distressed investors have long had to have thick skins — taking criticism as predators, even as they sometimes rescue firms no one else will touch and generate returns for pensions, endowments and foundations. But life in the business is getting even harder, as they can no longer count on a predictable stock market to hedge massive, multipronged bets.

With equities swept up in the whims of exuberant day traders, some funds are now being forced to rethink their business models.

“It’s become a much harder calculus to even consider,” said Scott Hartman, the global co-head of corporate credit and trading at $14 billion investment firm Varde Partners. “Frankly, many funds have decided to stay away from shorting these stocks altogether.”

Granted, there are other investment opportunities — some distressed funds are pivoting to private lending and emerging-market plays — and often other ways that money managers can hedge their exposures or engage in forms of capitalstructure arbitrage. (Plenty of their targets, after all, have no public equity.)

But fiscal and monetary stimulus have greased markets so thoroughly that many of the riskiest companies are now breezing through debt walls with cheap new financing, rather than running into the kind of dead-ends and defaults that generate restructurings or profitable loan-to-own plays.

Indeed, many fund managers say that beyond disrupting their ability to hedge, retail traders are increasingly propping up troubled firms, further limiting the universe of investment opportunities.

Clothing chain Express Inc., prison operator Geo Group Inc., coal miner Peabody Energy Corp. and others have, like AMC, seized on their popularity among day traders to seek equity financing — an option historically out of reach for firms with their debt loads.

That’s a problem for distressed-credit funds, where corporate failure is a key part of the investment thesis.

Their strategies often center on identifying companies that are out of options, providing last-resort financing and calling the shots throughout the workout process. Their controversial tactics — in which workers are often left bearing the brunt of the pain — can lead to huge payoffs, including outright ownership of the cleaned-up corporations.

Yet opportunities are dwindling.

“It’s eerily quiet out there,” said Colin Adams, a senior managing director at corporate advisory firm M3 Partners, where he focuses on debt restructuring. “You have the twin monsters of fiscal stimulus and low interest rates, and this phenomenon with meme stocks adds a whole new dynamic.”