April 9, 2014
They’re back, dudes, they’re back. Just like those canaries in those coal mines, PIK toggle notes are back and they are ready to party until they are dead because that is why and how canaries die in coal mines.
Scene from a coal mine:
“What’s that gassy smell, Fitz?”
“I don’t know, Mac, but that canary looks like it partied itself to death. Let’s keep hacking away down in this coal mine like everything is a-ok.”
What’s a PIK toggle note? Imagine a debt security that paid you very little each year and then your money back in 10 years if everything goes perfectly, nothing if things don’t go perfectly, and precisely zero if things go poorly. PIK toggle notes (sometimes known as “contingent cash-pay”) meet Dangerous Fund I’s suitability requirements, which are stringent, but they don’t seem to make sense for regular way money managers. Yet they’re selling like hotcakes. BlueLine Rental, Party City, Ancestry.com, Viking Cruises, Infor, BMC Software, Hot Topic and Michael Baker– these are all the PIK toggle flavors that have been available to yield-desperate fixed income shops lately.
While many market observers have scoffed at PIK toggles, we think these MOs are missing the big picture. Namely that these funds buying PIK toggles on behalf of pensions, grandmas, and HNWIs aren’t actually naïve, risk-obsessed maroons. No, these buyers are the ones who truly get PIK toggle better than anyone. These buyers fully understand that PIK toggle notes aren’t really PIK toggle notes at all — they are YOLO notes.
What happens if things go wrong? YOLO. What happens if things go ok? YOLO. Who wants returnless risk? YOLO. These savvy, returnless-risk-obsessed maroons understand the asymmetrical relationship their compensation has to their investors’ risks — in others words, they know YOLO.
Recommendation: Long YOLO notes because YOLO. Really long just about anything because YOLO.
SEC Disclosure: Dangerous Fund I, managed by Tinderbox Capital LLC, a subsidiary of Long or Short Capital LLC, has indiscriminately bought PIK toggle notes to such an extent that it is unclear how much PIK toggle Dangerous Fund I actually owns. Due to the layering of a diversification strategy similar to that deployed in Diversifying Fund I, it is also not possible for Tinderbox Capital to know what its actual positions in Dangerous Fund I are. Tinderbox Capital employs SAAP and “best guess” techniques to estimate their positions. I guess what we’re saying is we might not actually own any PIK toggle notes and if so you can just ignore this disclosure, which — if I’m being perfectly honest — why are you still reading? This is fine print, you’re supposed to tune it out, like the footnotes attached to numbers in prospectuses. This is not the adjusted EPS you’re looking for.