Credit bets are asymmetric.? Leveraged bets more so.? A bondholder can lose all of his investment, and can optimistically receive principal and interest.? A leveraged bond investor can lose it all with greater probability and perhaps faster, but at least has the chance of making equity-like returns in the right credit environment.

Thus for Highland Capital Management the recent comeuppance with a recovery of zero is particularly severe.? I don’t care what you did in the past, but if you didn’t pay some income out, then losing it all drives total returns to -100%.? It doesn’t matter if you were once deemed brilliant:

As recently as October 2007, Barron?s magazine ranked Highland CDO Opportunity third among the top 50 hedge funds, with an average annual return of 44.12 percent during the three-year period ended that June. Its fortunes reversed last year, as the securities it invests in, known as collateralized debt obligations, plunged in value amid the credit crunch and downgrades by ratings firms.

When reviewing alternative investments, it is very important to understand the underlying drivers of performance.? With corporate debt instruments, it is the corporate credit cycle.? With corporate credit, it is normal to see 3-5 years of moderate favorable performance, followed by 1-3 years of horrendous performance.? Secondarily, it is choosing the debt of companies offering high yields relative to their likelihood of default.

Understand the cycle, and see if performance isn’t due to the cycle, rather than true skill.? With Highland, it seems that the cycle delivered, and then took it all away with high leverage.