(Bloomberg) -- Diameter Capital Partners is handing back some money to clients to stay flexible amid uncertainty in a high interest-rate environment, even as the investment firm raised $1.6 billion for its debut private credit vehicle.

The New York-based firm could return as much as 10% of the assets in its Master Fund over time, a person familiar with the matter said, asking not to be identified discussing confidential information. Diameter managed $17.8 billion in firm-wide regulatory assets as of end-December, according to a recent filing.

It marks the second time in three years the alternative asset manager is shrinking its investment pool, according to a separate investor letter seen by Bloomberg News.

“It’s not that there aren’t things to do,” co-founders Scott Goodwin and Jonathan Lewinsohn said in the letter. “We started the pruning now because the dispersion in markets is best prosecuted nimbly, particularly on the short side.”

Founded in 2017, Diameter has typically traded public and liquid debt in global credit markets but has also branched out into private strategies in recent years. It has a hedge fund and dislocation funds, as well as a structured credit and direct lending business. Apollo Global Management acquired a minority stake in Diameter in late 2022. 

Large money managers, including hedge funds, sometimes return capital to investors or stop accepting money to help keep themselves lean and move in and out of bets more easily for better returns in volatile markets. 

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For instance, Jeff Talpins’s Element Capital Management gave investors $4 billion back last month, while Ken Griffin’s Citadel late last year disclosed plans to return about $7 billion to clients after its assets ballooned on double-digit gains in its multistrategy hedge funds over the past two years.

“The persistence of high rates means that capital structures are constantly in flux,” according to the Diameter letter. “One bad quarter, and there’s a rescue deal to do. One good set of numbers and there can be a refinancing.” 

While scaling back the money in its Master fund, Diameter also raised $1.6 billion for its first business development company, another person said. 

BDCs, which are essentially closed-end funds that invest in small- and medium-sized private businesses, have surged in recent years in response to the growth in private credit. 

A representative for the firm declined to comment.

Diameter’s master fund returned 2.9% in the first quarter and its long-only dislocation fund gained 4.1% despite a series of shocks that sent bonds of companies such as Altice and Intrum AB into a downward spiral. 

In comparison, European high-yield bonds returned 1.7% this year, according to the Bloomberg Pan-European High Yield Index. Meanwhile, credit hedge funds have gained around 2.4% in the first quarter, according to data compiled by Bloomberg.

Shielding Against Shocks

Intrum’s bonds tumbled in March following an announcement that it was hiring restructuring experts to help overhaul a €5.4 billion ($5.8 billion) debt pile, which includes almost €4 billion of unsecured bonds. 

Diameter bought the Swedish debt collector’s notes that mature later this year when they moved into the 70-cent price range, the letter said. The notes are now bid in the low 90-cent range, Bloomberg-compiled data show. 

By buying bonds coming due in the relative near-term, the firm is seeking to avoid so-called creditor-on-creditor violence — a tactic in which companies typically reach a deal with a section of its creditors on terms that are detrimental to others. The asset manager is betting Intrum will pay when those bonds mature. 

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One of the firm’s biggest wins came from an out-of-court deal with fiber firm Level 3 Communications — which was bought by Lumen Technologies Inc. in 2017 — after it triggered a clause in its agreement with creditors. The master fund’s position accounts for around 6% as a percentage of the NAV as of March 31.

Goodwin flagged opportunities to secure higher yields in the leveraged loan market, but said that while there remain pockets of quality in higher-rated loans, the entire index has become “a dumping ground for the worst credits in sponsors litter.”

“Most of the loan market is a minefield of poor quality, high leverage or both,” he added, attributing it to the revival of collateralized loan obligations in the first quarter, driven by investors “hungry for paper.”

(Updates with detail on Diameter’s Level 3 position in 17th paragraph.)

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