Hedge funds jump at opportunities in Europe’s financial distress

Alternatives funds focusing on distress and restructuring of European financials are launching en masse, to seize opportunities as politicians redraw the map for the eurozone’s financial sector. But some allocators are sceptical all launches will be able to profit.

The landscape for Europe’s banks is indeed undergoing near volcanic upheaval.

Their share prices are being buffeted around by a number of factors.

Yesterday morning, as news of Greece’s austerity referendum sunk in, the Dow Jones Stoxx600 bank sector index slumped by over 5%. To name but a few of this hit in early trading, Commerzbank dropped by 8%, Deutsche Bank by 6%, Barclays by 7%, Societe Generale by 12%, and Credit Agricole by BNP Paribas.

The variables affecting their peer group include the rate of haircuts it faces on Greek debt (the latest was a voluntary 50% reduction); by uncertainty whether the eurozone rescue deal will proceed at all (as governments in Athens and Rome wobble, and Greece holds a referendum on austerity); by banks’ ability to raise tier 1 capital reserve ratios to the required 9% by June 2012 (necessitating either fund raisings, state support, or asset sales); and ongoing changes under Basel III and Solvency II.

Late last month Luke Ellis, head of Man Multi-Manager said: “There have been more funds launched in the last weeks focused on European distressed financial credit than for every other strategy, multiplied by a factor.”

He doubts all will prosper.

Either way, he adds that the potential size of gains from an ‘illiquidity premium’ that longer-term investments ideally provide, are often outweighed these days by “outside risk you get from a number of things that have happened to put us in remarkably difficult places.

“Anyone running a strategy thinking they can simply buy long-term winners and sell the long-term losers among European financials is kidding themselves, because no-one knows.”

Over summer, groups such as Marathon Asset Management and European Credit Management launched funds to benefit from European distress.

Oaktree Capital Management, Apollo Global Management and Avenue Capital are believed to be raising capital for funds focused, respectively, on weakening economies in Europe and the US, non-performing European loans, and European distressed securities.

Other managers such as Aguilla Capital, run by alumni of Vega Asset Management, are advising on distressed investing specifically in Spain and Portugal, whose banks have been hit hard by their sovereigns’ woes.

The Luxembourg-domiciled Financials Fund from fixed income house ECM, which is part-owned by Wells Fargo, will invest in financial sector credits, through cash bonds and related products, to target net returns of Euribor plus 6% to 10% from 2011 to 2013, and thereafter a more modest Euribor plus 3% to 5%.

“The strengthening of balance sheets in the financial sector over the next few years may create significant opportunities for investors seeking higher risk-adjusted returns in a low rate environment,” said Ross Pamphilon, ECM’s head of investments.

“We believe that significant value will be created for credit investors over the next 10 years, as financial institutions, households and governments deleverage their balance sheets as a long term response to the current financial crisis.”

The fund’s team, headed by manager Satish Pulle believes Basel III and Solvency II will cause “significant new issuance of capital” from banks over three to five years.

“Opportunities for investors may exist across the capital structure, including contingent convertibles, Tier 1, Tier 2, senior unsecured debt and covered bonds. The ECM Financials fund will draw on ECM’s breadth of experience in top-down credit strategy, fundamental research and trading capabilities in the financials asset class,” the group said.

Its fund’s main focus will be senior and subordinated debt obligations and related instruments of financial services companies.

New York’s Marathon Asset Management launched in August a European distressed credit fund, which was expected to gather $1bn assets by year’s end.

The scepticism Man’s Ellis expresses that all the entrants will profit finds some support from the event-driven index for European funds by publishers HedgeFund Intelligence.

The broad strategy of event-driven, which typically includes distressed debt and merger arbitrage funds, fell 3.4% in August, a further 0.12% in September, and is down 3.9% this year.


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