Too many opportunities, too few managers for world of distressed debt
Allocators believe that there are not enough experienced local European distressed debt managers to satisfy the investment potential that lies ahead.
The positive attitude European distressed debt managers feel, as the Continent’s companies face having to refinance €140bn of leveraged loans from next year, is not shared by investors, who say too few skilled managers exist to run all the money they want to allocate to the strategy.
The investment potential is large, the allocators say. This is because of the volume of loans expiring, and the fact banks, which provided up to 90% of Europe’s leveraged loans in recent years, now face squeezes from Basel III and weakened balance sheets.
Galia Velimukhametova (pictured), manager of GLG’s European Distressed fund, says European companies have been able to reduce maturities expected between 2012 and 2016 by about 15%, through a “robust” high-yield market with good primary issuance. But she adds:
“We still have the issue of the ‘wall of maturities’ in Europe. In Europe the market is still largely broken, and we have not seen many new leveraged loans.
“The problem will be widely spread, and many leveraged loans will hit the wall. Some companies may be able to refinance, but a big chunk of them will have to be restructured.”
Velimukhametova says a possible trigger for stress could be strict bank provisioning that Basel III will usher in from 2013 on non-investment grade or unrated loans.
This, she says, will pressure capital ratios and “may force sell-offs of loans, which will exacerbate and speed up restructuring for some companies”.
Allocators believe the size of opportunity from all this is great. But the number of European managers able to exploit it is too small.
GLG, Sothic Capital Management and Fortelus Capital Management are among high-quality exceptions they mention, plus some US funds, including Apollo Management and King Street Capital Management.
Jeff Majit, managing director of Neuberger Berman, says: “There are still only a handful of true European distressed experts up and running.”
Allocators overseeing $1.3trn in hedge funds ranked distressed debt as their second-favourite strategy in a survey of their plans carried out in January for Deutsche Bank.
The managers made 4.8% this year to May, according to Hedge Fund Research.
Tim Beck, senior research analyst in charge of relative value and event-driven strategies at investor Stenham Advisors, says some large global distressed fund managers increased allocations to Europe relative to the US recently, and more US managers are seeking opportunities here.
Bill Bassin, managing director of UBP Asset Management, says quality distressed managers are valuable.
“The strategy typically involves investing in less-efficient markets where skilled investors can add significant alpha through knowledge of bankruptcy proceedings, experience with financing documents, and understanding complicated securities.”
A company’s liquidation value limits the downside, he adds.
Majit presently expects European distressed managers to make high-single, or occasionally low-double digit returns.
Targeting much higher now requires them to take “a decent amount of risk, either through taking on leverage or through high levels of directional equity exposure,” he says.
Majit prefers idiosyncratic trades driven by events at a company.
Internal rates of return on unlevered European distressed opportunities early this year averaged over 15%.
Rival allocator Hermes BPK Partners says Europe’s best opportunities now are in idiosyncratic situations. These can include event-driven catalysts companies looking for near term exits in refinancings, mergers, bankruptcies and value situations bank debt, and high-yield bond carry, though not necessarily to maturity.
Distressed corporates and liquidations, litigation and restructured equity are other opportunities the allocators mention.