Fund managers buying distressed European assets tell David Walker why the gloomy business climate is a good environment for their investments.
Distressed managers concede their strategy is less liquid, so patient investors are needed. Christian Hille, DWS Investments’ head of multi- asset, makes a distinction between two types of stressed assets.
One set has a huge liquidity premium because they have been “disproportionately sold down” – for example last summer, when other instruments such as some CLOs and asset-backed securities traded at stressed prices “but were ‘money- good’ because the underlying collateral is “fundamentally OK and subordination sufficient to cope with another downturn. “The only reason why they trade at a discount is due to liquidity and because these asset classes were stigmatised after 2007.”
He adds very few investors have capabilities for fundamental credit analysis, plus the ‘stomach’ to take a longer-term view, while also being prepared for higher volatility in the short run. Charlotte Valeur Adu, chairman of the Brevan Howard
The master fund is understood to be willing to take more capital in via the listed feeder, not least for its stability, and believes 10% to 15% of total strategy assets would be manageable.
DEALING WITH A FLUCTUATING CURRENCY
Debt, credit and equities were not the only markets that have reacted to eurozone stress. As James Wood- Collins, chief executive of Record Currency Management explains, the bloc’s currency also jumped about.
“There could be a lot of outcomes for the eurozone. But the process of getting from where we are now to the destination will involve risk, stress and volatility. It is about taking advantage of the cycles of risk and volatility, but how should they be
Record CM’s Euro Stress fund has a short euro bias, with rigorous downside controls. “We want to buy option protection when it is cheap – so the fund can seem a bit counter intuitive – then the rest of the world catches up with us. When investors are most worried about euro stress is when it pays off”.
The fund rose 2.4% in September 2011 and 3.3% in November 2011, though euro strength and rate compression saw it give back 3.7% this January.
HIGH TIME FOR HIGH YIELD
Phil Irvine, co-founder of pension consultants PiRho Investment Consultants, says: “Typically the best time to gain exposure to high yield bonds (or high yield bond funds) is just before the nadir of the economic cycle. This period is characterised
Only after this will the market in high yield and other similar bonds start turning. There are a number of ways to gauge this “second derivative effect”. One such measure is the National Association of Purchasing Managers index.
This doesn’t measure whether things are good or bad, rather it asks managers whether things are better or worse from the previous month. A score of 50 simply tells you that conditions are the same – ‘good, but not getting better’; or ‘bad, but not get- ting worse’) as the previous month.
For example, the index started to rebound from its downward trend in January 2009, which was shortly before the low point in the high yield bond index, Irvine says.
On balance, he suggests that it is better to buy a good asset from a distressed seller than a bad asset at a good price. There are a number of examples in the credit crunch of certain investors who were compelled to sell bonds or securities at extremely distressed prices that continued to pay their coupons and were eventually redeemed at par.
However, he does suggest caution if the investor, or the fund, purchasing these assets sold by ‘distressed owners’ are themselves dependant on leverage.
While this may seem obvious, each crisis over the past 20 years has seen certain investors increasing exposure to assets in the early stage of a downturn only to be squeezed out near market lows.
Irvine does feel that a major concern will centre on the impact of reduced bank lending to the corporate sector. Many, smaller reasonably sound companies, which in the past relied on bank debt, will no longer be able to rely on it anymore.
An opportunity will exist for investors to lend to these types of companies which are squeezed out of the mainstream lending system directly at attractive rates.