Institutional investors don’t have to wait for choppy waters to invest in event-driven credit, according to Duncan Farley, portfolio manager on the BlueRay fixed income team at RBC Global Asset Management, speaking during the Canadian Investment Review’s 2023 Risk Management Conference.
While the post-pandemic economy has negatively affected several industries, opportunities always exist for investors to find stressed or distressed assets that can provide attractive real returns, he said. “The investor in that asset class is either buying ahead of that distressed event, at the right price, in order to be part of the restructuring process or after the restructuring, which is what active managers should be doing.”
Stressed investments can take anywhere between three months and two years to produce adequate returns, while distressed investments can take a little longer, he added. “If you’re investing into businesses that have gone through restructuring, chances are it’s going to take at least a couple of years before you get to a point where you can crystallize and exit your investment.”
A perfect storm has created the ideal climate for investment in these assets, said Farley, noting that, while the pandemic may be in the rearview mirror for many, this isn’t the case for a lot of corporations. They still have higher leverage and lower profits than they previously had and they’re still trying to grow their balance sheets amid an inflationary environment and other pressures.
These issues aren’t going away and are creating a lot of pressure for companies that don’t have pricing power, added Farley. “In Europe, we’ve got a war going on. I think it’s fair to say that we’re seeing — and, unfortunately, will continue to see — headlines and pressure points, particularly around energy.”
Investors in this sector are waiting to see how the energy situation in Europe unfolds over the winter and whether energy prices will impact debt issuers. “We’re definitely seeing a lot of banks tightening their lending standards and requirements,” said Farley. “We are seeing a lot of banks where their non-core loans are not performing, so they’re now starting to sell again. . . . That will be a source of product for a lot of investors like us.”
But core funding remains the biggest prospect, he added, noting corporations are feeling the pressure and are looking for a resolution. Some private equity owners and shareholders will have to decide whether to write a bigger cheque and put it into the business or give the keys back to their lenders. “Anyone looking at this asset class needs to assess each of these scenarios and work out which are winners and what is the right price to pay.”
As an example, Farley shared a case study in which bonds secured against two offshore construction vessels were trading at roughly 15 cents on the dollar. The vessels cost $330 million to build, but industry dynamics had subsequently deteriorated, forcing the company into a restructuring. After assessing the current market value of the vessels, as well as the scrap value for the worst case scenario, he built a position in the bonds. Recovery over the next two years was in excess of 120 cents.
This strategy has a focus on capital preservation, he said, noting well-placed investments will look after themselves. “If you’re targeting returns of up to 30 per cent, you will generate those returns.”
Read more coverage of the 2023 Risk Management Conference.