Where are the investment opportunities for Distressed Debt post Covid-19?
As the first quarter of 2021 is ending, uncertainty remains a key theme in investment and the distressed debt pipeline is still in full flow as many sectors have been hit hard by the Covid-19 pandemic says CAMRADATA.
CAMRADATA’s latest whitepaper on ‘Distressed Debt’ explores the industries most impacted by Covid-19 and how active-investing can help portfolio managers take advantage of future opportunities.
The whitepaper includes insights from guests who attended a virtual roundtable hosted by CAMRADATA in February, including representatives from Invesco Ltd, PGIM Fixed Income, AON, Barnett Waddingham, Centrica, Isio and Redington.
The report highlights that Covid-19 had the side-effect of accelerating bankruptcies in areas already priced in as though they were going to fail. Amongst the hardest hit was hydrocarbons, as industry disruption is driving the move towards cleaner forms of energy in line with the Paris agreement. The pandemic has also impacted hospitality, transport, and retail.
With signs of fragile balance sheets, many businesses look set to fall victim to Covid-19 this year as well. Companies that depend on frequent human interactions, for example, are most at risk of getting caught up in the coming cycle.
Sean Thompson, Managing Director, CAMRADATA said, “This cycle could be prolonged due to high levels of liquidity, alongside ongoing fiscal stimulus packages and suppressed default rates. As distressed debt is cyclical, funds specialising in this asset class often see strong performance following a crisis.
“Our roundtable explored where the opportunities may lie as the dust settles from Covid, and how active-investing could come into its own, as managers endeavour to balance positions and quickly respond to an ever-changing macro-environment. Looking forward, due diligence, as always, plays a key role – and ESG is crucial.”
When asked what lies ahead, the representatives from investment consultancies, pension plans and asset managers said they expect State support in the fight against Covid to continue through 2021.
They were also asked if it is the right time to increase allocation to Distressed Debt before State largesse begins to recede, and companies must support themselves?
The asset managers at the roundtable also explored how far success in Distressed Debt depended on timing the market, followed by the consultants outlining what return expectations they had for Distressed Debt.
The panel also discussed the end of distress and which kinds of asset manager will fare best in the years ahead, before ending with ESG as the final talking-point. Given the volatility in the US energy sector and its weighting in junk debt, the panel were asked whether Distressed Debt is naturally an anti-ESG strategy.
Key takeaway points were:
- Looking at how far success in Distressed Debt has happened depended on timing one panellist recalled that when the battle to contain Covid really took hold last spring, “everything was trading at over 1,000 bps. The options were infinite.”
- They emphasised that to profit from these conditions, a trading mentality was required because the speed of recovery proved almost as swift as the fall.
- Another distinguished market-timing in large-cap and small-cap opportunities, saying larger managers taking larger opportunities may need longer duration.
- On expected returns from distressed debt, one panellist expected net IRR of 15% over the lifetime of a closed-end fund: with two others suggesting mid-teens. Another said a lower figure of 10-12% IRR over the cycle.
- It was noted that the previous five cycles for distress have all been economic, starting with autos in 2001 and ending most recently with retail. By contrast, this has been a pandemic-led cycle, which is much more definable and consequently less risky.
- Catchy phrases such as “special situations” are back in fashion, as are new terms such as “capital solutions”. It was explained that the latter is an advance on traditional bridge financing, where a provider steps up when the situation is too risky for direct lending.
- One panellist warned that the challenge remained in finding competent managers who can deploy capital successfully across the wide range of areas distressed/stressed strategies cover.
- Turning to ESG, one panellist said that it was now very important to model carbon intensity in client portfolios. For UK pension schemes there is a requirement to evaluate and report. They added when looking at recent track records, there has been poor performance where Distressed Debt managers have had large exposure to energy. Most managers are wary of that sector.
- Another noted that, while the US has had an “anti-ESG” President for the last four years, a new administration may make US oil and gas more palatable from an ESG perspective.
- Governance is crucial. One panellist said where Distressed Debt managers have opportunities is where governance has gone wrong; where they can take control, rectifying governance issues, aligning management with shareholders and setting a strategy, that creates value.
- Finally, oil was described by one panellist as a necessary evil, which fuelled not just most of the vehicles the world relies on but also powered steel and cement works. Another was also bullish on selective allocations in oil and gas adding that done correctly; they are some of the best opportunities around.
The whitepaper also features two articles from the sponsors offering valuable additional insight. These are:
- Invesco Ltd: ‘Persistence of Small Cap Distress Post-COVID’
- PGIM Fixed Income: ‘Why Now Is A Good Time to Invest in Distressed and Stressed Credit Opportunities’
To download the ‘Distressed Debt’ whitepaper click here