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.

Hermes BPK adds investors should expect rewards "commensurate to the added risks of illiquidity and complexity managers are taking".

While the allocators said some illiquidity risk was inherent in the strategy, all added managers had largely now matched their funds' redemption terms with market liquidity.

Hermes BPK says credit and distressed typically produce best returns following periods of extreme spread widening.

Annual double-digit returns, sometimes over 25%, came over three years following the 1991 and 2003 credit downturns.

Nearly three years on from 2008, and despite prolonged spread tightening and falling defaults, the investor says opportunities still exist for "meaningful returns".

Gregory Knott, co-CIO, Hermes BPK Partners, says: "It is possible that we will see multiple vintages of paper becoming stressed at the same time, leading to a second wave of opportunity, but one likely to be characterized by complications and complexity."

Partly because of this complexity, allocators including UBP AM, Hermes BPK Partners, Stenham and Neuberger Berman insist managers active in Europe have long-term coal face experience.

Majit watches for inexperienced managers drifting into distressed debt. This is common, but he cautions the strategy is not straightforward, "and if you do not have expertise and networks for sourcing and negotiating distressed debt deals, it can be a minefield".

Majit describes his ideal vehicle as "mid-sized, with multiple investment professionals with experience investing through different cycles".

He says some US managers had European offices since the 2001-02 cycle, and some did "reasonably well" with the opportunities in 2002 to 2005.

But after that, distressed opportunities waned and some transformed into direct-lending businesses. This got them into trouble in 2008, and some then cut staff.

Stenham's Beck agrees experience is crucial: "There are managers with a global focus who have been over here for a while and we would prefer to have a dedicated European team on a fund," he says.

"If you are not in Europe it is very difficult, not just in terms of understanding what the legal processes are surrounding restructurings and bankruptcies, but also sourcing of opportunities, which is not as straightforward as it can be in the US."

Allocators have more good reasons for wanting seasoned practitioners. Sourcing deals is one challenge.

Coping with the details of at least 20 European bankruptcy laws and processes is just as difficult.

Mark Barker, co-CIO at Hermes BPK Partners, notes restructuring solutions have been available to European companies for a relatively short period of time.

The UK ushered in a credit-friendly legal framework for bankruptcies in 2003, similar to America's model.

The French have a ‘safeguard procedure' which was introduced in 2006 and reformed in 2009 following the Eurotunnel restructuring, which highlighted many deficiencies in the structure.

Italy and Spain have legal frameworks that Barker says "are now being seriously tested for the first time". He continues:

"The resultant barrier to entry plays an important supply-demand dynamic in Europe, whereby there is a relatively small amount of capital being applied to corporate distressed situations."