As governments and central banks wind down their support programmes, more corporate defaults and restructurings will follow. For distressed debt investors, a particularly attractive return of 15 per cent per annum is in store.
This is what Andrew Amos, director of fixed income at M&G Investments and fund manager of the M&G Debt Opportunities Funds, explained in conversation with Fondsnieuws, Investment Officer Luxembourg’s sister publication. Many investors expected the coronavirus crisis to trigger a wave of defaults worldwide. But the strong economic recovery and ample liquidity have kept companies afloat.
“For some companies, credit quality is improving on a weekly basis. But for companies whose strategy, sector or assets are still affected by the coronavirus pandemic, the future is a lot less certain,” said Amos (pictured).
He explained that the unprecedented support programmes of governments and central banks have delayed the bankruptcy of companies that were already in poor financial and commercial health before Covid-19. “We are now seeing companies forced to restructure despite the support. When the stimulus measures diminish, the trend of more defaults and restructurings will continue.”
Promising sectors
Amos said he expects opportunities to arise in both distressed corporate debt and distressed real estate, related to the education, automotive, transportation, retail, leisure and hospitality sectors. “Within these sectors, we focus on investments where the main risks are related to the execution of the restructuring and the subsequent turnaround of the business or assets. These are risks we understand and are able manage with our in-house restructuring team of 20 specialists.”
His preference is for companies or assets that have a clear raison d’être but whose value is temporarily affected by major but solvable problems. “In the case of companies, these can be ineffective management, operational problems or balance sheet issues, such as excessive debt or short-term liquidity shortages. In the case of real estate assets, these problems include assets “stuck’ on bank balance sheets, poor asset management, excessive leverage or lack of scale or a sound commercial plan.”
However, Amos said restructuring can sometimes take several years, especially in private markets and the real estate sector. He does not expect defaults, restructurings and insolvencies to reach the same or similar levels as after the 2008 financial crisis. “The reaction of governments and central banks to Covid-19 was faster than during the global financial crisis and the euro crisis. Hence, the impact of the coronavirus crisis on credit and equity markets and on restructurings and bankruptcies is less pronounced.”
M&G is also looking at distressed debt opportunities in the leveraged and high yield corporate bond market. However, distressed debt funds have raised a lot of money, increasing competition in these segments and reducing yields. “In these public, more liquid markets, almost all of the distressed debt opportunities in which we deploy significant capital are situations arising from restructurings in which other M&G fixed income funds are already invested, with us providing restructuring advice to those funds. Given the size of M&G’s fixed income business, we have visibility into the whole market and often own a proportion of the bonds.”
Special investment situations
But the majority of M&G’s distressed investments are in private, less liquid markets. “We have access to a sourcing network of restructuring advisers, banks and specialists across Europe. The team uses this network to look for opportunities to deploy capital in complex, higher yielding and special situations.”
M&G also focuses on special situations investments, often in asset classes that are traditionally difficult for institutional investors to access, yet offer the potential for strong uncorrelated returns. “An example is our music copyright platform, Seeker Music Group. Music copyrights have very stable long-term cash flows, but it is difficult for institutional investors to invest in them directly. That’s why we set up our own platform.”