“Excess returns”: UBP alternatives group targets Covid-hit credit with new distressed fund
Seizing on the assortment of opportunities arising from the ongoing coronavirus crisis, Union Bancaire Privée (UBP) has unveiled a new credit-focused strategy which taps into stressed and distressed situations within mid-market US and European corporate credit, collateralised loan obligations and segments of the European commercial real estate sector.
The fund, named UBP Distressed Opportunity, is led by Kier Boley (pictured), CIO and co-head of UBP’s Alternative Investment Solutions group based in London and Geneva, which constructs portfolios and investment vehicles in hedge fund strategies and alternative assets for a range of institutional and private investors.
The new strategy, which had its first close earlier this month and is scheduled for a final close later in March, aims to raise between USD200-300 million in assets, which Boley says reflects the size of the emerging opportunity set in the fund’s target investment universe.
“We’re really aiming for that middle-market, the mid-cap opportunities, in distressed investing; companies usually with EBITDA of between USD10 million and USD75 million per annum,” explains Boley, an investor into distressed asset opportunities for more than 25 years.
Dealing in distress
Having begun his investment career in 1994 at City of London Holdings and Investments, initially focusing on emerging markets, Boley later spent 20 years at GAM Investments between 2000 and 2020, where he was head of alternative investment solutions and, from 2018, head of its private client & charities team.
Speaking to Hedgeweek, he describes how the various emerging market crises across Asia, Russia and Mexico in the late 1990s, along with the early 2000s dot.com crash and the 2008 global financial crisis, helped shape his trading philosophy and approach to investment management over the course of his 25-year-career.
“These were classic distressed conditions where, if you applied a contrarian approach, then once you came to a turning point in the fortunes of that country, or that market, you would get a very strong four-year recovery stage.
“You could generate excess returns which were often uncorrelated to wider emerging markets,” he recalls.
“Having got quite comfortable investing within that sort of volatility range in terms of expected loss versus potential annualised return over the upside, I then moved into the alternatives space at the start of 2000, and went straight into the TMT bubble bursting in the early 2000s.”
From those tumultuous events, Boley formulated a series of guidelines which mapped out a broader thematic approach towards distressed investing.
“We applied that same rule book in the 2008 and 2009 crash. Then, when I joined UBP at the beginning of last year, we very quickly had the crisis generated by coronavirus,” he says of the origins of the new strategy.
“By April, we were starting to see those same types of characteristics within certain sectors and certain asset markets, which again provide those opportunities sets for distressed investing.”
Amid the Covid fallout, UBP began to delve into assets hit hard by the pandemic, and which potentially could offer double-digit returns in distressed situations. The fund soon zeroed in on corporate credits spanning the retail, travel, and discretionary consumer sectors, as well as select pockets of commercial real estate, Boley explains.
“It’s quite focused in probably four to five sectors of the economy. But within each industry we’re focused on, there’s actually this large bifurcation between the large cap, investment-grade companies and middle-market, mid-cap names,” he says.
While the larger names that are able to access government support have withstood pressures and avoided distress, many mid-cap players within the same industries have found the past year particularly challenging, especially those which have sizeable debt-to-equity ratios and face capital restructuring.
“Those are the ones we’re looking at, which we find much more interesting,” Boley says of the strategy’s investment scope. “It’s here where you can find attractive credits, which are still providing a good yield and will actually be very attractive names as and when they come out of some form of restructuring.”
In the aftermath of the market turbulence, institutional investors such as pension funds and insurance companies are now looking to increase their exposures to distressed assets generally “quite significantly”, he adds, driven partly as a result of lower return expectations from their fixed income and credit portfolios.
As the economic shock of the Covid-19 pandemic unfolded and the distressed sectors were identified, the next stage of the investment approach was to track the wide universe of hedge funds and investment managers within each sub-strategy, with a view to assembling a select group of external investment managers to run the fund’s underlying strategies.
“We don’t try to do any tactical allocation around managers; we like to create portfolios that are stable and focused, with around five to ten underlying funds within a portfolio,” he says. “Within the distressed universe, there are around 200 managers, ranging from the very largest players all the way down to individual asset class specialists. We speak to all of those managers, and from those discussions we can build a picture of which asset classes, companies or geographies are particularly of interest to them in this phase of the cycle.”
For the Distressed Opportunity Fund, Boley’s team sought to unearth managers that could generate gains in the neighbourhood of 15 per cent per annum.
“We looked to identify which of those managers can generate an excess return above their peer group in an asset class, and whether that alpha can be sustainable,” he continues. “We decompose the expected returns at the strategy level and the manager level, to determine how much is passive beta, how much is what we’d call hedge fund beta, or a hedge fund premium, meaning the peer group return, and then, from there, we determine the excess return.”
As the fund’s investment manager, UBP ultimately picked four external specialist managers with expertise in the fund’s target areas – US and European mid-market corporate credit; collateralised loan obligations; and European commercial real estate - to manage each individual sleeve of the portfolio.
“We set up investment guidelines for each of the four sleeves, and appointed a specialist to run each sleeve. Therefore we can control which asset classes and which geographies the fund is exposed to, as well as the capital structure, sizes, and so on.”
The core of the strategy is focused on US and European mid-market publicly-traded credit along with smaller amounts of private credit. UBP appointed two separate specialists to manage this segment of the strategy: Beach Point Capital Management, a USD3 billion stressed and distressed credit manager based in Santa Monica focusing on US assets, and Brigade Capital Management, a European specialist manager running more than USD2 billion in European distressed debt.
This represents the bulk of the fund, at around 60 per cent of assets, split evenly between the US and Europe, and targeting returns of between 12 and 20 per cent per annum, Boley notes.
Meanwhile, at the more liquid end of the distressed sector, the new fund aims to generate returns of 10-12 per cent annually within the mezzanine and equity tranches of CLOs, which fell sharply during the initial Covid crash and which have yet to see the strong rebound experienced by higher-rated CLO tranches.
Here, UBP appointed CIFC Asset Management, a USD1 billion AUM New York-based CLO manager whose team boasts deep expertise of investing in ruptured CLO tranches in the aftermath of the 2008 financial crisis.
The final and longest duration asset class within the book centres around one of the most heavily impacted areas within real estate as a result of Covid-19, according to Boley: the hotel industry in Europe.
For this opportunity set – which has the potential to bring bumper returns of some 20 per cent annually – UBP picked London-based manager Pygmalion Capital Advisers, a USD400 million real estate debt investor, and specialist within the hotels sector.
“Here, as with the other opportunities, we’re looking at good companies but whose balance sheet or corporate structure is leveraged, and who need to restructure their balance sheet in order to benefit from the recovery.
“Because of Covid, and hotels facing closures or running at below capacity rates, they either face breaching their covenants on the mortgages or are trying to find some form of negotiation,” he says. “Pygmalion’s skill set here is negotiating an exit for the current owner, which can involve taking over the equity of the hotel and renegotiating the mortgage from a stressed asset or even an NPL to a performing loan.”
With the fallout from Covid’s economic shock still reverberating across economies, Boley remains resolute in his team’s approach, which he describes as “bottom-up driven and constructed”.
“There aren’t that many factors from the top-down that influence returns when you are doing distressed assets,” he says of his investment style. “The top-down influence comes right at the beginning, at the creation of the crisis, which typically then leads to downgrades in credit quality of individual companies.”
The downgrade event inevitably triggers forced selling from institutions who can no longer hold the downgraded credit, leading to “more forced sellers than there are natural buyers.”
He continues: “At the strategy level, we look to identify factors, and headwinds or tailwinds, which indicate when you’re approaching an inflection or a turning point in the fortunes of that strategy.
“You get that very attractive entry point where you can capture the value premium, and that generates a healthy component of a 15 per cent type return for a credit strategy,” he explains. “But then the real added value comes from the ability of the managers we appoint.”