(January 9, 2011) — Hedge fund and private equity firms are positioning themselves to take advantage of a seemingly bleak environment amid burgeoning economic and financial hardship that is taking hold of Europe.
While Europe struggles with its sovereign debt crisis and near-stagnant growth, distressed debt has emerged as a growing opportunity as investors seek to benefit from shifts of value from equity to debt securities. Hedge fund and private equity firms in the United States, such as Centerbridge Partners and Baupost, which specialize in distressed debt, are preparing for what they predict will be a flood of opportunities as Europe suffers financially, according to consulting firm bfinance.
Deals showcasing the growing value of distressed debt are numerous. In December, the Royal Bank of Scotland finalized a deal with Blackstone, the US private equity group, in which the bank agreed to hand over control of a £1.4 billion book of distressed property loans, representing the largest such disposal of UK commercial property debt.
Meanwhile, Norway’s Eksportfinans, a partially state-owned company that provides government-guaranteed loans to foreigners to purchase the country’s exports, was downgraded to junk bond status in November, triggering forced selling of its bonds by investors restricted to holding investment grade debt. Furthermore, Apollo, one of the biggest debt investors, has purchased at least £12 million of Premier Food’s debt from Allied Irish Banks, bfinance noted in a research report on the topic.
Lorenzo Rossi, Head of Private Markets at bfinance, said: “Much of the distressed returns can be attributed to timing. Some distressed debt and special situations funds which invested in 2008 achieved net IRR returns of 50%-70% because they got their timing right. However, we see several fund managers that have demonstrated that often one can get better returns and with lower risk over the long term from debt strategies than from traditional buyout equity investments.”
According to Rossi, generally, special situations and distressed strategies are most successful when companies in distress are struggling to find new funding from banks or from the capital markets. “It is in these circumstances that debt investments, especially distressed debt and special situations, can generate returns in excess of upper quartile buyout equity investments,” a report by the consulting firm said.
In a video with aiCIO in early December, Thomas Lynch of California-based consulting firm Cliffwater, said: “Europe is the big opportunity on the cuff. It hasn’t really occurred yet but everyone expects it because of what’s happening on the sovereign level and the financial institution level that there should be a lot of assets that will be sold. So looking at traditional distressed debt opportunities and acquiring loans from European banks may be very interesting opportunities.”
Despite the turbulence of today’s markets, Lynch noted that he believes that private equity still works. “European investors have been a little bit slower to the private equity markets than US investors have because of regulation of the pension industry in Europe, but they continue to have the same desire for returns that US investors have. Therefore private equity still has a place.”