Distressed debt fund SVP bets Europe will have long ‘hangover’ from Covid
Region likely to throw up opportunities for funds focusing on shaky corporate debt, SVP founder says
Europe’s economic and financial “hangover” from the coronavirus crisis will be much longer and more severe than the pain in the US, according to the head of a big US investment group specialising in corporate distress.
Strategic Value Partners raised a new $5bn fund earlier this week to buy debt issued by struggling companies, with a view to taking them over in a restructuring. The extra funds have catapulted its overall assets under management to $17.5bn.
Previous vintages of the money manager’s “special situations” funds have typically been divided roughly equally between US and Europe, but Victor Khosla, the firm’s founder and chief investment officer, reckons Europe will receive more attention in the coming years.
“The US is facing a long hangover from Covid, but the hangover that is coming in Europe will be much worse,” he said in an interview. “When we think about what’s coming over the next couple of years, Europe is going to be a bit more centre stage for us than it has been over the past year.”
The aggressive crisis-fighting measures of central banks and governments around the world have helped engineer a powerful market rebound and a strong economic recovery, easing much of the financial strain that typically supports ‘distressed debt’ and ‘special situations’ funds.
The average yield of US junk bonds — debt issued by companies rated below investment grade — has tumbled from a peak of over 11 per cent in March 2020 to under 4 per cent earlier this summer. That drop, the flip side of rising prices, takes yields to their lowest since at least 1996, according to ICE data.
Junk bond yields are even lower in Europe, thanks to the European Central Bank’s own aggressive quantitative easing programme and below-zero interest rates. The effective yield of ICE’s euro-denominated “high yield” index is just 2.3 per cent.
However, the legacy of the Covid crisis will be more indebted companies, which will elongate the distressed debt cycle and make many firms vulnerable to any fresh economic setbacks, Khosla argues. “Europe had a much worse crash than the US, and its recovery is much slower than the US,” he said.
And in Europe, dud corporate loans are clogging up the books of big commercial banks, with some of the debt dating back to the eurozone crisis a decade ago. The ECB warned last year that in a “severe but plausible” scenario, non-performing loans in the continent could reach €1.4tn.
Although that now looks less likely with the economic rebound gathering pace, Andrea Enria, the ECB’s main bank supervisor, warned in a speech last month that giving European banks too much leeway in dealing with these bad debts “would mean accepting that the EU banking sector may remain clogged with pandemic-related secured NPLs for longer than a decade, leaving it unprepared to face the next recession”.
Khosla stressed that SVP’s decision to raise the new $5bn fund did not indicate that the group expected an economic crash any time soon, and argued that the scale of central bank support likely meant that financial markets would remain buoyant for the foreseeable future.
“We are not boom-and-bust based investors. If there is a big crash we can accelerate our investments, but we aim to invest steadily,” he said. “Markets are strong at the moment, and we don’t think they’re going to collapse over the next year or two.”
SVP’s four earlier special situations funds produced a net return of 15 per cent a year, according to a presentation by the Connecticut Retirement Plans and Trust Funds, a state pension fund, which invested in the fifth one.