The credit crunch has the makings of a protracted distressed debt cycle, but many believe this is still years away. STEPHEN SHORE talks to institutional investors weighing up whether to sort through the plethora of new specialist distressed debt products in order to take advantage of some short-term opportunities.
“This is a once-in-a-twenty-year opportunity,” reckons Charles Wall, director of institutional business at Putnam Investments Australia. He is not alone. Over the past nine months, literally hundreds of new funds have sprung up to try and take advantage of the dislocation in debt markets stemming from the credit crisis.
The challenge for institutional investors is to determine which of these opportunistic managers have the skill to exploit the persistent opportunities in credit, says David Field, associate director in the ‘implemented absolute return’ division of Queensland Investment Corporation (QIC). “An average manager can take advantage of a price dislocation because it is primarily a beta opportunity,” he says. “But there will be greater differentiation of credit managers than we have seen in previous cycles because of the anticipated greater dispersion in default and recovery rates. Manager selection in the credit space has never been as important as it is now.”
One fund confident in its manger selection is the Australian Reward Investment Alliance (ARIA). The fund allocated around 1 per cent of its $19 billion portfolio to distressed debt in the second half of 2007. It has hired one manager so far. Appointed with a dry powder mandate, the manager made its first draw down – 5 per cent of the allocated capital – in June. Alison Tarditi, chief investment officer at ARIA, says that to identify the right manager, the fund “understood capturing sound long-run returns without undue risk would require patience, a specialised skill set, and a hedging strategy. “We sought to hire a manager with a long record of success that would only invest our capital when genuine opportunities to meet or exceed our hurdle rate of return, within limits, arose,” she says.
However, some super funds are hesitant to hire an opportunistic manager. Sam Sicilia, chief investment officer at the industry fund Hostplus, says that the problem with an event the magnitude of the credit crunch is that it has sparked the creation of funds by a whole lot of managers who do not have experience in either credit markets or the institutional space. “We are inundated by them,” he says. “It takes so much time to filter down to the mangers that have genuine skill and opportunities.” That is not to say he would not consider a specialist manager, Sicilia says, but when you have an event of such a huge magnitude as the global credit crunch, it is reasonable to expect that things will snap back. “If that happens in the short term, then you have gone through the diligence and cost of hiring a manager whose opportunity set will soon disappear,” he says.