By
Gary Stead, Shearwater Capital Group co-founder Thu 28 May 2009
Opportunistic credit has come onto the radar of institutional investors as supply and demand gaps in credit markets emerge.
Australian businesses need capital. Right now they are constrained by the sources and types of capital.
Credit is effectively available only from the four major trading banks and a limited number of foreign banks, each of which provide essentially only senior debt. The situation in the United States is different.
Businesses there still have access to myriad providers of a variety of forms of credit.
These supply/demand gaps create opportunities to be exploited, as evidenced by the plethora of overseas 'special opportunities' and 'opportunistic credit' managers flying in and out of Australia.
These fund managers have operated successfully in the US and Asia through economic cycles for more than 20 years and see Australia as the leading Asian market due to the size of the opportunity, the low level of competition and our creditor-friendly legal system.
More often than not, these managers lack an on-the-ground presence so necessary to ensure early identification of opportunities and easy completion of thorough due diligence. To that extent, the confluence of a 'domestic bias' and extensive international experience should generate greater rewards.
'Special opportunities', in particular 'opportunistic credit', investing differs from 'traded bond' investing, private equity and 'turnaround' investing, which typically involve significant equity investment, control and hands-on management.
Opportunistic credit investing generally involves investment across the capital structure, but focused on credit rather than equity.
It will typically be illiquid, and usually held for a term of three to five years. Any equity will usually accompany a secured or unsecured credit investment.
The target base return comprises a running yield on the debt provided and a capital gain on the original investment.
Unlike some other forms of credit investing, target returns rely neither on leverage nor improved market conditions.
Capital invested is strongly protected through participation in the credit component of the capital structure, conservative valuations and careful structuring.
Where possible and appropriate, an equity investment (for example, warrants) that captures additional upside is included. Capital protection on the downside and an 'equity option' on the upside is the ideal return profile sought after by most institutional investors.
Each investment opportunity is different, so a nimble, flexible but disciplined approach is essential. Right now many businesses need capital to acquire new assets or to refinance existing debt, but are unable to secure funding at an acceptable cost from either trading banks or existing shareholders.
'Special opportunities' investors can solve that problem by providing a tranche of mezzanine debt coupled with equity warrants.
Another example, particularly relevant in the current climate as banks restructure their balance sheets in response to the global financial crisis, is the acquisition of a loan portfolio from a bank at a significant discount to face value. Such transactions offer excellent running yields and potentially a significant capital gain at maturity.
Investment folklore teaches that the most successful investments often don't fit the established taxonomy or an established modus operandi. Domestic 'special opportunities' and 'opportunistic credit' certainly qualify on these characteristics.
The two non-consecutive alphabetic letters encountered most often last week caused more controversy than the underlying policy they represented, Wouter Klijn writes.... read more »
Home delivered!
Daily news, weekday mornings
Get the day's news delivered direct to your inbox. Register here (it's free!) and choose 'yes' to receive the InvestorDaily newsletter.
