This article is sponsored by AlbaCore Capital Group
Looking back at 2020, what are the biggest lessons for private credit managers?
David Allen: I have been investing in European credit since 1995 and 2020 was a good reminder to expect the unexpected, maintain discipline and focus, while also setting yourself up to make nimble decisions and investments.
Most private debt firms will focus on LBO lending to mid-market companies, which is the most common form of private debt. The difference for AlbaCore was to instead be active across the credit spectrum, both in public and private markets, including larger companies. The past year reaffirmed the power of this flexible relative approach.
If you look back at 2020 and pick out three dates you see three totally different environments. In February, something didn’t seem right, but the scope of the pandemic was not apparent. By late March, the markets were in crisis, and then by December they were looking strong again. We had set up AlbaCore to be prepared for dislocation environments, and so in February, we were busy underwriting and taking to investment committee credits that we loved and thought were still priced too high, in preparation for the storm to come. Through the year, we were able to move quickly to capitalise on those opportunities, while maintaining our deep diligence approach.
Another lesson was on leverage. By not being over-levered going into the crisis, we were in a healthy position to invest actively throughout. A lot of the businesses serviced by traditional private debt providers don’t work without leverage – they can’t generate double-digit returns without leverage – but we saw a lot of asset managers struggle directly as a result of this over-leverage, even if it seemed like the right play initially.
Bill Ammons: One key takeaway for us was the value of preparation. We have a strong analyst team and maintain active coverage of over 100 companies, so when we see an opportunity, we are poised to move quickly. As far back as late 2018, we had started studying 30 years of market data to identify the right triggers for dislocation capital, looking at price, yield, spreads etc. Sometimes when you meet a great company, you find there is a lot of competition and it prices too tight for us to invest. In these cases, we would put it on our watch list to track until the price is right at a later date. We had even taken many of those companies pre-emptively through investment committee approval.
A second key takeaway for us has been affirming the importance of being active in public and private debt when a company has both types of deals in their structure. In many cases, we were able to navigate the markets and buy secured debt at 70 that in many cases is now worth 100 and stay one step ahead because we had our watch list ready.
These two fundamental themes of being prepared and being nimble were confirmed by the 2020 dislocation and remain valuable and central to our investing approach going forward.
What new opportunities opened up for private debt during the year?
DA: For investors that were disciplined and ready, there was a lot of opportunity in 2020. With our hybrid abilities we could adapt our focus and be active where the opportunity was most attractive. We also launched a dislocation strategy which generated strong returns.
In March and April, it was hard to find a private transaction that beat the opportunities in the public markets. Where you can trade down in risk and maintain returns, we will always take that trade, and so we engaged more in secured debt. Our outcome was a significantly de-risked portfolio to capture material returns for our investors and outperform the credit markets.
There were also a lot of opportunities that opened up beyond LBOs, like rescue financing and more opportunistic capital.
BA: Unlike the global financial crisis, where most companies saw earnings drop, in 2020 we saw the unlikely combination of a huge contraction in certain companies that were negatively impacted by covid-19, while some companies still generated record revenue driven by the stay-at-home trend led by the tech giants like Amazon and Netflix, and also retailers like Academy Sports and Target.
Some sectors, such as the cruise market, saw previously investment grade companies downgraded and with new capital needs. Other sectors that have historically performed badly in times of economic volatility, such as building material retailers and distributors, were seeing good volume as building projects continued and people turned to home improvements. Notably, some of the credits that were particularly badly hit during the global financial crisis did well this time around, proving that each crisis is different.
Have you seen any shifts in the way that managers work with investors, sponsors and companies, and will those shifts endure post-covid?
DA: In 2020, the importance of being a trusted partner and being an agile solutions provider was highlighted. It is how we have always approached investing.
On a practical level, the way we all communicate and do business fundamentally shifted. At the start of the year, video conferencing was just a back-up system, but by the end of April it was clear that we could maintain decade-long relationships with sponsors, companies and investors entirely through this medium. The shift also was successful for communication with new partners and we have been able to raise money from new LPs in 2020. We have also seen a frequency shift and are certainly communicating more often with our LPs, due to the removal of travel involved.
This changes not only the way we communicate but the impact our business has. We measure and offset our operational carbon footprint and this shift will have significantly decreased our carbon footprint, while our business efficiency materially increased.
We still value seeing our partners face-to-face and so travel will return, but maybe only one in three meetings needs to be in person.
BA: We have definitely found access to management teams has improved as a result of no travel – it makes them more accessible to us as investors because they have more time not being on the road. It has also allowed us to bring more of our team into those relationships.
Although we will always want to see people, we don’t need to be in the room to deliver a presentation – in fact, you can sometimes have more information available if you are on Zoom with your computer at your fingertips.
We have also completely bought into the working-from-home mindset. We are always going to have our headquarters in London and an office in Dublin, but we are ultimately a talent and people business and flexibility is something we are now much more able to offer our team.
How has the world changed for private lenders and where will opportunities be found?
DA: The risks are still elevated. While the S&P may be at a record high, underlying economic fundamentals are still very weak and the effects are only starting to percolate around the world.
There will be a lot of losers in the post-covid world. Industries like airlines, restaurants and traditional retailers will never be the same.
One of the big trades of 2020 was buying the debt of companies that would survive the pandemic when it was priced at very low dollar values. If you bought companies that survived, you made money. But that is not going to be enough in 2021. More than ever, fundamental research will be crucial to understand each company’s risk profile.
BA: The big question for a lot of companies six months ago was whether they were going to survive the pandemic. Looking forward, we will be looking at fundamental credit questions – are customers going to return? People will need to start looking closely at business fundamentals, performance and leverage again. Where initial survival was the primary concern last year, this year will be about the ability to adapt and thrive.
Going into 2021, we also see a continued focus on ESG in the private debt sector, with more companies focused on ESG reporting. We see ESG as accretive to returns and continue to develop our decade-long discipline that integrates ESG into our investment decisions.
What do you think will be the key differentiators of successful credit managers post-covid?
DA: The ability to invest in different sub-sets of credit, be nimble, and maintain focus on fundamental research in a fast-changing environment will be key. A lot of the private managers have tried to operate in a predictable way, financing a certain number of LBOs a year. For the team at AlbaCore, being more dynamic and flexible is where we think you can capture alpha.
We all need to get used to the idea that things do not always go exactly as planned. The differentiators will be how you interact with leverage, how much attention you give to fundamentals and how disciplined you remain as a thoughtful investor in challenging times.
BA: If you’re a manager that is good at responding to a dislocation, with pre-committed trigger capital, then in the credit markets you can make as much in a period of months as you could in years by moving at the right time. Investors will now be looking at having some capital dedicated to those types of opportunities so they can take advantage when they arise again.