Capital Structure Forum: Proceed with caution

The common feeling on the morning of PDI’s London conference was that the asset class will continue to flourish, but Brexit uncertainty and intensifying competition pose threats to fund managers.

Brexit was the hot topic on the first morning at PDI’s Capital Structure Forum in London, where a mixture of opportunity and caution was the prevailing mood.

While many in the industry would wish to avoid a severe downturn, the consensus is that banks will restrict their lending under a period of economic uncertainty. Michael Arougheti, president of Ares Management, said that 2017 is likely to be more volatile, but that this could be a good thing for the asset class.

“The best environment is one of slow growth. The structure of the loans themselves allows you to reprice your risk in volatile markets. Making a mid-market loan can take between two and six months and you’re constantly re-underwriting the risk, which means you’re able to make changes as you go. And because we’re investing capital over a three-year period, the timeframe allows us to be measured in any market environment,” he said.

The role of the banks will be key to the development of the industry over the next 12 months. Where previously the leading financial institutions looked at them with suspicion, many now see funds as having an important role in maintaining relationships with key clients. “There is more co-operation with banks, they see us as partners,” said Karthi Mowdhgalya, founding member of BlueBay Asset Management.

Andrew McCullagh, head of origination at Hayfin, said that banks are keen on maintaining their footprint in the asset class, which has a track record of low default rates. “Some banks have been less busy and others have been a bit more on the front foot. Relationships with banks are an informal partnership and there is now long-term recognition that funds are providing a good service.”

Arougheti said that one way this is panning out is that they are outsourcing a lot of their risk management and loan origination to funds as they contend with restrictions on lending.

Panellists recognised increasing competition among funds in the market, with McCullagh stating it is a “terribly fashionable industry” as the asset class becomes more mainstream. But the experience of the team is a key factor in a firm winning deal. “It is a very labour-intensive market and if we see competition it tends to be around the structure of the deal and not the pricing,” said Paul Hatfield, global chief investment officer at Alcentra.

Nevertheless, there was acceptance that challenges lie ahead. Many of the panellists noted there may be an impact on their portfolios, albeit a limited one, as sterling continues to fall. “There is no doubt we are going to see stresses and it will lead to under-performance in some businesses,” said McCullagh. Mowdhgalya agreed there would be difficulties, but he explained that the firm’s portfolio was dominated by businesses which were “national leaders in their national markets”.

While the future may be a mixture of fear and hope, the industry has to contend with the more practical issues in front of it. Asked what the industry should demand if it had a seat at the Brexit negotiation table, Mowdhgalya was clear that passporting rights is a priority and that the UK government should continue to signal its support for the non-bank lending environment. McCullagh stressed the importance of ensuring London remains a welcoming place for talent from Europe and across the world.

Refusing to be put off by the prevailing uncertainty following the vote, James Keenan, global head of fundamental credit at BlackRock, echoed a feeling shared by many on the opening morning of the forum: “Beyond Brexit, we’re excited about the opportunities in credit”.