Five minutes with… Robert Petty

The managing partner of Clearwater Capital, which has so far raised $200m for its fourth fund, explains how global market turmoil might impact Asia’s credit markets.

How has the recent volatility in the public markets around the globe affected Asia’s credit market and Clearwater’s distressed investment strategy?

The sharp volatility and increasingly dramatic risk aversion over the last few months, combined with the heightened concerns around governance issues in India and China, have led to a dramatic widening of credit spreads across the full spectrum of Asian opportunities. Prices are off from 5 to 20 points across most parts of the corporate credit markets with spreads now wider than the peak in 2010 – itself, a great year for credit investing. What continues to underlie our strategy, however, is that the core economic fundamentals underpinning Asia are so at odds with the credit market picture.

Our core view, which we have held and advocated for several years now, is simply that Asia is not as inherently risky as it is perceived. All fundamentals – steady economic growth, youthful demographics and, most importantly, fiscal and monetary disciplines point to the opposite state of affairs. That said, the Asia region now faces serious challenges that are not to be ignored, especially in the political stability and corporate governance arenas, and these uncertainties coupled with fickle and transnational capital have historically created and are now creating great investment opportunities for very focused credit and special situations investors, especially those with long-term capital to support companies through a range of economic and market vagaries.

The second important component of this global market volatility, exacerbated by low interest rates in the US and most Euro markets in the Asian context that is often forgotten, is the intense pressure on Asian central banks to battle inflation, manage their currencies and try to restrict lending in most domestic environments. This sharp dichotomy from US and European issues has also created local market situations for direct financing as companies financing choices can be found restricted, onshore as well as offshore. These markets, both local currency and the offshore credit environments, have made for a very busy summer and we expect this to continue well into next year. The world will remain rightly nervous and it is now, and will continue to be, a great time to be a very selective investor in those Asian corporates that will not only survive and service their debt, but search for high yield financing and refinancing in an environment of capital scarcity.

When most investors are looking at Asia’s growth story, what are the opportunities here for distressed and special situations?

For over a decade since the Asian financial crisis, which marks the real beginning of dedicated special situations investing in Asia, this question has rightly been asked. Since that time, the Asian credit market, excluding Japan, has grown from $9 trillion to almost $20 trillion outstanding. We have seen new or updated bankruptcy codes passed in virtually every single nation to protect government owned bank balance sheets. This past decade has also generated a consistent series of crises – Russia’s financial crisis, SARS, dot com bubble, Korean credit cards, GFC and, today, corporate governance issues across Asia. These events in combination with the consistency of sector-specific difficulties – from shipping crisis to semiconductor cycles, from power sector restructurings to toll road restructurings – create an ongoing opportunity set for special situations investors. Looking back, when hasn’t there been a market for helping companies that have made mistakes get back on the growth curve?

The growing, entrepreneural mid-market companies that are so much the engine of these Asian economies simply make mistakes while pursuing growth, sometimes too aggressively, sometimes just making capex mistakes and with the scale of the Asian economies today – growth is a great environment to buy into good companies that have simply over-levered for any number of reasons.

I think it is safe to say that today, the Asian growth story is taking a backseat to the concerns of inflation, corruptions scandals and overall deleveraging in the region and world over. Since Q2, the concerns over global growth slowdown have sent the markets into a downward spiral creating ample distressed and stressed investment opportunities in the region starting with sectors like property, shipping and solar. Our view is that this situation will intensify in the fall when inflation concerns reappear on the back of poorer than expected harvests and persistent demand stemming from the expansion of the middle class across Asia. Added pressure from the rising energy prices in the environment of uncertainty over the future of nuclear in Japan and around the world has already begun to show itself in certain sectors in the region – notably shipping.

In this context, I think you will see a number of investors turning to countercyclical and opportunistic strategies revolving around opportunities coming out of the market turmoil we are experiencing even today.

What are the challenges dealing in Asia for Clearwater?

Local law, local language, local jurisdiction. These are the three challenges that face every investor in the Asia region. In order to do this business well you have to be on the ground and versed in the specifics of the local markets. Extensive on-the-ground diligence is what allows you to avoid situations like the recent Sino-Forest scandal. Our local team is based in several offices across Asia and has visited, in some cases multiple times, every factory and plant we have ever invested in. Cross fertilization and knowledge sharing between offices allows our team to not only use their local skills but also benefit from the regional knowledge of their colleagues in evaluating anything from accounting practices to intra-regional operations of a company we are considering. This process allows the analysts to identify any accounting irregularities or potential fraud in the early phases of diligence.

What are some themes you’re seeing in Asia’s debt markets?

The biggest theme in the Asia’s credit market today is the development and growth of onshore debt markets. Historically, Asian companies could rely on one source of debt financing – the local banks. Today, some companies have begun to reach a scale to access the offshore debt markets which themselves are growing notably, but the great phenomenon is the growing sophistication and range of local lending and credit market instruments. While the onshore debt markets have been developing to a varying degree across Asia, some have also suffered setbacks such as the collapse of many mutual savings banks in Korea that took place earlier this year. In the current macroeconomic context, local companies are increasingly turning to bridge loans, project completion linked financing and other non-bank lender solutions and it seems clear that this long term trend will continue for years and this growth will clearly continue to provide an array of opportunities for special situations investors with an ability to invest onshore.