Investors build war chests to buy bonds of distressed European companies

Industry:    2020-01-27

Years into a bond market bull-run, investors are banking on a brighter future for funds that buy the debt of financially troubled European companies whose bonds are offering meatier returns because they are more risky.

With European economic growth expected to be subdued in 2020, and default rates tipped to rise, investors expect an increase in the number of companies that will struggle to service their debt.

That creates an opportunity: to buy the bonds of a troubled company at a deeply discounted price, and make big profits if the company manages to turn itself around and the bond price recovers.

Private equity groups and asset managers are creating so-called special situation funds to identify suitable targets for these high-risk – and potentially high-reward – bets.

“We have seen a significant increase in the number of stressed and distressed European corporates being screened during our team’s discussions,” said Mark Brown, co-head of special situations in Europe at private equity firm KKR.

“We do think we are late-cycle and, as the fund is focused on deploying capital in a cyclical downturn, having capital ready to go makes sense,” he said.

The appeal of distressed debt is enhanced by the fact that a large chunk of the European bond market is offering yields close to or below zero.

KKR last year started fundraising for a third special situation fund and is seeking $1.5 billion.

Elsewhere, JP Morgan Asset Management launched its first ever special situations fund in November, raising just over $1 billion, while private equity firm CVC raised $1.4 billion for a global special situations fund in June.

PIMCO is also fundraising for a special situations fund, said a person familiar with the matter.

Bond prices show markets beginning to price in increased concern that the most troubled European companies will struggle to fund their debt obligations, providing an opportunity for those who specialize in dealing with such situations.

The ratio of European high-yield bonds trading at a spread of more than 1,000 basis points over their respective government benchmarks— one measure of distressed debt — hit 7% at end-2019 compared to 1.4% a year earlier, JP Morgan data showed.

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