Running Distressed Credit With Duncan Farley
In this episode, we sit down with portfolio manager Duncan Farley of BlueBay Asset Management. We discuss the profits to earn when running distressed credit, which Duncan has been doing for almost three decades. They explain how Money management firms can take advantage of this investment to maximize opportunity on a global scale, particularly in the European market. Duncan also discusses how to navigate the possibility of recession as the United States enters its election year.
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Meet Our Guest
Duncan Farley
Author | Experienced credit analyst | PM for Event Driven Credit Fund
Duncan is an experienced credit analyst and now PM for Event Driven Credit Fund. He works as part of team managing investments across various asset classes, inclusive of high yield bonds and leverage loans; related credit derivatives; equities, commodities and index instruments. Duncan has a heavy focus on stressed and distressed structures covering a majority of industrial, oil offshore and Retail sectors.
Running Distressed Credit With Duncan Farley
I would like to welcome you to a very exciting episode. On this show, we interview experts in the financial industry with topics, ideas, and situations that we think would be germane and important to those readers that we have out there. If you need to reach us, I’m in Elliot@ProsperityFinancialGroup.com. The company’s email website is www.ProsperityFinancialGroup.com, and my office is (925) 314 8503.
Let me tell you what we’re doing. It is something a little bit different. We’re interviewing an actual money manager, a portfolio manager, Duncan Farley. It’s very exciting. He speaks a little bit of money speaks. We’ll dissect through all these great words that he’s going to come up with. He’s in a sector of the industry, working for RBC BlueBay Asset Management for decades, running distressed credit.
We’re going to talk about what distressed part it is and why we, as a money management firm, put that in our client’s portfolios. If you have questions about why and how, the distressed credit or credit which we had in general to our portfolios sometimes on a more conservative side, balance, conservative fixed income. We do like that. What’s the upside or downside? Why is it sometimes better or worse than bonds? Why don’t we put in high-yield bonds into our portfolios anymore, and why do we prefer distressed credit or credit?
We’re going to talk about that. It’s all supportive and then driven philosophy, which means that this company, BlueBay, is going to look for situations that are in trouble, upside down, or companies that are flailing in the water, so to speak. They’re going to swoop in, take advantage of it and when the company turns around and that circle to figure it out, then we’re going to do great with that. They’re going to do great with us. Duncan, I want to welcome you to our show.
Thanks. It is a pleasure to be with you.
I probably messed up everything I said about what you do. Let’s start with the basics. I’m not worried about who BlueBay is or RBC. I want the clients to understand that you’re in the distressed credit world. What does that mean?
I like to speak in simple terms for my own sake. Simply put, we are buying stressed and distressed debt. That’s bonds, leveled loans and bank debt. We’re buying at prices that are at a big discount. When we talk about a Stress investment or bond, that’s probably trading at a price between $0.55 and $0.75 on the dollar that we think, for whatever reason, can recover to a higher price if we want to buy it. If we’re thinking about a distressed investment, you’re probably paying a price below that, as low as $0.05 in the dollar, where you feel that you’re going to be able to generate a return from buying at that level through a more complex and longer-term investment strategy. Simply put, that’s the distinction price distinction between the two commonly used phrases of distressed and stressed.
You’re looking for opportunities and you’re bottom fishing in a way, looking for companies that are not operating at 100% for whatever reason the market, management or whatever you consider to be something that’s fixable or you wouldn’t be buying it because if it wasn’t fixable, it would keep going down to zero. Is that accurate?
Yes. I think we love to use the phrase that’s used quite often, the good company, bad balance sheet. Fundamentally, there’s nothing wrong with the business or whatsoever. The management might be doing a great job. The issue is that, particularly at the moment when the cost of funding has increased, there’s too much debt on the business. If you think about a company whose debt is four times its profits, if it’s having to pay over 10% for the cost of funding its debt, then that’s simply not sustainable.
There will need to be some solution. If we go back to that definition of stressed and distressed, in a stressed investment, we are expecting it to survive. We’re not expecting it to go through some insolvency or Chapter 11 process. We are expecting either for it to be at a trade-out of its situation or maybe we think the owner or the sponsor is going to put more equity in to be able to restructure the balance sheet to survive.
In a distressed investment, we know it isn’t going to survive. We know it will default and we will buy either ahead of that, providing the price is right, and I’ll come back to that hopefully in a minute, or we’ll buy as it goes through that insolvency process. We are very European-focused over here. We’re in London. We’re focused on Europe. Europe has many jurisdictions. There are complexities around that distressed Investing, but to your point, you’re right. It could be that the company hasn’t been well run, but often, it’s a good company. It’s just the balance sheet that’s wrong.
A distressed company is not run well, but sometimes it is still a good company. It is just their balance sheet that is wrong.
Thank you for explaining that. Unlike in the US, with an open-ended mutual fund or an ETF that’s liquid every day, this is your product that we put into your portfolio. Call us if you have questions on that, but put in the portfolios is an interval fund structure. That’s new for most people on an understanding. Can you explain that in a way people can understand that?
If you think it’s new in the US, it’s still not even arrived in Europe. In fact, if I say into the fund in Europe, people tend to glaze over. What’s the neat thing about interval fun for portfolio managers like myself, investing in the asset class we are, is a good way to match the liquidity requirements of investors. In other words, an investor in an interval fund knows that every quarter, they have an opportunity to take out up to 5% of total funds invested.
If they want to take their money out and it’s less than 5% of the total, then they will take it all out. That provides the manager, I myself, the ability to know that I’ve got money that is going to be sticky. What’s good about that is some of the Investments that we do will take longer to play out. A stressed investment, we would say, as a rule, is anywhere between 3 and 18 months to work its way out, but a distressed investment might take as long as 3 years. Having this interval fund structure that matches the liquidity profile or needs of the investor with the liquidity profile of the investments is a good way to structure a fund for this asset class.
It’s a neat idea. I hope everybody understands that. Let me talk about the market because you’re awesome at what’s called event-driven. As a portfolio manager, I’ve shied away from high-yield bonds. They’ve had a pretty good year because I find the parallel between them too close to the stock market. The stock market goes up, and high-yield bonds follow proportionally. The stock market goes down, high-yield bonds can blow up on you very quickly. Most people buy high-yield bonds, not understanding the difference between a corporate bond, a treasury, a convertible bond, and a high-yield bond. They think it’s a safer place to be. I think it’s not a safe place. Am I wrong in that area? Is there a better place and alternative? What we’re talking about here and event-driven to have a situation?
I sit next to my high-yield colleagues within BlueBay. We do quite a bit of work with them. They’re a very useful source of trade for us. It’s quite different from what we’re doing. They’re buying an index. Their performance as much against an index. That index will be quite heavily correlated to equity markets. That’s their job to manage that risk for us. The portfolio comprises 30 to 40 single names that are largely uncorrelated and that are all there on their own merits. As I say, they can be high-yield bonds, but they can also be levered loans. They can also be banked or, on occasion, forms of equity, public and private equity. We’ve got a different mix of assets or investments within the fund. That fund is very concentrated between 30 and 40, so 3% to 5% individual positions.
All I can say is if you look at the correlation statistics on the system fund that we’ve been managing for over many years, we have a very low correlation with all other asset classes because we’ve got a targeted return on each investment that we make somewhere between 12% and 30%. We do tend to get most of our investments right and that’s why the performance on this fund has been in double digits for many years. The key to everything that we do is downside protection. We’re only buying 30 or 40 names, so we can make sure that we do all the necessary analysis that we need to do on those names. If you’re a high-yield investor, you’re having to own hundreds of names. Therefore, you can’t do that level of analysis and you have to accept the market risk that you’re taking.
This is exciting because one thing every investor looks for is what we call the US Bellwether funds. They’re going to do well in all markets. I want to go to heaven with my investments, but I don’t want to die before I get there. It’s difficult because when they turn on the TV, the radio and they see on these talking head shows, Fox, Business and CNBC, even when things are bad, they’ll bring somebody on that’s up 18% in the middle of a recession, and they can’t understand why they’re not.
They don’t see what that person’s investing in or that person has been buying puts the entire time or selling calls. They don’t see any of that or they don’t see that he predicted the oil embargo, shut out in a world hotel. We get this false platitude that we’re going to make money no matter what happens and then they come to me. I want them to make money no matter what happens.
Every one of my clients is personal to me, but that’s not real. In an upmarket, which we’re in now, a little bit of a mild bull market, you’ve been performing with double digits. Let’s say all these prognosticators are right. In 4th quarter of ‘22, we’re going to have a recession, and then in ‘23, we’re going to have a recession. In ‘24, we’re going to have a recession. I don’t know if we’re going to have one, but if we do, how does this affect your fund? Is it going to create more opportunity or like with high-yield bonds, it crushes them?
What we say to investors is we certainly don’t need the world to win. We don’t need a major recession to create the opportunities. Who wants one? We’ve got better things to do in our lives to be waiting for that because I do think that when people think about distressed, they often assume that you need that financial crisis moment to create all those opportunities for us. What our track record on this fun demonstrates is that in all markets, up or down, there is plenty going on.
I’ll watch the list of names is over 200. Whilst it’s true, in particular, IU Market has performed well, spreads have tightened in, that’s not helping a lot of the weaker, more leathered names that we’re focused on. Compared to when I started looking at the European high-yield market back in the late ‘90s, where I could probably name all the issues for the first 4 or 5 years. Now, there are hundreds, if not thousands, of issuers of levered loans and bonds. The bank debt market has trillions of dollars in Europe, where we’re focused.
Even default rates of what are running at 2% or 3% are generating plenty of ideas for us. Now, if there was to be a big sell-off then we’d have a lot more to look at. That would mean it would be busier than we are now and hopefully, our experience would mean that we are quick to work out which ones we want to be playing or don’t want to be looking at in the first place. Whilst we wouldn’t want there to be a major recession, we recognize that is probably going to present itself with an even better buying opportunity or bit at some point. We need to sell and crystallize the investments we’ve made. Unless that recession was deep and went on for many years, I wouldn’t see it having any impact on the performance of the country. It would probably help inthe interim.
It’s a good idea for everybody. I understand that. What you’re bringing to the table is much broader rather than narrow because I think of not just event-driven, but I think of fixed income. I don’t think of Growth and I even don’t think of model or growth. Now, when you’re talking about what your performance has been, I’m thinking maybe there needs to be a sprinkling with that. Is that a fair statement?
I’d always advocate as I do to investors, that they should have some of their portfolio in alternatives. If you think about it, we’re investing in structures or instruments that are often as close to the underlying assets as possible. They’re secured on. They have collateral. We’re at the top of the capital structure. Remember, equity is at the bottom of the capital structure. A lot of the things that we look at, the equity gets totally wiped out. We’re close to those assets. We’re protected on the downside. Hopefully, if we do our job properly, we’re buying at particularly low prices. We can make very sizable returns on what we do.
Equity is at the bottom of the capital structure.
We will say to investors, “This particular asset class, this particular farmer offering, gives you diversification and it gives you that something uncorrelated to everything else that you have.” It can perform in all markets, as evidenced by the performance of this bond over the years and the other fund that we manage that’s been going for many years.
Who is BlueBay? You work from BlueBay RBC.
BlueBay is the fixed-income asset manager of RBC Broadband Canada. It is purchased by Royal Bank Canada many years ago. We have 500 investment professionals predominantly in London, but we do have offices in the US as well and some sales officers around the world. We’re managing over $110 billion of assets across the board.
I wanted to make sure that people understood that you’re not just this little money manager in a corner of an office there, but you are managing sizable assets, especially if you’re thinking about what you’re doing with event-driven alternatives in the credit world. It’s not like the equity world where we suddenly can get to $500,00 billion to $1 trillion. It’s debt.
It’s worth a penny at this special team that I work within. It’s a fraction of that. We’re out over $300 million. You raise a good point because what we’re doing does have a cap. We don’t want to compromise performance. If we had $10 billion under management, we would not be able to generate the returns that we are generating in this market. There’s a cap that is where we would be uncomfortable going beyond. Fortunately, we’re a long way below that cap, but there will be a point, hopefully, fingers-crossed, that we’ll get to that level. We would have no reservations about closing the fund and sticking with what we had because we wouldn’t want to jeopardize the returns that we’re seeing.
Set a cap when running distressed credit to avoid getting to a point where you will feel uncomfortable or get compromised performance.
This has been great for people to understand why we as money managers here at Prosperity Financial Group, have added this to our portfolios. You’ll be sprinkled in between now and, theoretically, because we see the opportunity there. We’re going to an election year. There’s weird displacement in the US during an election year. There’s the possibility of a recession coming. It doesn’t look like we’re going to get an interest rate hike again. Are these good things when you talk about opportunities for you?
In terms of interest rates, there’s a lot of talk about a rate caps happening in Europe, maybe towards the end of the year. That isn’t going to make a lot of difference to a corporate that’s facing borrowing costs of 12% to 13% quarter pay. 25 bits move in rates or 50 bits is not going to change the dynamics there. We don’t fear that. That probably means, however, is the Economy is it in an okay state or without maybe basing a recession, but maybe it doesn’t. Who knows?
We sit on a floor with some very clever macro people. We listen and take note as we should do as the portfolio managers on the funds to what they’re saying, but it doesn’t dictate too much in terms of our underlying investments that all have to stand up on their single merits. That’s the advantage of what we do versus some others who have to worry about market moves on a daily basis. We don’t need to do that.
One more question. You’re international, which is a little bit different than other credit funds that we do in the US. When I think of international, we think of every place outside the United States. It could be Canada, South America, Europe, emerging markets or even China, which, as a firm, we’ve tried to stay away from because we’re concerned about the future politically and militarily with China. We think that’s bad for everybody’s business. Where are you in this world as far as the fund you are in is international?
We could and can go anywhere. Certainly, we have an emerging markets team here. We do have access and have looked at China as an opportunity we decided that we would pass and that’s certainly proved to be the right thing to do. However, our bread and butter, our edge is definitely in Europe and the UK. The team comprises 3 British men and then we’ve got 2 Italian and a Spaniard, which gives us an edge over both those countries, but we’re looking across Europe and the fringes of Europe, Eastern Europe and maybe the Middle East.
Have we been in the US in the past on the funds? Yes, we have, because we have a leverage Finance team based on the East Coast that we can use on occasion, but it’s not where our edge is. I normally say I’m taking a call from a US broker on a potential opportunity in the US. I figure I’m at least the 100th person they’ve called. We don’t want to do that. We want to be the first person that people call to look at opportunities. That’s, frankly, only going to happen in Europe.
We’ve done a lot in the Nordic regions. We’ve done a lot in the offshore space. I work particularly hard with the broker community in Oslo to make sure that I’m on the speed dial. With many years of experience between us, we work on networks and contacts very well and most of those are, as I say, either in London or across Europe.
This has been great. I want to thank you so much for being part of this. We’ve been talking with Dr. Farley of RBC BlueBay Asset Management about a very unique topic and that is distressed credit and maximizing opportunity in a global market, particularly the European market. It is something that you don’t usually have a conversation about and we’ve added that to our portfolio. Come contact us and find out why we’ve added that and what we expect to do. Duncan, thank you for joining us.
It’s been a pleasure. Thanks for inviting me.
You’re very welcome. Thank you.
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