Fundamental changes in the banking sector coupled with periodic bouts of market dislocation result in a multitude of opportunities in Emerging Markets (EM) illiquid credit. Lack of capital markets alternatives for borrowers and low demand for bank loans drive EMIC’s ability to focus on high quality, low levered credits with potential to achieve compelling returns.
Watch time: 4 minutes
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Emerging markets illiquid credit strategy focus on, as the name suggests, on illiquid instruments. Those are either loans or notes. We do look at three underlying sleeves. The first one we call it performing secondary. Those are healthy companies that we purchase secondary debt in the market. These are widely syndicated loans that the banks are ultimately selling. The second sleeve we call it new money. That is very much akin to a direct lending strategy. We're still doing it in a syndicated club facility. The third sleeve we call it stressed. These are not focusing on loan to own, but these are focusing on situations where the company is just coming out of restructuring rather than a loan to own type of situation.
Our investment philosophy focuses on medium to large emerging markets corporate borrowers where we are able to achieve anywhere between 300 and 500 basis points of an illiquidity premium. We focus on healthy corporates where the underlying leverage is anywhere between two and four times. The underlying loan documentation is what we call old style documentation where we have a full set of financial covenants, where we have restrictions on asset disposals and payment to the shareholders.
In terms of how we achieve this, we do look in the market at forced seller. These are banks that, as I mentioned, they need to reduce their capital and risk exposure to the emerging markets borrowers. That's one aspect. The other aspect, it's the new funding that these underlying borrowers would need, the restrictions that they faced when they accessed the capital markets. That ultimately drives the opportunity that we ultimately see in the market. We achieve all of this by being on a very strong platform. We are part of the emerging markets team here at RBC BlueBay. This team has north of 30 people dedicated to emerging markets fixed income. We have a track record of 21 years in the market.
The market opportunity is ultimately driven by the changes that happen in the industry after the financial crisis. We have seen that banks are under capital and regulatory constraints, which drives their less appetite for emerging markets corporate credit. If we look at emerging markets, we see that about 90% of the funding needs are coming from the banking sector versus anywhere between 20% and 40% in the US and 50% to 60% in Europe.
At the same time, the debt capital markets within emerging markets are very shallow. Again, comparing to the developed markets, are anywhere between 10% and 20% of the GDP. While in developed markets, it's anywhere between 50% to 100% of the GDP. In addition, you do not have the same alternative sources of capital. You do not have the same depths of private credit, insurance companies providing credit to these emerging markets borrowers.
Key points:
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We focus on three pools of assets:
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Performing secondary – healthy companies
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New Money – akin to direct lending, but through a syndicated vehicle
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Stressed – companies coming out of restructuring
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We focus on healthy companies where we can earn a strong illiquidity premium.
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We seek out “forced sellers” to find opportunities.
