After years of outperformance during the great recession, distressed debt investing has cooled off for most of the last year with positive but nearly flat returns as an industry for the last ten months. That’s to be expected for an anti-cyclic strategy that has more opportunities to choose from when companies are struggling, but investors risk appetite has also created a challenge for fund managers, explains Marc Lasry, chairman and co-founder of Avenue Capital Group, in recent interview with NYU Stern School of Business magazine Evaluation.
Marc Lasry: Investors expect 40x the risk free rate of return
“The biggest difference between today versus when we first got started is that back then the risk free rate was somewhere between 4% and 8%. Today, the risk free rate is 25 bps,” says Marc Lasry. “People expect you to make 8%-12%, which is about 40x the risk free rate.”
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With limited bankruptcies for him to work on in the US, Marc Lasry says that he is involved in corporate restructurings domestically and that there is still a good deal of activity in Europe. He favors northern Europe because of the legal system, a major consideration when investments rely on predicting how assets will be spread among competing claims, and is invested in companies with hard assets like Punch Taverns and Travelodge.
Distressed debt requires better credit analysis than the competition
To meet his investors’ expectations, Marc Lasry explains that he has to have better credit analysis than both the sellers and the other buyers on the market so that he can take advantage of investors’ tendency to avoid devalued assets without getting burnt.
“If some says they’re buying a bond at 60, the follow up question is, ‘why not 50? People tend to have a natural bias against something that has traded down significantly,” says Marc Lasry.
He gives the example of Ford Motor Company (NYSE:F) secured bank debt, which Avenue Capital Group started buying around 70% of par, and kept buying as it fell into the 40s and 30s. The market was telling him that the debt was a terrible investment, but he had confidence in his investment thesis and kept buying. When the debt traded back up to par a year and a half later, the IRR was one of his company’s all-time best.
Of course things don’t always turn out as well, and Marc Lasry recommends continually testing your thesis as prices fall, analyzing your own work as a contrarian to make sure that you haven’t missed an important factor that the rest of the market is taking into account.
You can check out the entire interview in the spring edition of NYU Stern’s Evaluation along with in-depth interviews with other distressed debt and bankruptcy experts including Allan Brown, Edward Altman, and Julia Bykhovskaia as well as the winning entries in the Stern Investment Idea contest.