Fairwater Capital LLP

Altice Group: the next widowmaker for credit markets. It follows a long tradition of causing both widespread damage and certain books/strategies to suffer outsized losses. After nearly 25 years of experience in credit, I can make these observations: 1) Credit is a non-linear asset class, especially on the downside. 2) Liquidity is inconsistent and diminishes as volatility increases. Investors move down the liquidity tree as they move down the credit spectrum and from the US to Europe to emerging markets. 3) The market is exposed to gap risk. 4) Data is difficult to aggregate and clean. 5) In a normal market environment, most fixed-income securities are negatively convex. 6) VAR is suboptimal if not invalid for credit strategies as there is insufficient accurate data to calculate a precise outcome. Furthermore, most VAR calculations are flawed by using an end-of-day price rather than the low or high for the day. 7) Credit ratings are backward-looking and do not give an accurate estimate of price risk, default risk or loss-given default. Furthermore, corporate credit ratings and ABS credit ratings are not comparable. 8) Financial models are often flawed and are based on subjective inputs. I first experienced this with CDO pricing using Gaussian copulas/correlation model. More recently, we have developed a much more intimate knowledge of convertible bond and option pricing methodologies and their weaknesses. 10) Returns are often not normally distributed. 11) Many credit strategies are highly correlated with the market. 12) During credit market upheaval, it is often non-credit-focused investors who capture the asymmetric pay-off profiles. My career has spanned many crises including, but not limited to the Asian Financial (1997-1998), Russia (1998), LTCM (1998), Dotcom bubble bursting (2001), Ford/GM/Correlation (2005), Great Financial Crisis (2007-2008), European debt (2009-2010), Russia (2014-2016), COVID (2020), Russia (2022...AGAIN) and last but certainly not least Liz Truss/LDI (2022), which may not register in the record books. Nothing comes close to the GFC in terms of the sheer daily hell as an investor, while COVID was obviously in a different league for humanity. I have learned to stop thinking in binary terms of good and bad and to focus primarily on risk, and thus how to deliver superior risk-adjusted returns. In my mind that simply means minimising the size and frequency of drawdowns. We also need to learn from the actions of the main actors. For credit investors that means understanding that banks are in the business of structuring and syndicating; not providing impartial recommendations, that equity sponsors are seeking to maximise their profits, that credit ratings are paid for and not impartial, and that other creditors are not your friends unless by chance your interests are aligned. My motto: buyer beware!

Ardagh Group: yet another example of where the sponsor reaps the benefits of cheap debt financing and unrestrictive covenants. Investors should not expect Paul Coulson to do anything beyond what is in his best interest and what is in the covenants and indentures of the loan and bond documentation. This also creates a very interesting situation for Ardagh Metal Packaging, which is listed in the US, and currently has a market cap of $2.079b on an enterprise value of $5.376b. Ardagh Group owns circa 76% of the shares, so in theory, this should be a source of liquidity. However, I strongly suspect that will not be straightforward. This cycle is shaping up to clearly differentiate the stock prickers/deep fundamental credit analysts from their peer group. In CLOs, there has always been a high dispersion of equity returns. In this cycle, there is a high probability that dispersion is even higher and that some managers fail to deliver a zero IRR. #credit #distresseddebt #abs #clo