Ask the Expert with Franklin Templeton Special talk

In this Ask the Expert interview, Eric Larsson, Managing Director, Co-Head and Portfolio Manager at BSP-Alcentra (a Franklin Templeton company), explores the growing opportunity set in European special situations investing. He’s in conversation with Alexandra Brown, Investment Content Specialist at Savvy Investor.

What is the main attraction of investing in special situations?

Special situations investments can deliver equity- like returns with a risk profile akin to a secured debt portfolio. It is the best of both worlds: we buy debt at a discount, often with low loan-to-value ratios and security on the main assets of the company, but with the ability to capture upside convexity. The strategy offers a high current yield as well as capital gains, achieving all-in returns similar to private equity, but with lower risk and less volatility.

How can exposure to special situations in European private credit complement a traditional private credit portfolio?

The majority of private credit portfolios focus on four or five core sectors, such as services, healthcare, IT etc. Special situations strategies tend to be sector-agnostic in their approach which allow investors to gain exposure to a wide range of opportunities in various sectors, leading to a more diversified portfolio overall.

Furthermore, special situations strategies outperform during downturns when private credit portfolios fair less well, effectively providing a hedge to counter any underperformance in the private credit portfolio.

BSP-Alcentra specialises in ‘corporate special situations.’ Are there further distinctions within this bracket?

We divide corporate special situations into three key areas: stressed credit, recapitalisations, and capital solutions. Stressed investments involve purchasing a bond or loan with the expectation that things will improve, either through the company’s recovery or an injection of capital by the equity sponsor, with the goal of selling at a higher value once that event occurs. In the case of recapitalisations, creditors step in as shareholders following the company’s restructuring and capture returns from selling their equity once performance improves. Finally, capital solutions involve providing new capital to corporates that face some form of stress or need assistance to navigate a difficult situation and for whom traditional sources of financing are not available.

“[…special situation credit] is the best of both worlds: we buy debt at a discount, often with low loan-to-value ratios and security on the main assets of the company, but with the ability to capture upside convexity.”

Tell me more about the importance of deal sourcing within the special situations space.

Deal sourcing in this space is vital. We source between 50 and 60 percent of our investments internally from the platform. BSP Alcentra have been a market leading underwriter in the European sub-investment grade space over the past 20 years and have a tremendous proprietary library of information on target investment opportunities, covering both syndicated and private transactions. This means that we are often dealing with companies of which we have superior knowledge that allows us to act with greater speed and conviction compared with other market participants. We also have a deep network among brokers, law firms, financial advisors, sponsors etc. across Europe that provide a steady flow of investment opportunities.

What are the differences between the European and US special situations markets?

The European market is less mature than the US market and characterised by small to medium size issuers and low liquidity in secondary trading. The market is more complex, given the many jurisdictions within Europe, each with its own legal and regulatory framework. In addition, there are cultural and language differences that further add to the complexity. You need to understand the specific dynamics of each country you operate in, and since the market is largely private, information may be difficult to access. Compare this to the U.S. where one language is spoken, and a widely understood bankruptcy code applies. The jurisdictional complexities, information asymmetries and liquidity gaps prevalent in the European market, cause pricing inefficiencies which can be unlocked by well-informed locally based investors.

The article continues on page 10 of our Special Report: 'Private markets: A pivotal moment'