Investment process: Seeking return across the capital structure
CVC Credit Partners organises its business into three principal areas: credit opportunities and special situations (c $3bn AUM in European and global strategies), performing credit (c $12bn AUM in US, European and global strategies) and private debt (c $1bn AUM in US and European strategies, lending directly to small and medium-sized enterprises). The CEC investment vehicle invests across the first two areas, and is the only CVC strategy to combine exposure across credit opportunities, special situations and performing credit.
On the performing credit side, managers seek mainly senior secured, floating rate credits from liquid, large-cap issuers, offering stable and consistent income generation. These may be sourced in the primary or secondary markets. Return comes mainly through income. The managers look for credits trading from 97 (based on a par value of 100) to just above par, and may take advantage of opportunities to move between different credits within the same capital structure (for example euro or dollar issues, or loans or bonds) to lock in trading gains. In credit opportunities (which for the purposes of the investment vehicle includes special situations), credits may be senior secured or subordinated, fixed or floating rate, offering a mix of income generation and capital gains. This portfolio may include event-driven, opportunistic positions. Positions in the credit opportunities portfolio are usually bought at well below par value, with returns coming through merger and acquisition activity, refinancing, restructuring or a fundamental improvement allowing an exit.
The bias of the portfolio is to floating rate, senior secured debt. The outlook for floating rate assets (which make up a huge majority of the opportunity set in loans), where the interest rate on borrowings can rise and fall according to prevailing market rates, is more favourable given the beginning of normalisation in developed market monetary policy. In a rising interest rate environment the managers are cautious on the outlook for sub-investment grade fixed rate debt, and tend to limit the fixed rate exposure to a maximum of 30%. A minimum of 70% of the portfolio by value must originate from Western European issuers. The credit rating of the portfolio tends to be BB and below, with the majority in B-rated issues, although a significant portion (29% at 31 May 2017; see Exhibit 1) is in credits that do not have an official rating.
Exhibit 3: Core market segments
Market |
Asset |
Source |
Target yield* |
European performing leveraged loans |
Floating rate, senior secured |
Primary/secondary |
4-7% |
European high yield |
Fixed rate, senior secured and subordinated |
Primary/secondary |
4-15% |
European credit opportunities/regulatory driven |
Fixed/floating, senior secured, subordinated (Equity, PIK) |
Direct |
10%+ |
Structured corporate credit |
Floating rate secured/equity |
Primary/secondary |
6-20% |
Source: CVC Credit Partners European Opportunities. Note: *Target yields based on CVC Credit Partners' observations of the market; there is no guarantee the investment vehicle will hold investments with these characteristics.
The CEC investment approach centres on fundamental, bottom-up analysis of more than 3,000 credits, with around 600 being held in CVC funds at any one time and the rest being monitored as former or potential future investments. There is a bias towards larger-cap, higher-quality companies (particularly on the performing side), which may offer more liquidity than other issuers. Detailed due diligence aims to ensure a vigilant and conservative management style.
There are four main stages to the investment process.
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Sourcing: CVC Credit Partners can source deals through its extensive network as part of the wider CVC Capital Partners group, as well as relationships with global and regional banks and institutions, and directly with issuers. Sourcing teams operate from both the US and European offices.
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Screening: Analysts prepare a high-level overview based on a review of borrower information, producing a summary credit analysis and a screening paper, focusing on topics such as management or industry concerns, which are presented to the relevant investment committee (performing credit or credit opportunities) to decide if further analysis should be undertaken.
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Fundamental analysis: CVC Credit Partners’ US-based performing credit analysts are sector specialists, while the European-based analysts are generalists focusing on either the performing credit or credit opportunities segments. If the investment committees approve an idea for further research, the analysts undertake a more detailed due diligence process, focusing on the quality of a company’s business and management, its capital structure, sector, and where it is based. Models are built to analyse recoverability and likely returns, and stress-test different scenarios. Investments may be sourced in the primary or secondary markets, and where CEC would be investing alongside others, the composition of the syndicate is also analysed. Following this deeper analysis, ideas are referred back to the investment committees, which make a decision as to whether or not to invest.
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Monitoring: The analyst teams continually monitor all invested assets, using multiple metrics to analyse the development of an investment thesis. Once an investment is in the portfolio, the portfolio managers can buy, sell or trade within the capital structure (for instance moving between US and euro-denominated issues) where better relative value can be found. Many European credit issues are private rather than public, and investors can elect to receive information more frequently than the statutory quarterly updates typically received by US investors. Because of this, CVC Credit Partners’ European analysts typically cover 15-20 credits each, while their US counterparts, who have less frequent information to analyse, cover 40-45. Monitoring is an iterative process, with analysts assessing factors such as the progress of recovery, rating categorisations, and relative value versus peer companies and those on comparable yields. Analysts enter the information into a global database, which pushes out real-time information to portfolio managers via email, to assist them in making timely investment decisions.
As a major investor in assets that rank highly in the capital structure, CVC Credit Partners may take an active role to drive restructuring or corporate activity to accelerate or strengthen the recoverability of credits. Some investments are held for many years (although the actual asset may vary over time as the managers seek to unlock relative value within the capital structure), while others may reach an exit event, such as a refinancing or takeover approach, more quickly than expected. Across the portfolio, turnover is c 100% a year.
While essentially a long-only strategy, a small number of short positions (4.5% in May 2017) may be held to offset industry-level risk to favoured issuers in areas such as energy or retail.
Current portfolio positioning
At 31 May 2017, the investment vehicle portfolio was diversified across issuers from more than 12 business areas (Exhibit 4) and more than seven countries (Exhibit 5). The largest individual issuer exposure was 3.8% of gross asset value (Exhibit 1). While the investment policy requires the portfolio to be at least 70% invested in Western Europe, a major change over the past 12 months has been the increase in US exposure, which now represents the largest single country at 23%. The managers comment that with spreads over US Libor and Euribor being at similar levels, superior returns are available from US assets of a similar credit quality, because the three-month US Libor rate is c 1.2% while the Euribor floor is zero.
Exhibit 4: Portfolio sector exposure (% unless stated)
Sectors |
Portfolio end-May 2017 |
Portfolio end-May 2016 |
Change (pp) |
Retail store |
11.0 |
10.0 |
1.0 |
Finance |
10.0 |
10.0 |
0.0 |
Electronics |
9.0 |
N/A |
N/A |
Broadcasting & entertainment |
7.0 |
10.0 |
-3.0 |
Hotels, motels, inns & gaming |
6.0 |
8.0 |
-2.0 |
Buildings & real estate |
6.0 |
8.0 |
-2.0 |
Chemicals, plastics & rubber |
6.0 |
9.0 |
-3.0 |
Diversified/conglomerate service |
5.0 |
N/A |
N/A |
Ecological |
5.0 |
3.0 |
2.0 |
Leisure & amusement |
4.0 |
11.0 |
-7.0 |
Health, education & childcare |
4.0 |
8.0 |
-4.0 |
Transportation & logistics |
4.0 |
N/A |
N/A |
Automobile |
N/A |
3.0 |
N/A |
Other |
23.0 |
20.0 |
3.0 |
|
100 |
100 |
|
Source: CVC Credit Partners European Opportunities, Edison Investment Research. Note: N/S=not separately stated; may be included in ‘other’.
At end-May 2017, the performing portfolio accounted for c 58% of assets (including cash balances), up from an average of 44% during FY16, driven by new issue flows and strong market momentum. The first quarter of 2017 saw the highest new issue volume since 2007, with a high level of demand causing yield spreads to fall.
Exhibit 5: Portfolio geographic exposure by country of issuer (% unless stated)
Country |
Portfolio end-May 2017 |
Portfolio end-May 2016 |
Change (pp) |
US |
23.0 |
12.0 |
11.0 |
France |
20.0 |
23.0 |
(3.0) |
UK |
18.0 |
19.0 |
(1.0) |
Spain |
9.0 |
13.0 |
(4.0) |
Germany |
8.0 |
N/S |
N/A |
Luxembourg |
7.0 |
7.0 |
0.0 |
Sweden |
N/S |
11.0 |
N/A |
Other |
15.0 |
15.0 |
0.0 |
|
100 |
100 |
|
Source: CVC Credit Partners European Opportunities, Edison Investment Research. Note: N/S=not separately stated; may be included in ‘other’.
Across the portfolio, more than 70% is invested in senior secured assets (Exhibit 6, left-hand chart), with more than 80% in floating rate. Only 5% was held in structured finance/CLOs. The currency breakdown (right-hand chart) has altered significantly over the past 12 months (comparable figures for 31 May 2016 were 64% euro, 18% US dollar, 17% sterling and 1% other), partly because of the increase in US-based issuers, but also because of opportunities to move within the capital structure of issuers who have both US dollar and euro-denominated debt. The fact that loans can be held by mutual funds in the US means that pricing can be more vulnerable to sentiment, so in a risk-off move a US dollar loan could move to a discount to its par value while a euro-denominated loan within the same capital structure could remain near par. Assuming that the company fundamentals are unchanged, switching from the euro to the US dollar part of the capital structure gives the managers a yield pick-up as well as capital growth potential. UK exposure is usually in the 20-25% range because of strong corporate governance, higher yields and an illiquidity premium due to the relatively small size of the sterling market; however, a strong recovery has reduced the number of opportunities available, and the managers are happy to remain at the current lower level while uncertainty over Brexit negotiations remains a risk.
At 31 May 2017, the weighted average price of issues across the investment vehicle was 95.0% of par, indicating capital upside of c 5pp. Within the credit opportunities portfolio, where more of the return is expected to come from capital appreciation, the weighted average price was 89.3% of par.
The investment vehicle focuses on large, liquid issuers, which helps to create a favourable risk profile. These issuers have bigger balance sheets, better access to international capital markets, strong management teams, diverse cash flows and supportive private equity sponsors.
Exhibit 6: Portfolio analysis
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Asset breakdown at 31 May 2017 |
Currency breakdown at 31 May 2017 |
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Source: CVC Credit Partners European Opportunities, Edison Investment Research
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