Investment process: Blend of performing and special situations
CCPEOL’s investment manager, CVC Credit Partners, invests across three principal areas: performing credit ($13.6bn AUM at 30 September 2017); credit opportunities and special situations ($3.1bn AUM); and private debt ($1.4bn AUM). The investment vehicle, CEC, concentrates on the first two areas, blending exposure to performing leveraged loans, high-yield bonds, structured corporate credit, and credit opportunities in senior and subordinated debt (Exhibit 3).
Performing credit is owned principally for its income generation. The managers seek mainly senior secured, floating rate credits, from liquid, large-cap issuers, at prices ranging from just below to just above par. The portfolio is actively managed rather than buy-and-hold, and the managers may move around the capital structure of an issuer (for example between euro and dollar credits, or from loans to bonds) to maximise returns.
In the credit opportunities portfolio, the focus is on finding discounted assets (the current average price is 95.2 [at 31 January 2018] compared with a par value of 100) that have the potential for capital appreciation as a result of refinancing, restructuring, merger and acquisition (M&A) activity or a fundamental improvement in the business. Such credits may be senior secured or subordinated, fixed or floating rate, and will usually offer an element of income as well as capital growth potential.
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.
There are a number of limits governing the construction of the investment vehicle portfolio:
■
A minimum of 50% of the portfolio must be in senior secured assets, which may include cash.
■
At least 70% of the portfolio must be in credits from issuers that are domiciled in Western Europe or do the majority of their business there.
■
No more than 7.5% of the portfolio may be invested with a single issuer, although an exception allows a single investment of up to 15% as long as it is reduced to a maximum of 7.5% within 12 months.
■
No more than 7.5% of the portfolio may be invested in collateralised loan obligations (CLOs), and no primary investments may be made into CVC-managed structured finance transactions.
■
Borrowing of up to 100% of NAV is permitted by the investment vehicle (CCPEOL is not permitted to borrow).
■
Short positions are permitted in order to offset industry-level risks to favoured issuers.
Credit selection is the output of deep, fundamental analysis of more than 3,000 credits, around 600 of which are held in CVC Credit Partners’ portfolios at any one time. The investment process has four main stages – sourcing, screening, fundamental analysis and monitoring. Sourcing teams operate from both US and European offices, and identify deals through CVC Credit Partners’ extensive proprietary network, as well as the wider CVC Partners group, and relationships with banks, institutions and issuers. Analysts screen potential investments, reviewing borrower information and focusing on topics such as management or industry risks. They then make a presentation to the relevant investment committee (performing credit or credit opportunities), which decides whether further analysis is warranted. If the committees approve an idea for further research, the analysts undertake more detailed fundamental analysis, focusing on a company’s location, sector, capital structure, and the quality of its business and management. The analysts build models to assess recoverability and likely returns, and stress-test for a variety of scenarios. Where an investment would be made alongside other investors, the composition of syndicates is also analysed. The idea then goes back to the investment committees, which decide whether or not to invest. Once an investment is made, portfolio managers can buy, sell or trade within the capital structure, for example moving between euro and dollar-denominated debt, in order to enhance returns. Holdings are continually monitored by the analysts, who use multiple metrics to assess the development of the investment thesis, looking at factors such as the progress of recovery, rating categorisations, and relative value versus peer companies and those on similar yields. This information is circulated to portfolio managers in a daily email, to assist them in making timely investment decisions.
The high level of detailed due diligence aims to ensure a vigilant and conservative investment management style, which is also expressed in the performing part of the portfolio by a bias towards liquid, high-quality large-cap companies. While the average holding period is one year, some investments may be held for many years (although often moving between different parts of the capital structure, to maximise relative value), while others may reach an exit event much more quickly. CVC Credit Partners may also take an active role in investee companies to drive restructuring or corporate activity to accelerate or improve the recoverability of credits.
Current portfolio positioning
At 31 January 2018, the investment vehicle portfolio split was 54% in performing credit and 46% in credit opportunities. More than 85% of the portfolio was in senior secured assets (including cash; see Exhibit 6), reflecting the manager’s slightly more defensive world view, and the majority of the portfolio (see Exhibit 1) had a credit rating of B. The proportion invested in high-yield bonds was low at 12% and is likely to fall, as CCPEOL’s managers have concerns over the outlook for highly valued fixed income markets in a rising interest rate environment. Their cautious view of fixed income naturally leads the managers to favour floating rate assets such as loans. Compared with 12 months ago, positioning (particularly in the performing portfolio) has become more defensive, with senior secured loan and cash exposures increasing by 7pp and 6pp apiece, while bonds, structured finance, payments in kind and other assets have seen small declines.
The portfolio was diversified across more than a dozen business areas at 31 January 2018 (Exhibit 4). Notable changes in exposure over the previous 12 months included increases in exposure to the diversified/conglomerate service, ecological and retail store areas (the largest exposure, Saur, is a wastewater services company classified as ecological), and reductions in finance, buildings & real estate, and broadcasting & entertainment.
Exhibit 4: Portfolio sector exposure (% unless stated)
Sectors |
Portfolio end-January 2018 |
Portfolio end-January 2017 |
Change (pp) |
Retail store |
12.0 |
10.0 |
2.0 |
Diversified/conglomerate service |
10.0 |
5.0 |
5.0 |
Electronics |
9.0 |
10.0 |
-1.0 |
Finance |
6.0 |
12.0 |
-6.0 |
Ecological |
6.0 |
3.0 |
3.0 |
Broadcasting & entertainment |
5.0 |
8.0 |
-3.0 |
Chemicals, plastics & rubber |
5.0 |
6.0 |
-1.0 |
Hotels, motels, inns & gaming |
5.0 |
6.0 |
-1.0 |
Business services |
5.0 |
N/S |
N/A |
Buildings & real estate |
4.0 |
8.0 |
-4.0 |
Health, education & childcare |
4.0 |
5.0 |
-1.0 |
Transportation & logistics |
4.0 |
N/S |
N/A |
Other |
25.0 |
27.0 |
-2.0 |
|
100 |
100 |
|
Source: CVC Credit Partners European Opportunities, Edison Investment Research. Note: N/S=not separately stated; may be included in ‘other’.
Geographical exposures to major markets (Exhibit 5) have remained broadly steady over the past 12 months, with the exception being a 6pp increase in exposure to UK issuers, where the manager is finding higher spreads than in other geographies for similar levels of credit risk, and a smaller 3pp increase in exposure to the Netherlands. US exposure is unchanged on a year ago but significantly higher over 18 months. The manager reports greater liquidity and retail investor participation in the US loan market than in Europe, which can lead to opportunities from market volatility on the back of investor repositioning.
Exhibit 5: Portfolio geographic exposure by country of issuer (% unless stated)
Country |
Portfolio end-January 2018 |
Portfolio end-January 2017 |
Change (pp) |
France |
23.0 |
24.0 |
(1.0) |
US |
23.0 |
23.0 |
0.0 |
UK |
21.0 |
15.0 |
6.0 |
Netherlands |
8.0 |
5.0 |
3.0 |
Germany |
7.0 |
6.0 |
1.0 |
Spain |
5.0 |
7.0 |
(2.0) |
Luxembourg |
5.0 |
5.0 |
0.0 |
Jersey |
3.0 |
N/S |
N/A |
UAE |
3.0 |
N/S |
N/A |
Other |
2.0 |
15.0 |
(13.0) |
|
100 |
100 |
|
Source: CVC Credit Partners European Opportunities, Edison Investment Research. Note: N/S=not separately stated; may be included in ‘other’.
The currency exposure of the portfolio (Exhibit 6) differs from the geographical split in Exhibit 5 because many issuers have credits denominated in more than one currency, which can lead to interesting opportunities for investors who understand the credits. The manager gives the example of Luxembourg-headquartered ink manufacturer Flint, whose US dollar debt is priced more attractively than its euro debt, offering a yield pick-up.
Exhibit 6: Portfolio analysis
|
Asset breakdown at 31 January 2018 |
Currency breakdown at 31 January 2018 |
|
|
Source: CVC Credit Partners European Opportunities, Edison Investment Research
|