24 January 2012

Alcentra Launches New Alcentra European Floating Rate Income Fund

Alcentra Limited, one of Europe’s largest and longest established credit managers, which is majority owned by BNY Mellon (95 per cent stock holding), is launching a new leveraged loan and high yield bond fund.

Alcentra European Floating Rate Income Fund Limited, which was announced at a London press conference last week, is a Guernsey closed ended investment company listed on the London Stock Exchange. It has a target annual return objective of 7 per cent to 10 per cent and will pay out a quarterly dividend initially targeted at 5.5 per cent per annum.

Three of Alcentra’s senior executives hosted the press conference to discuss the new fund’s details. They included: David Forbes-Nixon, CEO and co-founder of Alcentra; Graham Rainbow, Senior Loan Portfolio Manager, and Simon Perry, Head of Business Development for Europe, Middle East and Asia ex-Japan.

The new fund will invest in the secured loans and high yield debt of both European and North American corporates, although there will be a large bias (at least 80 per cent) towards Europe. At least 80 per cent of the fund’s NAV will invest in senior secured floating rate debt, with a maximum of 20 per cent in senior subordinated debt. Unsecured fixed rate high yield bonds will be limited to 15 per cent of NAV.

The Loan Syndications & Trading Association (LSTA) refers to leveraged loans as the “third leg of the corporate capital tripod”: the other two being bonds and equities.

One of the reasons for Alcentra favouring Europe is the fact that the U.S. has a more mature market.

“The average yield to maturity for U.S. loans is 6.5 per cent whereas in Europe it’s more like 12 per cent,” said Rainbow, noting that nervousness surrounding the future of the euro was likely priced into this.

Aside from having higher yields, the private nature of European deals allows greater transparency of borrower performance. Also, Europe is less affected by volatility in new issue spreads, which in the U.S. is more pronounced due to retail investor flows.

Alcentra gave a number of reasons for why it had decided to launch the fund now. As well as low secondary market price volatility and the attractive risk/return characteristics of senior secured loans right now, one of the more encouraging signs is that the number of primary deals has started to recover post ’08: around USD40million of primary deals over the past 12 months according to Rainbow.

“The floating rate nature of the loans provides investors in the fund with a portfolio hedge against inflation. It’s a defensive asset class with covenant protection. Also, 80 per cent of the fund will be in senior secured debt so the recovery rates should be high,” explained Rainbow, noting that recovery rates in 2009, for example, were above 70 per cent.

Even though limited to 20 per cent of NAV, Rainbow said that only the best-risked subordinated (junior) debt would be “cherry picked”.

Another reason for launching the fund is the fact that there’s a capital shortfall. Traditionally, banks have oiled the wheels of the leveraged loan market, packaging up and securitizing pools of loans – just like they’ve done with mortgages – to create Collateralised Loan Obligations (CLOs).

But as Forbes-Nixon commented: “As banks pull back (and refinance) there’s going to be more leveraged loans being held by credit managers, insurance companies and private equity companies. The CLO market is not dead but equally it’s not likely to see significant growth.”

The attraction of Alcentra’s new fund is that it offers investors daily liquidity, and by virtue of being listed on the LSE, daily NAV. “The investment company format allows us a way of accessing the loan market for those investors who wouldn’t normally have access due to liquidity restrictions,” stated Perry. “The fund includes a Redemption Offer which will allow investors to redeem up to half of their investment at NAV rather than its market price if there’s a discount to NAV of more than 5 per cent per annum over a 12-month period.”

The fund aims to target capital in excess of GBP150million and although still not a mainstream investment yet, Forbes-Nixon believes more European institutions will be investing in loan markets over the next five years. “Investors have been asking for daily liquidity in this kind of product. The UK is, dare I say it, a little slower to embrace these kinds of loan products compared to the U.S. where endowments etc are familiar with investing in them. But for those wanting daily pricing and daily NAV, this fund is ideal for investors wishing to allocate to credit and loan markets,” said Forbes-Nixon.

Certainly, momentum for leveraged loan funds is building.

Last April, on the back of the CLO market drying up, Neuberger Berman tested the markets when it launched its NB Global Floating Rate Income Fund. It’s proved popular, raising an additional USD187million last October on top of the fund’s existing USD507million in assets. “Listed loan funds could be the new version of CLOs for European investors,” Joseph Lynch, a Chicago-based managing director at Neuberger Berman Fixed Income LLC told Bloomberg. “The CLO market is unlikely to come back in Europe anytime soon,” said Lynch.

And with Vanguard Group Inc and Fidelity Investments leading a record USD833million of investment in Europe-listed loan funds, Alcentra are probably right to feel confident about their new fund, which, incidentally, will have the same 1 per cent TER as Neuberger Berman’s fund.

“We anticipate other players entering the space but you need scale to survive in this business,” commented Forbes-Nixon. Alcentra doesn’t lack in that department. Through strong sponsor relationships the firm is able to see deals at the pre-primary level – the majority of lenders rely on General Syndication but this comes with increased competition for assets.

Last year, thanks to its efficacy at partnering up with leading sponsors, Alcentra secured allocations of approximately EUR1.55billion from European primary market transactions in addition to EUR1.48billion in European secondary loan markets.

The fund limits each position size to 5 per cent of the NAV and holds a portfolio of 60 positions across 26 different industries. The weighted average maturity is 4.96 years. “Healthcare and satellite/cable TV companies will make up around 25 per cent of the book,” confirmed Rainbow, adding: “The fund is focussed on defensive sectors and Northern European countries. Whilst I wouldn’t necessarily exclude Italy or Spain, they’re much more likely to be a smaller part of the fund’s portfolio.”

One of the biggest risks to investing in a fund like this is, unsurprisingly, credit risk. Alcentra uses a robust two-stage due diligence process when selecting companies. Forbes-Nixon, who said that each company has to pass a stress test based on no revenue growth, confirmed that Alcentra always met management in person and conducted company visits. He admitted that access to management in Europe was “much easier than in the U.S.”. As well as reviewing the portfolio on a daily basis, Rainbow said: “We conduct a formal quarterly review on every position.”

“High yield bonds and leveraged loans are an attractive investment provided you share our thoughts on default rates. We think the default range will be 3 per cent to 5 per cent this year,” commented Forbes-Nixon.

As for why investors should consider the new fund, Perry explained: “To invest in a fund targeting cash returns of 5.5 per cent in the first year of full investment through a secured asset class like senior loans, plus the fact that it is listed on the London Stock Exchange, makes it an attractive proposition and extends the opportunity of investing in the loan market to a wider investor audience.”

Alcentra has USD16billion in AUM, including USD9billion in European assets and USD4billion in U.S. assets. The funds it manages have a 10-year track record in secured loan investing.

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