AlbaCore Capital Group believes that European credit could provide equity-like returns and sees an especially strong opportunity set for direct lending and structured credit, where the floating rate nature of loans may offer some degree of inflation protection.
AlbaCore was co-founded in 2016 by David Allen, Managing Partner and CIO. Previously Allen ran GoldenTree’s European Credit business and created and ran the European Credit Investment business for Canada Pension Plan Investment Board. AlbaCore’s President, Matthew Courey, worked with Allen at Morgan Stanley. Partners Bill Ammons and Deborah Cohen Malka worked with Allen at Canada Pension Plan Investment Board (CPPIB). Deborah Cohen Malka featured in the 2020 edition of The Hedge Fund Journal’s 50 Leading Women in Hedge Funds report. Allen has been investing in European credit since its nascency in the late 1990s. Zeynep Tumer Bayazid, Partner, Investor Relations, and Micaela Kelley, Partner, Deputy COO, Head of Risk, round out the leadership team.
Private debt financing continues to grow at a double-digit rate, driven by banks losing market share and more players able to execute and fund larger deals.
David Allen, Managing Partner and Chief Investment Officer
AlbaCore launched with a €500 million seed investment from Canada’s PSP Investments (PSP), one of the largest commitments PSP made to an external strategy. Assets have now grown to $9.8 billion as of 30 June 2023 and AlbaCore’s planned strategic partnership with multi-boutique firm First Sentier Investors should further accelerate asset growth.
AlbaCore invests in public and private corporate credit across both primary and secondary markets, as well as in structured credit through its own CLOs and third-party CLO tranches. Since 2016, the firm has invested over $25 billion in 300+ companies. The firm’s investible universe is primarily larger companies in Western Europe, where jurisdictions allow for the enforcement of creditor rights.
In Europe, large cap is defined as an EBITDA of €200-300 million on average. A large number of these companies have private equity sponsors, even where families, founders or others have some form of ownership and AlbaCore’s founders have forged strong relationships with European private equity firms. Refinancings have been an important theme in the first half of 2023 while M&A has been subdued. On the private debt side, AlbaCore can work with somewhat smaller companies, down to EBITDA of €50m-€75m.
The asset split is currently one-third in public markets and two-thirds in private markets. The balance between public and private credit partly reflects the opportunistic and active allocation which pivots between them within some strategies and vehicles: “The Covid sell-off spurred more interest in liquid public markets,” says Cohen Malka. At the firm level, it is also influenced by product and strategy launches and their asset growth: “A lot of asset growth since 2020 has come from CLOs,” she adds.
Allen argues that the opportunity set for private credit is now the best he has seen since the aftermath of the Global Financial Crisis, with high coupons and yields and lender friendly terms filling a funding gap: “Private debt financing continues to grow at a double-digit rate, driven by banks losing market share and more players able to execute and fund larger deals”.
On the private debt side, “AlbaCore’s private first lien product launch is targeting returns in the mid to high single digits through the cycle, with low double digits possible today, from first lien large cap loans. These loans will often replace bank debt for private equity sponsors and companies seeking faster solutions that are not linked to market conditions,” says Zeynep Tumer Bayazid, Partner, Investor Relations, who featured in the 2022 edition of The Hedge Fund Journal’s 50 Leading Women in Hedge Funds report.
Since 2016, the firm has invested over $25 billion in 300+ companies.
Historically, AlbaCore mainly structured deals to meet its low teens return target in the AlbaCore Partners Funds. This strategy has a flexible mandate, permitting investments across the capital structure. Currently, to meet the low teens return target, the firm can now focus more on senior opportunities versus junior investments, which were largely made when base rates in Europe were negative.
Now the market climate means that private loans can pay as much as 600-700 basis point spreads, with unitranche deals paying more. In addition to coupons, returns are boosted through layers of fees: upfront fees e.g. original issuer discount, early repayment fees and call protection fees can all enhance yields from single digits into high single digit to low teens. Early repayments could arise from M&A activity triggering change of control provisions, and thus the strategy has some convexity given a potential recovery in corporate activity.
Private first lien loans tend not to have equity kickers which are more often seen in capital solutions, junior debt and special situations. AlbaCore’s investment in travel operator Hurtigruten, demonstrates how relationships with borrowers can lead to opportunistic special situations deals. Hurtigruten did a club deal during Covid paying 800 basis points over, essentially to keep control of the business, which could otherwise have been seized by creditors. More recently, Hurtigruten has entered a facility paying mid double digits which includes an element of Payment in Kind (PIK). “Some loans are fully PIK and pay a premium for the flexibility. We work in partnership with borrowers based on their needs,” says Cohen Malka.
Most of the increase in yields has come from risk-free interest rates. High yield spreads have remained sub 500 basis point spreads at the index level for most of the time since the Russia/Ukraine conflict, which reflects both default forecasts and capital flows. AlbaCore envisage equity-like returns in the low double digits, which may encourage a re-allocation from equities. This does of course rely on controlling default losses. Fear of defaults sent high yield spreads to approximately 700 basis points in mid-2022 during the energy crisis. Bearish macro research analysts were predicting a 10% default rate. However, these concerns have been alleviated due to factors such as lower energy prices. “Consumers have been resilient so far, partly due to Covid savings and strong labour markets. Company earnings have been reasonable, with most large European companies beating earnings estimates, which also helps to push back default forecasts. The maturity wall has been extended through amend and extend activity and refinancings, which creates breathing space for issuers,” explains Ammons.
AlbaCore is prepared for more volatility in the fourth quarter and beyond. “We expect to see more bifurcation between weaker credits and stronger ones. Given higher interest rates for corporate borrowers, we expect volatility could last for an extended period rather than seeing a big trough and snap back,” says Allen.
The Covid sell-off spurred more interest in liquid public markets.
Deborah Cohen Malka, Partner and Portfolio Manager
There is some risk that the US credit markets, with more sensitivity to commercial real estate, could contaminate Europe. However, AlbaCore are amongst many credit managers viewing European credit as safer than US credit, “Notwithstanding a higher cost of capital, banks in Europe have relatively clean balance sheets, in contrast to US banks left nursing hung deals and other problems,” says Allen.
Nonetheless, near zero defaults are not sustainable. AlbaCore’s base case is that a 4% default rate (issuer weighted and including distressed exchanges and restructurings) is more realistic. AlbaCore would however hope that their own large cap, sponsor-related portfolios have fewer defaults than the wider market. Ammons observes that, “Private equity backed companies did better during Covid because sponsors supported them. We think that larger companies have better downside protection and better access to capital markets”.
If defaults do occur, AlbaCore expects to recover some value and do have experience in workouts and restructurings including the associated committees: “We are willing to sit on credit and restructuring committees in instances where, through our involvement, we believe we can drive a better outcome for our investors. We are willing to restrict ourselves and become private on an issuer when we believe we can unlock value through a better understanding of a company’s financial position and outlook,” explains Allen. AlbaCore does not however view “credit activism” as part of its strategy.
AlbaCore started its CLO management platform in 2019 and has since then issued $2.2 billion of CLOs, with the latest priced in April 2023.
More recently AlbaCore also launched its CLO investing platform, which invests in liabilities and tranches of third-party CLO managers. In 2022 AlbaCore hired Seán Golden, a senior structured credit portfolio manager from Alcentra, to expand its third-party CLO investing capabilities working alongside Cohen Malka. CLO investing also naturally builds on AlbaCore’s existing expertise in European credit structures and collateral packages. “Seán and Deborah map out the market, assess the strength of collateral and expect to obtain a big edge,” says Allen.
CLO tranches can offer a large yield pickup over corporate loans and bonds of the same credit rating. “The rally in loans in 2023 has been caused partly by a supply/demand imbalance as a lack of M&A leaves more money chasing a limited supply of loans. Therefore, the yield on the asset side of the equation has come down, but in terms of liabilities the AAA tranche still demands a spread of circa 180 basis point spreads. That has somewhat compressed the arbitrage as of June 2023 and the equity tranche is less attractive at the moment,” explains Cohen Malka.
This feeds into investor demand. “There are large buyers of AAAs not active at the moment and also limited appetite for third-party equity in primary. We have seen good demand for mezzanine tranches that have also materially tightened since the beginning of the year,” says Cohen Malka.
“There are 60 plus CLO managers in European credit, the large majority of which have priced deals over the last 18 months. However, going forwards, only managers who can keep their own equity for a period will realistically be able to issue CLOs,” says Cohen Malka.
AlbaCore has the flexibility to retain all its equity if needed. “It is not optimal to sell equity at the moment in primary given current levels. We have sold and can sell it to third parties in secondary when timing is appropriate,” says Cohen Malka.
AlbaCore is continuing to develop its risk retention strategy within structured credit with a potential capacity of USD $200 to 250 million.
AlbaCore’s Partners Funds currently allocate to structured credit. Currently, AlbaCore is planning the roll out of pure play strategies on the structured credit side due to investor demand. An investment grade strategy would invest in floating rate senior secured paper from AAA to BBB. An opportunistic strategy would invest primarily in sub investment grade from BBB all the way down to equity. Both could invest in third party CLOs, though neither would be precluded from investing in AlbaCore’s own CLOs.
ESG considerations when investing in structured credit have their own nuances. ESG for third-party CLOs involves assessing the managers’ ESG policies, rather than delving into 100 or more underlying borrowers. “CLO documents could for instance include restrictions on oil and gas, gaming or payday lending,” says Cohen Malka.
President and COO, Matthew Courey, “Welcomes the EU Sustainable Finance framework in providing common language around the principal sustainability risks, which is helpful for managers’ direction of travel in terms of the systems and data that needs to be developed internally. We are getting lots of questions from investors on all of these trends”.
AlbaCore’s funds are in scope of SFDR by virtue of being a European fund manager marketing to European investors. However, they are proceeding cautiously with SFDR disclosure categories: “Currently our products that are in scope of SFDR are categorised as ‘Article 6’. We continuously monitor and evaluate considerations for offering Article 8 and 9 products,” says Courey.
Equally, AlbaCore are conscientious in providing some degree of SFDR equivalent disclosures for products outside the scope of SFDR: “For our managed CLOs, we do also provide some reporting on the quantitative elements of certain principle adverse indicators as required under SFDR as if these products were in scope,” explains Courey.
Some of AlbaCore’s loans, both private and syndicated, may have sustainability-linked ratchets, which might for instance vary coupons by plus or minus 7.5 basis points in response to ESG Key Performance Indicators (KPIs). However, these are becoming controversial and are not universal: “We are seeing some pushback from investors. Why offer a rebate for doing something that companies should be doing anyway? And some of the KPI targets set too low a bar; meanwhile the increased yields for missing the KPIs were not punitive enough,” points out Cohen Malka.
Some asset managers are marketing strategies invested in sustainability-linked loans as “impact investing” and reporting under Article 9 of SFDR. “AlbaCore is not doing “impact investing” and would only contemplate doing so in response to investor demand,” says Courey, who notes that AlbaCore’s investors do allocate to impact strategies.
For now, AlbaCore looks at ESG as a risk tool and framework. “We have been talking to investors about ESG from day one. This has been a key area of focus for a number of our investors including our UK, Nordic and Canadian investors who have been at the forefront of ESG initiatives. We have taken on board their feedback on how we evolved our ESG policy and how to incorporate it into the investment process, starting with transparent carbon footprint reporting,” says Tumer Bayazid.
AlbaCore has introduced a solution called Carbon Conscious Investing (CCI) which provides transparency on a portfolio’s estimated carbon footprint. AlbaCore reports portfolio companies’ Scope 1 and 2 emissions covering direct emissions controlled by a company and indirect emissions like electricity and heating, but does not currently include Scope 3 emissions, which include the emissions that companies are indirectly responsible for along their value chains.
Investors can then choose whether, how, and to what degree they wish to offset this carbon exposure in their own portfolios. The costs of doing so can vary enormously with exposures and the price of carbon: “It might range from a few basis points to as much as 1.5%,” says Courey. It also depends on the objective: some investors may seek to fully neutralize exposures while others just want to see a downwards trend.
AlbaCore’s ESG reporting will broaden out over time. “Implementing AlbaCore’s CCI tool was our first step towards developing our proprietary in-house ESG reporting capabilities. Over the past twelve months, we have made considerable progress in enhancing our ESG processes,” says Courey.
This is all part of an active brainstorming exercise. “We are looking strategically at capabilities, demand, enforcement and regulation frameworks, and having really helpful conversations,” says Courey. AlbaCore has hired leveraged loan consultancy, Environmental Resources Management, to advise on some aspects of ESG. More broadly, AlbaCore is actively engaging with the industry, including climate scientists, to explore the best ways of reporting, measuring and standardizing common language, including regulatory and accounting standards. AlbaCore also works collaboratively with industry bodies, such as the European Leveraged Finance Association, where Cohen Malka sits on the board. This industry lobby group can put forward its members’ views and influence banks, regulators and other market participants.
At the same time, AlbaCore are realistic about ESG ambitions. “As debt investors it is usually harder to direct what company management does. In some cases, we are however working with owners and shareholders, who are usually private equity sponsors,” says Cohen Malka.
A meeting of minds on ESG was one prerequisite for AlbaCore’s deal to sell 75% of its equity to multi-boutique, First Sentier Investors (FSI), while continuing to operate autonomously and independently, with its own office and name. The strategic alliance is distinctive since there is no geographic nor asset class overlap: FSI is based in Australia, most of its managers run equities, and AlbaCore is its first manager in alternative credit.
But crucially there is a very strong cultural alignment, including on investment culture, risk culture and ESG. “It took a long time to find the right partner as we did due diligence on their values. We also spent eight months working with the management of FSI to get to know each other,” says Courey.
“FSI gets access to the European alternative credit space. The deal provides a bigger balance sheet and more capital for AlbaCore to invest back into the business,” says Allen.
“There are also distribution synergies, especially in Asia Pacific where FSI and its corporate parent Mitsubishi UFJ Trust and Banking Corporation have a big presence, and where it can otherwise take a long time to build brand recognition and relationships. We are looking forward to working with FSI in unlocking strategic conversations within Asia Pacific in particular to further diversify our investor base. We are also thinking more creatively about solutions and customization to meet clients’ needs through the cycle,” says Tumer Bayazid.