Investment tips from a veteran distressed debt investor

Warren Allderige, chief executive of Pacific Harbor Group, outlines his special situation fund's approach to distressed debt investments.

What is your Asian background?
I've spent two decades in Asia, having lived in Hong Kong, Japan, Korea and Singapore, and for most of that time have worked on pan-Asian assignments in credit trading. In 1999 I joined Amroc Investments Asia and set up the firm's Asian distressed debt trading and advisory capability and helped Avenue Capital Group and TPG affiliated funds in sourcing and transacting investments. Before that, I was at Peregrine Investments, where among other roles, I managed the firm's Korean joint venture securities house (the country's biggest) solvently throughout the Asian crisis. And between 1986 and 1994 I worked for Lehman Brothers, where I was managing director of its Singapore office.

How would you describe your fund?
We run a special situations fund that can make investments in 10 Asian countries as well as Australia and New Zealand. These investments fall into four categories: distressed debt, which ultimately earns a high internal rate of return but typically no running yield, which we buy at a deep discount, and then do the necessary legal and administrative restructuring so that it is in a condition to sell on to other investors; stressed debt, where we push the envelope a little both in terms of higher yield and higher quality of collateral, but lend to companies that are emerging from a restructuring; private placements, which are better credits; and public high-yield bonds, which provide a useful gauge for market sentiment and liquidity. The blended net yield is between 15% and 17%, and we have 20 to 30 investments at any one time.

What is your investment strategy?
We adopt a bottom-up approach to asset selection rather than a top-down macro style. We concentrate on basic industries, such as commodity-based companies, infrastructure and manufacturing, while avoiding high tech and venture capital-type opportunities. There are likely to be more corporate restructurings, similar to those in 1998, and the focus will increasingly be on individual credits. Our average holding period is short, normally less than six months, so we need to be very clear about our exit strategy from the outset. Much of what we do at present is provide short-term financing for companies while they arrange a longer-term bank loan. Also, we have never used leverage since the fund's inception in February 2007. We've always taken the view that there is enough risk through our investments.

How do you find suitable investments?
Because we are so well known and have such close contacts at domestic banks and corporations -- another benefit of longevity -- between 80% and 90% of investments are made as a result of reverse inquiries. The seller of non-performing bank loans, more often than not, want to make a low-profile sale, especially if it is a single credit. So discretion and trust is all important. Negotiations tend to be friendly, and we adopt a non-confrontational approach. We've known many of the financial professionals we deal with since the Asian crisis more than a decade ago, and we work within the context of the accepted practice of each business community.

What is one of your firm's strengths?
The investment team has been together now for eight years, and all are country-nationals of the countries for which they have responsibility. One advantage of having worked together for so long is that we can make decisions fairly quickly and informally -- although the analytical process, for instance creating cash flow models or evaluating collateral takes longer of course.
Our in-country sourcing from our eight pan-Asian offices gives us a first mover information advantage.

What causes you the most difficulties?
The hardest part is not identifying worthwhile assets or even getting over legal hurdles. Instead it's explaining our Asia strategy to our US and European investors; convincing them of the strength of our relationships, the solidity of the collateral backing the debt we own; and clarifying the nuances of individual legal systems. Our strongest suit is our firmly installed infrastructure, encompassing close contacts with borrowers and sellers, and wide ranging relationships with top in-country accounting and legal professionals. It is this which differentiates our investment process.

Is it time to be a distressed debt investor?
Bankruptcy laws and protection of creditors and collateral are a function of government policy that determines the character of a distressed debt cycle. Following the Asian financial crisis, many countries -- although not all -- amended bankruptcy codes so that debt restructuring and collection, and enforcement of collateral was as transparent as possible. Meanwhile, the depth of the current economic crisis will determine the amount of assets that come to market. Many governments set up debt administration vehicles a decade ago to help sell off distressed or non-performing loans in an orderly manner. And they are still here today in some form, ready to react to any increase in distressed debt levels. But it is clear that Asia, with its healthier banks and abundant foreign exchange reserves for instance, is much better positioned to manage a financial crisis than it was in 1997.

Who will win?
Successful participants in Asian distressed debt will need a debt sourcing and origination network, investment analysis capability, and experience in the region's legal and accounting disciplines. Ground level understanding of the region is all important.

This story was initially published in the June issue of FinanceAsia magazine.

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