Kempen Outlook 2021 Uncorrelated strategies

What are you looking forward to as an investor in 2021? 

‘While traditional investors are worried about a surge in insolvencies, we in fact see opportunities in this kind of situation. That’s because it enables us to set our distressed strategies to work. That involves buying debt from firms in distress at lower prices and restructuring their balance sheets and operations. I expect the number of firms in distress to increase in 2021 given that the economy is still essentially on life support. 

A record amount of debt has been issued by companies this year and earnings have been very low, so debt-to-earnings ratios are going to be sky-high. Businesses are entering a tough phase: once they have to rely on themselves again, we’d expect to see an increase in the number of insolvencies. We believe central banks will continue to shore up the markets, but their fiscal largesse cannot go on forever. 

By the way, I view the support programmes as positive because the virus doesn’t discriminate, and some sectors and people are being hit disproportionately hard. But these programmes can’t go on indefinitely.’ 

Don’t some companies primarily do well when the economy is booming? Who will still have money to go to a festival every weekend or to lots of fancy restaurants?
‘Yes, this will also apply for instance to hotels. A hotel room isn’t really that expensive to book as long the hotel’s occupancy rates are around 70%. Yet when occupancy rates go up to 90–95%, prices go through the roof. But I don’t see that happening for a while. Hotels will be glad just to get back to 70%, and this will have a huge impact on prices. Many debt positions of those hotels are then becoming untenable, which in some cases will result in a petition for bankruptcy.’

How do you respond to that as fund managers?
‘Traditional moneylenders will pull out at a certain point. Companies may then go into administration. We provide money to specialists who try to buy up that debt at a discount. This is possible because many financial institutions don’t possess the skills to conduct a restructuring, so they want to get rid of the loan. The next step in the bankruptcy proceedings is to identify a capital structure that matches the situation, so to say the ‘new normal’. 

Hema is a good example. It held far too much debt, but that’s now been bought up and the overall picture is now being re-examined. The verdict is that while the company cannot bear a debt of around EUR 750 million, it could potentially cope with a debt of EUR 300 million. The difference is being converted into shares, and the company will now have to pay interest on the remaining EUR 300 million. The new creditors become the new shareholders and need to inject fresh capital to give the company some breathing space. Yet this is only a financial restructuring. The operational restructuring comes after that, and that’s the tricky part.’

So is there work to be done for Distressed specialists? 
‘There’s such a thing as specialist distressed debt investors. They’ve not had much to do since 2010, but now is a good time for them to get to work again. And we’re keeping a close eye on things as well. 

There are enormous regional differences. In the US, the system is set up so that when a business files for bankruptcy, the bankruptcy judge issues a decision, restructuring takes place and the business can make a fresh start. In Europe we have governments that are fairly conservative in terms of their economic policies. They don’t really want companies to go bankrupt and prop them up with even more debt. This leads to what are known as ‘zombie’ companies. Take Air France KLM, for example: if it were to go bankrupt, the leases on all the aircrafts could be renegotiated, as could the pilots’ salaries.’

The general tendency is: job preservation is good, bankruptcy is bad, but that’s not the case in your profession. 
‘You need sectors to be sustainable, so they shouldn’t be held together with sticking plasters. Many of the companies affected by Covid-19 were already facing difficulties prior to the virus outbreak and yet they’re now receiving billions in support. They’ll never be able to repay that amount of debt. You’d be better off identifying the sound components: what can you retain and who wants to continue the business? A restart is often perfectly viable for large companies. That also applies to Hema, which at its core is a healthy company. But this wasn’t the case for V&D, for instance. That’s how the capitalist system works and I think it’s a good thing. US airlines aren’t propped up like they are here. The distressed investors get involved. They take a huge risk in doing so, because things don’t always go well and if that happens then they lose some of their money.’ 

“You need sectors to be sustainable so they shouldn’t be held together with sticking plasters”

What are you not looking forward to in 2021? 

‘We’re enthusiastic about the things our fund invests in, and that also goes for our investments that focus on reinsuring property catastrophe risk, i.e. damage to buildings as a consequence of natural disasters. Insurance premiums have soared over the past few years because natural disasters are occurring more frequently. So that’s one thing I’ll be examining more critically from 2021. More claims are being made, and from increasingly unexpected quarters as well. 

This insurance mainly covers damage to buildings. Even though the coronavirus doesn’t cause this, insurance contracts are sometimes so loosely worded – particularly in Europe – that so-called business interruption claims could potentially be covered. And that could involve payouts of billions of dollars. Contracts are more robust in the US, but insurers there are having to pay compensation for all the wildfires.

Climate risk is the new normal and it’s important that it continues to be insurable, otherwise communities hit by natural disasters will be unable to rebuild themselves. So climate change and the role of the insurance industry is something we’ll need to take into consideration in the coming years.’

A number of major events are looming, including the US presidential elections and Brexit, not to mention the ongoing impact of the coronavirus. How do you incorporate them into your investment decisions?
‘Only indirectly. They are truly enormous themes that can quickly affect prices in the very short term, but much less so over a horizon of 12 months. What you will see is a great deal of dispersion. Not just in markets, but also in economies. Each country has a different approach to the virus, announcing different restrictions. This translates into significant differences in the extent to which economies are slowing and then accelerating again. I think this trend will persist next year. Spain and Italy, for example, simply cannot afford the kind of large-scale fiscal stimulus plans that the Netherlands and Germany have implemented. And you can see that reflected in their economic recoveries. And the fact that the UK is suffering from an additional dose of self-inflicted pain in the form of Brexit is no longer a surprise for the financial markets. 

You used to see synchronised markets and synchronised policies, but now there are local differences. That makes the use of long-short positions by hedge funds highly attractive. If their predictions are correct, of course.’

So you’re optimistic about the opportunities available next year?
‘Our portfolio is well positioned for 2021. We have no direct exposure to the equity market, but to alternative asset classes. And these aren’t dependent on exactly how the situation with the virus evolves, more on the regional differences. I do see opportunities in this respect. If we see a calm, widespread upwards trend in the financial markets, there will be significantly fewer opportunities but that phase seems to over. We will now see economies operating at vastly different speeds and when forecasting winners and losers you’ll be proved right much more quickly, assuming you’re right to start with. The flipside, of course, is that you could be wrong. Things could move quickly in that case too.’ 


“In 2021 you’ll be proved right much more quickly, assuming you’re right to start with”

What’s the most common question your clients are asking you at the moment? 

‘In March we witnessed a mass sell-off in both distressed debt and structured credit. Yet those markets later rallied very strongly. Clients are now asking themselves: back in March I could have earned a return of 10% on structured credit but now it’s just 5%. Is it still worth investing in? Volumes are also smaller: there was USD 550 billion of high yield corporate bonds and bank loans trading ‘distressed’(i.e. HY bonds below 70 cents and bank loans below 80 cents) in March, but now it’s just USD 160 billion because the rally -led by the Fed who started buying HY bonds- occurred so quickly. People are thinking: have I missed my chance?’

And what do you say to that?
‘Within structured credit we focus on high-quality debt involving relatively low risk. You can’t earn sky-high returns on this type of debt. Its return prospects are still higher than those of comparable corporate bonds, but not as high as they were in March. I don’t expect this to change soon. There’s nothing we can do about that. 

I do anticipate a fresh chance to participate in distressed debt though. The bankruptcy rate is rising and we’re going to witness more suffering. But I don’t really expect to see another round of bargains in 2021, especially for structured credit. There are a few areas in which it could happen, such as aircraft leases. If that picks up again. Risk premiums are high here as it involves complex deals.’

Do you anticipate any new services or revenue models? 
‘Digital solutions will receive an even greater boost. Insurance has long been a very private market, incredibly old-fashioned. I expect it to become more quantitative and data-driven. You can see this at banks too, where they’ve quickly come up with solutions for operations that you used to have to arrange in person. The disadvantage is that it will initially cost jobs. We might enter a phase where we are more productive than ever but with fewer jobs. Who knows, in the distant future we might even end up with a guaranteed basic income.’



Alternative credit and uncorrelated strategies come together in the Kempen Non-Directional Partnership, or KNDP. This fund contains both  alternative strategies under the same roof. KNDP is a fund of hedge funds that takes well-diversified exposure to hedge fund strategies, typically allocating to 10–20 underlying hedge funds. KNDP has an unconstrained mandate and can invest in a wide array of primarily non-directional strategies. Its objective is to earn a return at least 3% higher than Euribor per year.



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The Author

Remko van der Erf


The views expressed in this document may be subject to change at any given time, without prior notice. Kempen Capital Management N.V. (KCM ) has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments.

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