Japanese investors cautious on distressed assets

Date: Tuesday, November 17, 2009
Author: Jame DiBiasio, Asian Investor

Domestically there are concerns about creditor protection, while overseas there is wariness towards hedge funds but more interest in private equity.

Japanese limited partners (LPs) and institutions are watching the distressed-asset market but not yet committing large amounts of capital.

"We expect to see more corporate distressed situations worldwide," says Hideya Sadanaga, deputy general manager of credit and alternative investments at Nippon Life Insurance.

Seiji Murakata of the Development Bank of Japan's fund investment group adds: "There should be some chances" in corporate restructuring plays, despite the current high level of valuations.

They made their remarks yesterday at a conference on distressed and troubled asset investing in Tokyo, organised jointly by AsianInvestor and FinanceAsia.

Sadanaga says private equity funds are the best way to access such opportunities. Japanese pension funds, insurance companies and other institutions have had large exposures to hedge funds, mainly via funds of funds. These funds of funds often had distressed strategies in their portfolio, but didn't carve out special liquidity conditions and subsequently refused to return capital to investors last year when markets panicked.

Veryan Allen, whose firm Allen Investment Advisors provides alternative investment advice to Japanese institutions, says the easy money was made in the 2009 rally, but lucrative opportunities remain. "This year has been great for distressed debt beta," he says. "Next year will be a great year for those managers that have demonstrated the ability to add value."

Allen sees a role for Japanese investors to invest directly with single-strategy distressed hedge funds, provided LPs agree to at least a three-year lock-up of capital, and preferably alongside other LPs making the same commitment. Multistrategy hedge funds trying to add illiquid plays to their broader products may struggle to raise new money.

However, Murakata says the cycle in distressed is still shorter than most traditional private-equity funds, and investors can expect to get their money back within three years.

"You need a mid- to long-term focus, which is hard to have if you're running a hedge fund strategy," says Nippon's Sadanaga.

One problem for Japan's would-be investors is that they only get to see the very big PE funds that come through Tokyo. Therefore they miss out on the mid-sized players and boutiques in the US and Europe that may have attractive, high-return strategies. Big financial institutions such as Nippon Life can get around this by outsourcing manager selection to overseas offices in places like New York.

Another challenge is image. Murakata says the concept of distressed investing is too often blurred with 'vulture investing', and many institutions in Japan don't appreciate its role in helping to turn around troubled companies.

A third issue is risk appetite, which is only recovering slowly. Given the heavy exposure among many Japanese institutions to funds of hedge funds, they are often not yet ready to take new risk.

One head of a Japanese bank's prop trading desk told AsianInvestor that his firm has been forced to sell off much of its alternative exposures full stop, including distressed assets. "We've become a distressed asset!" he joked.

Less dramatically, Nippon Life is watching the market, but is not yet prepared to increase its allocation to such strategies, although Sadanaga does say that commercial real estate, particularly in the US, may become a desirable arena.

Allen says: "Investors are aware of the opportunity globally, but you won't see big flows from Japan in the next six months. However, distressed investing is a genuine source of alpha, not a repackaged source of beta, so over the coming two or three years there will be steady investments into this area."

There is also a domestic distressed story. Hong Kong-based hedge fund Pacific Alliance has so far made several deals in Japan acquiring convertible bonds from large real-estate managers, including Reits, or refinancing such assets. He says the firm has a pipeline to close this year that could hit $200 million.

"The process is frustrating and opaque, but the data on the underlying assets is very robust," says Anthony Miller, chief executive of Pacific Alliance Japan, who joined the firm earlier this year. Pacific Alliance also hired four distressed specialists from Deutsche Bank in Hong Kong last month.

Restructurings in Japan are not driven by creditors, as they are in the US and other jurisdictions. Recent deals, such as that involving Aiful, have seen courts allow companies to continue activity under restructuring, with an appointed trustee that controls what information about the company is made public or given to creditors.

Under this arrangement, management, labour, government and other perceived stakeholders work out an understanding that is then usually presented to creditors as a take-it-or-leave-it proposition. In theory, creditors are assured of getting their coupons paid, but there have been cases where they were forced to swallow haircuts.

Moreover, there is no precedent yet in Japan as to whether such events constitute a default for holders of credit-default swaps (CDSs). "There is the potential to kill the entire Japanese CDS market," one institutional investor from the audience told AsianInvestor.

That said, while the process is frustrating and takes a very long time, it still works, and the rules are followed. "Communications via the trustee are commercial and realistic," says Peter Hammond, director of Citi's institutional recovery management team in Asia.

And in a few cases, creditors have been able to band together to veto plans forwarded by trustees, resulting in liquidation, says Hideyuki Sakai, managing partner at law firm Bingham McCutchen Murase, Sakai Mimura Aizawa.