Dynamics of this sort may present opportunities for investors who can analyze securities and the value of their underlying real estate in a timely and effective manner. This frequently creates potential opportunities for investors prepared to engage in hands-on asset management. Profits may be captured by transitioning risk between public and private markets, typically through some form of active structuring. An example is taking a public real estate investment company private to capture a discount to net asset value. Simplifying or stabilizing cash flows in the process may allow those assets to be sold to a market hungry for the fixed-income-like yield of core real estate.
3. Structured Deleveraging
European banks still have non-performing and sub-performing loans to resolve, but regulations complicate the process. The European Bank Recovery and Resolution Directive (BRRD), for example, prohibits state bailouts. That leaves banks in a bind: They can’t afford to sell loan assets at the deep discounts to which they are marked since that would trigger a markdown in their regulatory capital; buyers can’t pay more without leverage to enhance returns, but banks are generally retrenching from financing sub-investment-grade assets given higher capital charges.
Structured solutions that are capital-efficient for banks and result in stronger ultimate recoveries may become more prevalent going forward. There is an opportunity for managers with less constrained capital and a more hands-on approach to partner with banks, reducing information asymmetries and infusing necessary asset management expertise.
Capitalizing On Disruptive Regulations
When prospective returns on capital are lower, focusing on where the supply of capital is impeded by regulation is a logical strategy for seeking excess returns. In that sense, disruptive regulation must rank among the biggest investable themes over the secular horizon. Banks may be ceding economic profits, but to capture them, investors must consider the financial industry relationships, the intensive resources and the regulatory compliance expertise required. Importantly, investors should also have a patient and flexible approach to capital deployment, in order to enable investment in the sectors and assets where risk is most attractively compensated.
These represent material barriers to entry for most investment managers, but ultimately, responsible non-bank capital is essential to plug funding gaps and facilitate transactions, so as to help drive economic recovery. A new market structure is emerging, one needed to fulfill the goal of regulators to create a safer financial system.
Christian Stracke is global head of credit research at PIMCO.
Tom Collier is product manager of alternative strategies at PIMCO.