Alternative credit: why overlooking Europe is a mistake
From private debt to distressed and special situations, Europe is fertile ground for investment in alternative credit. It's a region investors can't afford to ignore.
Written by
Gareth Payne
Head of Credit &Alternative Fixed Income Client Portfolio Management
Share this article
When it comes to investing in listed equities or traditional fixed income instruments, investors routinely take a global approach.
Yet as soon as their focus shifts away from mainstream asset classes, they tend to gravitate to their domestic markets or, more frequently, the US.
Indeed, Europe is often overlooked by American and Asian investors in alternative credit – whether that's in direct lending or distressed and special situations. We believe this is a potentially costly oversight. It is a myth that Europe is still a niche player in alternative fixed income. Its private credit market is growing at faster rate than the US equivalent (see Fig. 1).
Fig. 1 - Growing opportunity
Assets under management (USD bn) and 10-year compound annual growth rate (%, RHS) for private credit markets by region
Source: Preqin. Data covering 31.12.2013-31.12.2023.
Another plus for investors is that Europe isn ’t oversupplied with lenders, in contrast to the more mature and more saturated US market. This matters because if businesses have fewer funding options, lenders can secure higher yields on any loan they provide, a factor only amplified by Europe ’s relatively less efficient and less harmonised market.
A simple, aggregated comparison of returns from direct lending over the past five years bears this out: Europe has consistently outperformed the US despite its materially lower base rates. This reflects the more attractive spread achievable in Europe (see Fig. 2).
Fig. 2 - Superior returns
Returns for senior debt, %
Source: Lincoln International. Data covering period 31.12.2018-31.12.2023.
Digging deeper into Europe’s vibrant and even less saturated lower mid-market, senior-secured loans recently originated by Pictet Asset Management’s direct lending team, for example, have been made at spreads of over 650 basis points over Euribor.
There are other factors that set Europe apart. For a start, Europe’s business cycles and socio-economic make-up differ considerably from those of Asia and US. Next year, for example, our economists expect the pace of growth to accelerate in Europe and to slow in the US.
Moreover, Europe is home to a wide range of countries, currencies and industry sectors, presenting opportunities for portfolio diversification – an investment landscape that is potentially more varied than that of the US or Asia. The possible currency contribution from investing Europe looks appealing. Pictet Asset Management's macroeconomists forecast
the euro will appreciate by an average of 1.4 per cent per annum versus the US dollar over the next 5 years, boosting returns for US dollar-based investors, reinforcing the case for an allocation to the region.
Not a level playing field
The diversity of Europe's alternative credit markets means the dispersion of returns across countries and sectors is generally higher than that of the US. This opens up investment opportunities for astute fund managers as they can more easily arbitrage opportunities - across countries, for example - and in doing so build diverse portfolios that are also more resilient over time.
In more liquid credit and leveraged loans, the dispersion creates pricing discrepancies that investors can take advantage of.
Currently, our direct lending strategy sees potential in low beta sectors (those which tend to be less volatile than the overall market, like education or healthcare) and smaller companies with strong market share in ‘micro-niches’ across Europe. These firms tend to be highly resilient to shifts in the business cycle and leaders in their markets. One of our recent investments is a German manufacturer of ‘Made in Germany’ high-tech laser heads for medical devices; another is a technology company that develops software for French real estate developers that require energy efficiency certifications. This firm has built a dominant position in its niche market.
The opportunities within Europe's distressed and special situations credit market are equally rich and varied. Our teams have established long positions in select European real estate investment trusts (REITs), which they believe have been trading at unusually cheap levels.
The sector has experienced a tumultuous few years, suffering from mis-steps made when interest rates in Europe were far lower than those in the US. Back then, real estate firms sought to take advantage by borrowing heavily to fund acquisitions; they were given credit ratings that were in many cases at least a notch or higher than they should have been.
When euro zone interest rates began to rise as inflation took hold some of these debt instruments began to decline sharply in price. Many REIT instruments are now trading at stressed or distressed levels. Some of these have fallen to unjustifiably low valuations, offering a cheap way for investors to gain exposure to both residential and commercial sectors of European real estate.
But bond prices can also be too expensive. In European credit markets right now, there are sectors where yields provide insufficient compensation for risk. In some cases this reflects a misunderstanding of deep-rooted problems some firms face. They can also present investment opportunities – establishing short positions in these securities can produce strong returns if prices fall to more realistic levels. Portfolio managers of Pictet Asset Management’s distressed and special situations debt team see such opportunities in a handful of sectors, including chemicals, an industry which has yet to find its footing in the wake of the Russia-Ukraine war. Here, many European firms face significant long-term competitive pressures, with lower cost producers from outside the region threatening their viability.
Challenges and opportunities
None of this is to say that European markets don't have their own challenges and risks. Some might point to Europe’s relatively lacklustre economic growth in recent years. But, while relative economic performance is crucial for investors deciding on their geographic allocations in listed equities, we believe it is of less relevance for alternative credit markets. Here, bottom-up fundamental analysis is critical to success, and there will always be companies who do well (or badly), whatever the economic weather.
Of greater importance to investment decisions, we believe, is the complex web of national and regional regulations. While in the US all companies follow the Chapter 11 bankruptcy mechanism, in Europe each country has its own restructuring rules which lenders need to navigate, for example when seeking to take or enforce security as a creditor. Our in-house legal team has identified the emergence of a more creditor-friendly environment in some European regimes. This sits in contrast with the US, where so-called “creditor-on-creditor violence”, enabled by typically looser documentation, has historically been far more prevalent. The complex legal tapestry presents risks for the uninitiated but can also be a source of opportunities for experienced distressed investors with local knowledge. A deep network of local restructuring and legal advisors, and hands-on experience of investing throughout the economic cycle are crucial to correctly pricing credit risk and recovery rates.
In alternative credit markets, bottom-up fundamental analysis is critical to success, and there will always be companies who do well (or badly), whatever the economic weather. .
Many of those who have overlooked Europe point to the fact that its capital markets are dominated by banks: despite a decline in loan-making over the past decade, euro area ’s banking assets are still equivalent to some 290 per cent of GDP, compared to just 120 per cent for the US.
But we expect bank lending will continue to decline in the face of tighter regulation (such as the Basel IV global banking supervisory standards). That opens the door for private debt and other alternative sources of credit to take some of that share and in certain cases to pick up assets or lend at attractive rates. This is particularly the case when it comes to lending to smaller and medium-sized companies, firms which have seen bank funding pared back as European banking groups are now obliged to hold much bigger capital buffers when lending to SMEs. Europe is home to some 23 million small and medium-sized companies, providing nearly two-thirds of its jobs and adding EUR3.4 trillion of economic value a year, so would-be non-bank lenders have plenty of choice over where to deploy capital
Boots on the ground
Navigating such complexity, of course, requires local knowledge and expertise. The recent political uncertainty in France is just one example of why investors must remain nimble. Language barriers, differences in legal systems, divergent local cultures and businesses practices are issues that US markets do not have to grapple with.
Non-European investors seeking to allocate capital to Europe’s alternative credit markets should therefore seek out longstanding, proven ‘through the cycle’ experience and demand on the ground regional presence. These are key success factors to harness the opportunity set.
In summary one thing is clear: including Europe within an investor’s alternative credit portfolio – via direct lending, distressed and special situations or credit dislocation strategies – is more than just a diversification play. Due to the unique dynamics of the market landscape, investors risk leaving alpha on the table by overlooking it.
alternative credit at pictet asset management
European Direct Lending
Our pan-European Direct Lending strategy aims to deliver strong long-term risk-adjusted income to investors by providing senior-secured debt financing for privately-owned, performing lower mid-market companies in Europe (EBITDA of EUR5-15 million). The strategy was launched in 2023 with team members located in London, Paris and Frankfurt.
Distressed & Special Situations
An absolute return long/short credit and capital structure arbitrage strategy which focuses on financially stressed and distressed companies, predominantly in Europe. Managed by a highly experienced and specialised team led by Galia Velimukhametova, it targets strong net absolute returns across the cycle, leading to low correlation with traditional asset classes.
Credit Dislocation
A purpose-built ‘drawdown’ vehicle investing into dislocated corporate credit at the most attractive point in the cycle when prices dislocate from fundamentals. Managed by the same highly experienced Distressed team as above, it can act as a portfolio diversifier and provide attractive directional returns.
Gareth Payne joined Pictet Asset Management in February 2019 and is Head of Credit &Alternative Fixed Income Client Portfolio Managers.
Before joining Pictet, Gareth was the Client Portfolio Manager for Man GLG ’s Credit and Convertibles business with responsibility across both alternative and long-only strategies. Prior to that Gareth worked in a number of business development roles at Man ’s multi-manager hedge fund unit, FRM. He began his career in 2007 at Lehman Brothers in London. Gareth holds a Masters and BA from the University of Cambridge
Share this article
Important legal information
This marketing material is issued by Pictet Asset Management (Europe) S.A.. It is neither directed to, nor intended for distribution or use by, any person or entity who is a citizen or resident of, or domiciled or located in, any locality, state, country or jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. The latest version of the fund ‘s prospectus, Pre-Contractual Template (PCT) when applicable, Key Information Document (KID), annual and semi-annual reports must be read before investing. They are available free of charge in English on www.assetmanagement.pictet or in paper copy at Pictet Asset Management (Europe) S.A., 6B, rue du Fort Niedergruenewald, L-2226 Luxembourg, or at the office of the fund local agent, distributor or centralizing agent if any.
The KID is also available in the local language of each country where the compartment is registered. The prospectus, the PCT when applicable, and the annual and semi-annual reports may also be available in other languages, please refer to the website for other available languages. Only the latest version of these documents may be relied upon as the basis for investment decisions.
The summary of investor rights (in English and in the different languages of our website) is available here
and at www.assetmanagement.pictet
under the heading "Resources", at the bottom of the page.
The list of countries where the fund is registered can be obtained at all times from Pictet Asset Management (Europe) S.A., which may decide to terminate the arrangements made for the marketing of the fund or compartments of the fund in any given country.
The information and data presented in this document are not to be considered as an offer or solicitation to buy, sell or subscribe to any securities or financial instruments or services.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. The management company has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
The value and income of any of the securities or financial instruments mentioned in this document may fall as well as rise and, as a consequence, investors may receive back less than originally invested.
The investment guidelines are internal guidelines which are subject to change at any time and without any notice within the limits of the fund's prospectus.
The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a specific security is not a recommendation to buy or sell that security. Effective allocations are subject to change and may have changed since the date of the marketing material.
Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares.
Any index data referenced herein remains the property of the Data Vendor. Data Vendor Disclaimers are available on assetmanagement.pictet in the “Resources ”section of the footer.
This document is a marketing communication issued by Pictet Asset Management and is not in scope for any MiFID II/MiFIR requirements specifically related to investment research. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any products or services offered or distributed by Pictet Asset Management.
Pictet AM has not acquired any rights or license to reproduce the trademarks, logos or images set out in this document except that it holds the rights to use any entity of the Pictet group trademarks. For illustrative purposes only.
Cookie Policy
This website uses cookies to enhance user navigation and to collect statistical data. To refuse the use of cookies, change your settings or for more information, please click on the following link: Cookies policy
. By continuing to browse this website, you accept the use of cookies for the above purposes.
