Interview with Jiffriy Chandra, Managing Partner and CIO for Special Situations at Income Partners
Income Partners is a Hong Kong-based asset management company dedicated to the Asian emerging markets. We provide an investment platform that covers all asset classes in the Asian markets, ranging from high grade and sovereign credit, high yield, special situation, distressed and restructuring opportunities, equity and long/short equity, and macro fund products.
We provide independent asset management and investment advisory services to institutional, private and high-net-worth investors, foundations, pension funds and government agencies. Headquartered in Hong Kong with offices in Beijing and Singapore, we are authorised and regulated by the Hong Kong Securities and Future Commission and registered with the Japan Financial Securities Agency (FSA).
Can you tell us a little about your background? You used to work in the Asian high-yield sector in its early days. What are the key lessons learnt from that experience?
I joined Salomon Brothers’ training program in New York in 1991 and left Salomon’s Treasury Department and came to Hong Kong in 1994. I started my career in Asia on the investment banking front at Chase Manhattan Bank’s Debt Capital Markets group. I left Chase in 1996 and worked with the emerging markets fixed income team at ING Barings until the onset of the Asian financial crisis in 1998. At Chase and ING Barings, I worked on some of the first high-yield corporate issuance in the Asian markets covering Indonesia, India, Thailand and the Philippines. I joined Income Partners in 1998 as a distressed and high-yield analyst.
Certainly, having gone through a crisis of historical proportions, Income Partners and I have learnt a number of valuable lessons. First and foremost, there are great opportunities in every crisis. The products and funds that we raised in the immediate aftermath of the crisis generated above returns for a number of years for our investors. Markets tend to overshoot when liquidity and capital are scarce. Second, local knowledge and networks are critical factors in selecting winners and losers. Being on the ground in Asia with great local contacts, we were able to successfully pick the majority of survivors after the crisis. Third, in distressed situations, a focused but consensual strategy provides the best outcome whereas a court-based/legal approach generally provides fairly poor recoveries for creditors. Fourth, equity of post-restructured going concern companies tends to outperform the debt over a period of three to four years post-restructuring.
It is exactly because of Income Partners’ experience in the Asian financial crisis that we decided to develop a platform that specifically takes advantage of the distressed and illiquid investment opportunities that had resulted from the global credit crisis. We had incorporated everything that we had learnt over the past decade and a half into the IP Asian Opportunities Fund.
Income Partners has been in the Asian credit space for a number of years and you have previously managed other portfolios that have seen commendable returns to your investors. What opportunities did you benefit from in 2009 and how did they contribute to your positive performance last year?
2009 was a year of tremendous change in a number of different ways. The 2008 crisis completely changed the landscape of the credit markets and there were whole-scale shifts in the market on the buy side, the sell side and the regulatory side.
We observed a polarisation of the credit markets after Lehman’s collapse in 2008. On the one hand, investors who have a preference for liquidity flocked to highly liquid sovereign and high-grade bonds and away from less liquid high-yield and special situations credit. On the other hand, investors with long-term capital are keen to avoid mark to market volatility and prefer to focus on point-to-point private equity-like investments.
We saw this trend developing early on and repositioned our flagship Asian Credit Hedge Fund in 1Q 2009 to focus on investment grade and sovereign credits and reduce our allocations to illiquid high yield. We also spin off the special situations component in the flagship fund into a self-liquidating special situations SPV as requested by a majority of our investors.
In 2009, across our liquid credit portfolios, we generated between 33 to 62% and we did this without any leverage. In fact, we had retained a reasonably large cash cushion in 1H 2009 as insurance against potential investor liquidity requirements.
Importantly, since mid-2009, when the special situations SPV was created, we started pursuing an active workout strategy and were able to generate 38% return in six months on the distressed strategy. Since the SPV was created on 30 June 2009, the eight-month return to 28 February 2010 was 57%. We had generated cash of 44% from active workout since the SPV was set up. It was due to our success in special situations that we decided to launch the IP Asian Opportunities Fund which was specifically set up to take advantage of such investment opportunities.
How do you decide on which securities/companies to invest in? Could you walk us through the qualitative and quantitative research that you perform on prospective companies before actually investing in them?
Since Income Partners has been investing in Asian emerging markets since 1993, we have an established investment team and process in place covering the three asset classes: liquid fixed income, special situations and liquid equities. Emil Nguy is the managing partner for liquid fixed income, Jiffriy Chandra is the managing partner for special situations and Agus Tandiono is the managing partner for liquid equities.
On the special situations front, we have a detailed screening process when reviewing the pipeline of new deals in the market. Deal flow comes from four main sources: (1) investment banking counterparties; (2) transaction brokers; (3) industry peers; and (4) self-sourced. The filtration process goes through several layers and a deal could be eliminated/turned down at any point in time during the process. Historically, 5 to 8% of the deals make it through to the final investment stage.
Every deal that comes through the IP special situations group team goes through the same review. First, an analyst/manager would summarise key points/features of the deal and provide his/her assessment of the draft term sheet. At this stage, we narrow down the key risk variables and determine whether the risk factors individually or in aggregate are acceptable given the target return. The deal is discussed by the team and the CIO will make a call on whether it flows through to the next level of assessment.
The next stage is a critical assessment level: one or two of the managing partners will meet with the sponsors/promoter or controlling shareholder of the company/project in question to conduct a face-to-face smell test on the counter-party in question. The objective is to assess whether the objectives and execution capabilities of the counter-party and whether he/she is someone IP can work with especially when things go wrong. This may be supplemented by information from IP’s network of contacts on the ground. If there is a certain comfort level, the deal goes to the next level.
In the next stage, a portfolio manager, supported by an analyst, would evaluate the business/project model, the financial model as well as conduct both a quantitative and qualitative analyses and due diligence on the deal. Usually, scenario analysis and stress tests are conducted to evaluate downside scenarios. We would also brainstorm on alternate potential exits from the position on the first day. A risk-return analysis is performed as part of this exercise. The write-up will be presented to the CIO and the investment committee for review and decision.
Finally, once a deal has been approved by the CIO and not vetoed by the investment committee, the legal process begins. The final commercial term sheet would be reviewed and commented by IP’s in-house legal counsel. External counsel may be appointed to provide legal opinion on structural questions or enforceability of collateral. The formal documentation would go through several rounds of internal and external comments before final sign-off. There are instances whereby a deal was pulled right before signing if the documentation is not in a form that is satisfactory to IP.
What does your fund’s portfolio look like in terms of industry sector exposures? Are you biased towards investing across any particular sectors? If so, why?
Diversification has always been a hallmark of our investment approach for both liquid and illiquid strategies. We are fairly diversified in terms of country and sectoral allocation for our special situations investments. Our exposures tend to be kept at below 30% both for country and sectoral allocations. In the special situations SPV, the highest country exposure was 22% and the highest industry exposure was 20%.
Since special situations investments are generally lowly correlated to the broad market, the country and sectoral limits are generally less relevant from a risk perspective since each case/event may be different and each deal may have a different driver to the returns. Individual position limits are quite important given the event risk exposure. Typically, we keep individual exposures to 5% or below with a 10% hard limit when the portfolio is fully ramped up.
Can you give us an overview of the fund’s structure and management personnel?
The IP Asian Opportunities Fund has a structure that encompasses an umbrella Cayman Islands fund that can accommodate a broad range of investment mandates and investor preferences. Under the umbrella fund, the manager can set up various sub-funds with different investment mandates, assets, investor bases and requirements. Deutsche Bank acts as seed investor, technical services provider (TSP) and placement agent to Income Partners.
The flagship Opportunities Fund 1 is a co-mingled pooled sub-fund that invests in illiquid event driven workout opportunities that cover everything from senior secured debt to mezzanine financing to private equity. Generally, the objective is to target distressed situations, conduct recapitalisation and swap discounted debt to reasonably cheap equity. The flagship sub-fund targets a 20 to 30% IRR.
The fund is private equity-like with a maturity of five years plus two one-year extension options (by the manager). The investment period is three years after which no reinvestments will be allowed. We expect the average life of Opportunities 1 to be about four years. Also, during this period, at least 50% of the current income (interest income plus dividends) of the underlying investments will be paid out to investors. Fees are 2/20 with an 8% preferred return to investors first and a performance fee claw-back feature at the end.
In addition to the flagship sub-fund, the manager may set up thematic sub-funds (such as a real estate or shipping sub-fund), single-asset sub-funds and/or single-investor managed account sub-funds. Each sub-funds’ assets and liabilities would be ring-fenced from that of those of any other sub-funds in the structure. Investors of above a certain amount are provided with co-investment rights in exclusive deals.
What classes of investors is your fund best suited for, given its risk/return profile? And ideally, what time horizon must an investor have in order to consider investing in a fund like yours?
We are speaking to a broad range of investors for the IP Asian Opportunities Fund. Given the illiquid nature of the underlying investments, by definition, this will be targeted at investors with a longer-term investment horizons. Investors who have expressed interests include sovereign wealth funds, pension funds, insurance companies, family offices, ultra high-net-worth individuals, private banks, private equity fund of funds and endowments among others.
We believe it is important to be honest to investors and let them know that this is a private equity-like investment product with returns and investment horizons that are commensurate for this type of risk and typical workout durations. With the umbrella fund structure, investors of sufficient size would be able to tailored sub-funds to their own needs. But irrespective, each sub-fund would be closed-end and would self-liquidate over time.
What is your starting capital? What would be the critical mass/break-even point for your fund?
Deutsche Bank as seed investor invested almost US$20 million and a cornerstone investor (a Hong Kong-based family office) invested US$100 million in the IP Asian Opportunities Fund. We would like to close Opportunities Fund 1/Sub-Fund A at between US$250 to 300 million. We have exceeded the critical mass/starting point on day 1 so that is not a problem. What we aim for is to grow the platform to house future sub-funds that could encompass a variety of thematic sub-funds and managed accounts that cater to the requirements of different types of investors.
How has your capital raising been so far for this fund? Do you have any marketing trips coming up?
Deutsche Bank as placement agent has opened up its global markets investor base to the IP Asian Opportunities Fund. Along with senior management within Deutsche Bank’s global markets group, we have visited Deutsche Bank’s and Income Partners’ investors across all of Asia spanning Hong Kong, Japan, Korea, Thailand, India, Indonesia, Singapore, Malaysia and Brunei.
We had taken a break in February and March as we had to focus our efforts on completing the first closing which was done on 25 March. The fund has issued a capital call and would begin investing in mid-April. We are resuming our roadshow later in April and that would include a second or third round visit to interested investors in Asia and a first-time visit to European institutional investors.
What developments do you expect in the Asian private equity and distressed sector in the year ahead and what opportunities do you see in the near term?
Unlike liquid Asian equity and credit markets that had seen a V-shape recovery from the lows, the opportunities in the Asian private equity and distressed sectors are just beginning to emerge. With global governments and central banks having taken the decision to pursue a spend and print policy in response to the global crisis, an imbalance in the capital markets has resulted involving an excess/flooding of short-term liquidity in the liquid securities markets and a dearth of medium- to long-term capital in the private placement/private equity markets.
Importantly, with short-term rates at close to zero, many highly leveraged companies that are able to service the high level of debt that were piled on during 2006/2007 would have trouble in repaying, refinancing or recapitalising such debt at the time of maturity. The cheap money policy extended the time to default/restructuring for many companies and a whole series of such debt are coming due in 2010 through 2012.
Despite the strongly recovering markets since the crisis, we tracked a series of defaults in 4Q 2009 and 1Q 2010 totalling US$4.7 billion and US$3.6 billion, respectively, in Asia including Japan and Australia. We believe this is just the tip of the iceberg with many of the opportunities likely to emerge as and when global interest rate cycle begins to turn over the next 12 to 18 months. We are positioning the IP Asian Opportunities Fund to take advantage of these emerging lucrative opportunities.