Within the finance world, many sophisticated investors assume opportunistic funds are primarily focused on event-driven strategies designed to step in during economic dislocations and make directional bets. During normal markets, the conventional wisdom is, these funds will “wait around” holding capital (often with a severe drag on returns) until the next cyclical shift takes form and these funds go “all-in” on a handful of themes or mandates. However, the past 12 months – marked by extremes to both downside and upside scenarios – have demonstrated that certain opportunistic strategies are indeed “all-weather,” characterized by returns that can be consistent in any market and are often elevated during market dislocations.
In the immediate aftermath of the COVID-19 shutdowns, opportunistic investors generally provided a stabilizing force in the form of rescue capital and in the form of much needed liquidity (in the secondary and liquid markets). But as the government stimulus and subsequent market rebound took hold, secondary investments and rescue financing deal flow mostly gave way to commitments that are more typical in less volatile markets. Today, the opportunity set for most distressed or special situations firms revolves around “directional bets” or loan-to-own strategies in specific sectors or industries.
Ironically, “typical” for Monroe’s Opportunistic strategy is best characterized by “atypical” investments in the specialty finance, structured real estate, and asset-heavy corporate credit segments.
Opportunistic strategies, given their inherent and necessary flexibility, provide something of a Rorschach test in which it can mean different things to different lenders. For Monroe, we launched our opportunistic strategy to take advantage of an underwriting skillset already in place to focus on high-quality assets whose value is often masked by collateral complexity, nuance around existing credit structures, or restricted access to more traditional capital markets.
Unlike most “opportunistic” strategies, however, our funds avoid deep distress and loan-to-own situations, which typically require an operational turnaround. And while the thesis is enabled by deep underwriting, most investments tend to fall outside of the market’s more traditional ABL or direct-lending archetype. It’s a niche that historically had been dominated by hedge funds with uncertain intentions; as a result, there exists a massive gap in the market for high-quality asset owners, private equity firms and borrowers who will not and should not borrow from typical distressed or special situations funds (many of which are often considered lenders of last resort).
For Monroe, another key differentiator in this area, is an ability to move quickly. This affinity for the complex, rather than the distress in the first and second quarter last year, has provided a tailwind heading into 2021. This is reflected in our pipeline of new deals, which has grown considerably since the initial lockdowns last March; and recently has gravitated to highly structured real estate, asset-heavy corporate credit, and specialty finance investments. Within Monroe’s opportunistic strategy, alone, repayments on deals have reached approximately $700 million over the past 12 months, underscoring the high-quality nature of borrowers and asset managers who could access capital markets during the COVID-19 era and most importantly Monroe’s “credit first, zero loss” emphasis of the strategy. The asset-level returns on these realizations – in the mid-teens (unlevered) over the same time period – speak to why we see value in chasing complexity.
At our core, we endeavor to finance the highest quality assets and borrowers in spaces where there likely is less capital and competition. As the saying goes, we “skate to where the puck is going to be, not to where it has been.” Still, to understand the thesis that has been employed by us for nearly a decade in opportunistic investing, it helps to appreciate the diversity of certain of our credits and asset types that comprise our deal pipeline.
Litigation Finance
The complexity of litigation finance, for instance, represents a less trafficked pool of assets, whose inefficiency can translate into attractive returns for investors able to gain familiarity and comfort to evaluate and de-risk the opportunities. It can be very similar to a rated structured product or CLO. Risk, in this regard, can be managed through investing in a diversified pool of assets, with extensive historical data available to better understand potential threats and the overall return profile across categories ranging from commercial or mass-tort litigation to pre-settlement funding and law-firm financing.
The complexity is in understanding the nuances that differentiate litigation finance from more traditional credit. The underwriting will factor in the nature of the cases, from large disputes to personal injury claims. Analysis will also focus on the obligor or relevant payors and their ability to fund judgments. The jurisdiction and historical rulings for similar cases can also help assess likely outcomes. And prospective returns are extrapolated from bottom-up analysis that also consider “downside” scenarios to stress test assumptions, deal structures, and documentation.
In a sense, it’s no different than traditional analysis around accounts receivable, albeit with far different variables, nomenclature and risk factors. It is often uncorrelated with the broader economy, given that the settlement of lawsuits is not affected by recessions or economic shifts. Furthermore, the underlying payors tend to be highly rated insurance companies or large corporations.
Crypto
Cryptocurrency is another area drawing interest. However, it requires a bit of creativity for institutional investors to gain comfort in the space.
To be sure, the recent entry of larger, recognized players, has instilled a sense of credibility. Goldman Sachs, for instance, hired Mary Rich recently as the global head of digital assets, marking its entrance into the category, while Fidelity has offered cryptocurrency custody and trading services since 2019 and more recently took steps to launch a bitcoin ETF. Fidelity’s move follows in the path of Galaxy Digital Holdings, started by Fortress Founder Michael Novogratz. Meanwhile, the Coinbase IPO in April was billed by the New York Times as marking crypto’s official entry into the mainstream. The challenge for institutional investors, however, is in finding creative approaches to structure an investment that does not absorb currency and pricing risks in a market so prone to excessive volatility.
Through a specialty finance lens, a path into the market can be found by viewing cryptocurrency as a “quasi-intangible asset” and securing the loan against assets with tangible value (such as the businesses of companies marketing or transacting in bitcoin). While there is certainly a learning curve, in many ways it’s an “ABL 101” approach to find solutions that are no more exotic than traditional loans against inventory, receivables or equipment.
Opportunistic in Action
The distinguishing characteristic is that no two deals are ever identical, yet all share the common threads of deep underwriting marked by bottom-up analysis. Downside protection is also a prerequisite via structures that mitigate risk through advance rate, cash traps, diversity, eligibility and by other means. Sometimes, new credits may even resemble traditional financing arrangements, but are far more complex under the surface.
A few months ago, for instance, Monroe helped back a merger between Vertical Bridge REIT and Eco-Site. Vertical Bridge is the country’s largest private owner and operator of wireless infrastructure, with over 20,000 owned and master-leased tower sites and an entire portfolio of more than 290,000 sites across the U.S. The deal included additional funding to support the combined company’s future development of build-to-suit locations.
Beyond just the unique collateral, the transaction had to be completed under a tight timeframe – no small feat considering tower deals historically involve nuanced zoning rights, sale-leaseback arrangements and other considerations. It’s a heavy lift from an underwriting perspective, albeit risk averse to those who understand the industry dynamics and intrinsic value of underlying assets.
Among investors, the primary draw to opportunistic credit is the alpha found through the complexity. Many are also drawn to the current-income that mitigates the J-Curve and the overall consistency of return. Indeed, “special situations” do not have to imply high risk or lender of last resort. For Monroe, it is complexity and bespoke transactions that create consistent alpha through multiple cycles and economic landscapes.
Borrowers, too, seek us out when they need speed and certainty to fund high-quality assets that may not be a fit for most hedge fund strategies. Moreover, typical direct lenders and ABL firms cannot service many of these borrowers without overreaching beyond their investment mandate or skillset. To us, the appeal is that we don’t have to sweat the cycle, because it’s an all-weather strategy that not only is protected against economic shifts, but allows us to stay active in any market.
