Distressed debt investors focus on Europe For one group of hedge funds, Europe has been a source of ongoing frustration: neither crushingly bad nor roaringly successful. Until now, that is. In spite of a banking crisis, sky-high leverage and flatlining growth, distressed debt investors - those who aim to profit by snapping up the steeply discounted bonds of companies in bankruptcy or on the cusp of it - have seen opportunities elude them across the eurozone bloc. They hope that may finally be starting to change - though there is plenty to suggest that unless they become more creative, it won't. "People have been raising a lot of money for distressed funds in Europe since 2010," says Luke Ellis, president of Man Group, Europe's biggest hedge fund outfit. "And they all say "there's a lot of stuff in the banks that needs to be shifted and they are going to sell us it for 20 cents on the dollar." Well so far that hasn't happened. There are still a lot more buyers than sellers for distressed assets. As Howard Marks, the founder of private equity firm Oaktree - which has raised billions for European distressed funds in recent years - admitted last March, returns have disappointed. Having hoped for profits of as much as 30 per cent annually on its capital, Oaktree has had to make do with figures in the low teens. Part of the problem is that European companies have enjoyed huge ease of refinancing: a wave of yield-hungry investors has depressed the cost of new capital - dramatically in some cases. Hedge funds point to companies such as Europcar, which once would have been prime candidates for restructuring, but in the current environment have avoided difficulties. In short, Europe's big attraction - a bloated banking sector with underperforming assets it needs to offload - has so far failed to draw crowds. "The deleveraging process is slow and is going to continue to be slow," says Theo Phanos, founder of one of Europe's most prominent distressed debt hedge funds, Trafalgar, and now the chief executive of CapeView Capital. The area that has been particularly slow is with single name corporate distressed situations. The price that hedge funds want to buy at is much much lower still than where banks are willing to sell. Perhaps more notably, says Mr Phanos, it has become harder to make money from the corporate situations themselves. The Italian directories company Seat Pagine Gialle, he notes, has just undergone its third restructuring. You would think that having been restructured already, and with a very difficult structural profile, Seat debt would have been trading at deeper value levels early this year, before a further restructuring was announced. Instead, restructured bonds traded at 60 cents on the dollar. They are now trading at 20 cents. Hedge funds that bought into the deal have been badly burned. But there are signs that European distressed debt investing may finally be set to have its heyday. "Recovery" trades, where hedge funds have bought assets in countries such as Greece, Portugal or Spain, have been particularly lucrative. "We are in a post crisis environment," says Michael Weinstock, chief executive of US distressed debt hedge fund Monarch Capital, which recently opened an office in London. It's like what we saw in the US in 2003 and 2009 - it's a very good time to invest. And with the European Central Bank's Asset Quality Review looming, many believe that banks will finally have to begin shifting some of their troubled assets off their balance sheets - a process so far hindered by the ECB's extensive liquidity operations. Sources at the ECB itself have been beset by hedge fund enquiries. Crucially, the opportunities are abundant for distressed hedge funds willing to look beyond just corporate bonds. "Probably less than half our distressed European investments are in regular corporate debt," says Mr Weinstock. Structured credit, residential and commercial mortgage backed securities, covered bonds, shipping loans and regional government debt all offer "extremely lucrative" opportunities in Europe, he says. More complex companies like Punch Taverns - whose assets are almost completely securitised - are trading at attractive enough levels for significant upside. A £200m mezzanine note issued by the company was trading at 60 cents on the dollar earlier this month, for example. Enterprise Inns, another UK "whole business securitisation," has meanwhile seen the yield on a bond due in 2018 drop from highs of 24 per cent in 2009 to just 6 per cent currently. Hedge funds say the restructuring of the shipping company Torm in 2012 also provided a welter of opportunities as the effects of its renegotiated contracts with other shipowners and builders affected a broad spread of loans and credit arrangements. Even where banks are unwilling to sell down their holdings of underperforming assets, cannier hedge funds have been able to strike big, bold deals: funds such as US-based Magnetar, which made a name for itself in 2007 by profiting handsomely from the subprime housing collapse, have turned their hands to "balance sheet arbitrage." Funds enter into structured transactions with banks where they agree to take the first losses on a pool of underperforming assets in exchange for big premiums. Banks benefit from reducing their risk exposures without losing all of their assets" upside potential. "If you can source the right opportunities, then Europe is one of the best return environments globally," says one distressed debt trader in London. Coming in with $2bn or $3bn doesn't work. You need to be smarter, and more patient. There are absolutely huge deals out there. Additional reporting by David Keohane