1. Opportunities in Illiquid Credit 25 April 2013
Opportunities in Illiquid
Credit
Pete Drewienkiewicz
David Bennett
1

2. Opportunities in Illiquid Credit 25 April 2013
The Seven Steps to Full Funding TM
2
Design an efficient
investment strategy
Destination for agile
hedging strategy
Transparency to make
timely decisions
Articulate clear objectives
and constraints
Mission Statement
To help our clients achieve full-funding with the minimum level of risk
CLEAR GOALS &
OBJECTIVES
ACCESS TO
DERIVATIVE HUB
LIQUID ALPHA & BETA
STRATEGIES
LIQUID & SEMI-LIQUID
CREDIT STRATEGIES
ILLIQUID CREDIT
STRATEGIES
ILLIQUID ALPHA & BETA
STRATEGIES
ONGOING
MONITORING

3. Opportunities in Illiquid Credit 25 April 2013
Seven Steps to Traditional Asset Classes
3
Step
(2)
Derivative Hub
(3)
Liquid α & β
(4)
Semi-Liquid Credit
(5)
Illiquid Credit
(6)
Illiquid α & β
Collateral
Management
Equities Corporate Bonds Infrastructure Debt Insurance-Linked
Hedging Multi Asset
Asset Backed
Securities
Social Housing Debt Private Equity
Active LDI Sovereign Bonds High Yield
Direct Mid-Market
Lending
Infrastructure
Equity
Equity Derivatives Commodities / CTA Leveraged Loans Mezzanine Finance Unlisted Property
Swaptions Currencies
Emerging Market
Debt
Distressed Debt
Hedge Funds with
Longer Lock-Ups
Gilt Repo Liquid Hedge Funds
Commercial Real
Estate Debt
Long Leases /
Ground Rents

4. Opportunities in Illiquid Credit 25 April 2013
Terminal Portfolio Approach
The Role of Credit Within a Scheme’s Asset Allocation
4
Corporate
Bonds
Direct
Lending
Corporate
Linkers
Infrastructure
Debt / Long
Leases
Ground Rents
Gilts
Cash

5. Opportunities in Illiquid Credit 25 April 2013
Introduction: Illiquid
Credit
5

6. Opportunities in Illiquid Credit 25 April 2013
European Bank Distress
6
“Much has been written on the entanglement
between banks and sovereigns in Europe since the
financial crisis started in 2007-08.
At its heart, we believe, the issue is quite simple:
European banks are too big.
By “too big” we mean that the size of their assets
and liabilities is such that – in theory – they have
the capacity to threaten the solvency of their
own sovereign.”
Source: Barclays Research, ‘Bank Deleveraging in Europe: Not Done Yet’ (October 2012)

7. Opportunities in Illiquid Credit 25 April 2013
• Recourse to national sovereign in times of crisis
implies that overall size of banking system is
manageable.
• Where this is not the case (e.g. Ireland), deposit
guarantee schemes can lack credibility.
• National regulators in Europe thus have an
important interest in ensuring ‘their’ banks have
sufficient capital to withstand stress scenarios.
Pressure on Banks to Delever
7
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
Barclays RBS Santander BNP
Paribas
ING Group Deutsche
Bank*
Unicredit
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
JP Morgan Goldman
Sachs
BAML Wells Fargo Morgan
Stanley
Citigroup
Bank Liabilities vs. ‘home’ country GDP in Europe and the US
*All data as at year end 2012 except Deutsche Bank at year end 2011 (date of last available annual report). Source: Company Filings, Eurostat, Barclays Research
“Global banks are global in
life, but national in death”
- Mervyn King

8. Opportunities in Illiquid Credit 25 April 2013
Impact of New Regulations
8
I
Capital and
Liquidity
Basel 3
II III
Risk Mgt.
and
Supervision
Market
Discipline
Narrower
range of
eligible
capital
Increased
capital
reqs.
Capital Ratio
2019 deadline to complete implementation of Basel III.
Institutions are seeking to demonstrate capital and
liquidity resilience much earlier.
Capital standards require banks to hold more capital of
higher quality under Basel III than under Basel II rules.
Quantity of capital:
• Total common equity Tier 1 capital ratio rises from 2%
to 7% (includes capital buffer of 2.5%)
• Minimum total capital (Tier 1 & Tier 2) increased from
8% to 10.5% (including buffer).
• Banks may target total capital ratios of 13-15%
• Introduction of 3% non risk-based leverage ratio
• Liquidity requirements: Liquidity Coverage Ratio
and Net Stable Funding Ratio
Quality of capital:
• Common equity and retained earnings should be the
main component of Tier 1 capital, not debt-like
instruments

9. Opportunities in Illiquid Credit 25 April 2013
Scarcity of Capital in the Face of Robust Demand:
The ‘Maturity Wall’
9
• Recent strong US loan and bond sales have pushed
out the maturity on the corporate debt of the
neediest borrowers to c. 2017.
• $645bn of sub-investment grade maturing in
next five years
• Peak due in 2017
• Macro concerns (e.g. US debt ceiling) could
disrupt financing markets
• Total amount of debt maturing in the next five
years is down modestly from 2012...
• ...but amount of maturing debt held by lower-
rated companies is now higher.
Source: S&P Leveraged Credit Review, Ares Capital, Barclays Research, Moody’s
0
50
100
150
200
250
300
350
2013 2014 2015 2016 2017 2018 2019 2020
$bnmaturing
Secured Loans High-Yield Bonds
0
10
20
30
40
50
60
70
2013 2014 2015 2016 2017 2018 2019 2020
€bnmaturing
Secured Loans High-Yield Bonds
2. European Maturity Wall
1. US Maturity Wall

10. Opportunities in Illiquid Credit 25 April 2013
Current Opportunities
10

11. Opportunities in Illiquid Credit 25 April 2013
Higher-Rated
Lower-Rated
“Shorter-Dated” “Liability Matching”
Infrastructure
CRE Debt
Ground Rents
Long Leases
Aircraft Finance
Direct Lending
Distressed Debt
11

12. Opportunities in Illiquid Credit 25 April 2013
Real Estate Long Leases
12
Maturity Profile 20 years +
Liquid Alternative 20-Year Tesco Bond
Expected Spread / Rate 285bps
Approx. Premium over
Liquid Alternative
108bps
Attractions
• Security over underlying asset provides downside
protection
• Long-dated, inflation-linked cashflows
• Potential to target sub-asset classes (e.g. social
housing) as part of long lease portfolio
Points to Note
• Potential for concentration risk given prevalence of
long-lease deals in certain sectors (e.g.
supermarkets) – also may have exposures
replicated in corporate bond portfolio
• More popular pooled funds have built up capital
queues
Investor
(Lessor)
Rent
Tenant
(Lessee)
Right to
occupy
property
for
duration
of lease
Legal ownership of
property remains with
investor and property is
transferred back at end
of lease

13. Opportunities in Illiquid Credit 25 April 2013
Ground Rents
13
Maturity Profile 99 – 999 years
Liquid Alternative
BBB Long-Dated Sterling
Corporate Credit
Expected Spread / Rate 300bps
Approx. Premium over
Liquid Alternative
73bps
Attractions
• Long-dated, index-linked cashflows
• Security of underlying asset
• Freeholder has recourse to mortgage lender
in case of tenant default
• Over-collateralisation of ground rent via
property built on land
Points to Note
• Individual rents must be acquired in volume to have
meaningful impact on portfolio and to provide
diversification
• Large-scale supply is limited
Ground
Rent
Mortgage
Leasehold Equity
Ground rents rank higher than any claim on the
leasehold including mortgage repayments

14. Opportunities in Illiquid Credit 25 April 2013
Infrastructure Debt
14
Maturity Profile 15 years +
Liquid Alternative
BBB Long-Dated Sterling
Corporate Credit
Expected Spread / Rate 275bps
Approx. Premium over
Liquid Alternative
48bps
Attractions
• Long-dated, index-linked cashflows
• Secured lending
• Government support for sector via PFI
• Many projects are likelier to experience lower return
volatility due to the natural bias towards essential
service sectors
Points to Note
• Time to become invested
• Prepayment risk exists (although prepayment
penalties are common within loan structures)
• Limited availability of debt investment opportunities
• Potential for exposure to development risk
• Different sectors have different risk factors (e.g.
Ongoing demand for services offered)
Indicative risk breakdown:
• Education
• Rail
• Water
• Pipelines
• Airports
• Satellites

15. Opportunities in Illiquid Credit 25 April 2013
Commercial Real Estate Debt
15
Attractions
• Bank deleveraging has arguably created
fundamental dislocation in asset class
• Falls in LTVs have resulted in cushion on falling
property values to senior loan providers
• Security on underlying asset mitigates default risk
Points to Note
• Diversification of tenants / loans required to
counteract void risk
• Significant allocation required to achieve
diversification
• Prepayment risk exists (although prepayment
penalties are becoming increasingly common)
Maturity Profile 5-10 years (varies)
Liquid Alternative
Sterling IG Corporate
Credit
Expected Spread / Rate 350bps for Senior Loans
Approx. Premium over
Liquid Alternative
104bps
Sponsor
(Property
Owner)
Lender
Commercial
Property
Tenants
The lender has a lien
on the underlying
property
Principal + Interest
Loan Advance

16. Opportunities in Illiquid Credit 25 April 2013
Aircraft Leases
16
Maturity Profile c. 5 – 10 years
Liquid Alternative
BBB Short-Dated US
Corporate Credit
Expected Spread / Rate 350bps for senior debt
Approx. Premium over
Liquid Alternative
155bps
Attractions
• Nature of underlying asset as global commodity
(supports resale value in case of default)
• Opportunity to structure either via sale and
leaseback of aircraft or as asset-backed debt
secured on underlying planes
Points to Note
• Difficult to price residual value of asset accurately
(given depreciation, potential for technological
change, upkeep costs etc.)
• Limited manager universe
• Exposure to business cycle0
100
200
300
400
500
600
700
800
900
Sep
2004
Sep
2005
Sep
2006
Sep
2007
Sep
2008
Sep
2009
Sep
2010
Sep
2011
Sep
2012
Global Commercial Aircraft Order Backlog (Bn $USD)
Source: Bloomberg

17. Opportunities in Illiquid Credit 25 April 2013
Direct Mid-Market Lending
17
Maturity Profile 24 – 72 Months
Liquid Alternative
BB/B Non-Distressed US
High Yield
Expected Spread / Rate
600bps prior to defaults,
450bps after defaults
Approx. Premium over
Liquid Alternative
230bps
Attractions
• Attractive spreads available relative to other illiquid
opportunities
• Loans typically secured on borrower’s assets
• Direct origination allows greater capture of loan
economics
Points to Note
• Private-equity style structure of manager offerings
implies high fees (including performance fees)
• Prepayment risk exists (although prepayment
penalties are common within loan structures)
• Dependence on manager sourcing abilities in
allocating capital
Corporate
Corporate
Bank
Asset
Manager
Bank
Asset Manager
Bank
Asset Manager
Bank

18. Opportunities in Illiquid Credit 25 April 2013
Distressed Debt
18
Maturity Profile Varies
Liquid Alternative
BB/B US Distressed High
Yield Credit
Expected Spread / Rate
N/A (owing to difficulty in
quantitatively assessing
defaults, and differing
IRRs according to
investment approach)
Approx. Premium over
Liquid Alternative
Attractions
• Large proportion of available deals sourced outside
of public markets – same considerations apply as in
direct SME lending
• Diverse opportunity set, including non-performing
loans, special situations lending, liquidation claims
• Potential for attractive returns
Points to Note
• Wide range of potential opportunities – some are
difficult to analyse / idiosyncratic (e.g. liquidation
claims)
• Importance of manager skill in identifying good
deals and avoiding blow-ups
• Managers differ in extent of control over borrower
desired
Discounted Debt Activist Investing Control Investing
Secure Companies
No Restructuring
Short-Term
Investment Horizon
Lower Target IRR
Companies Under
Pressure
Restructuring
Mid-Term
Investment Horizon
Middling Target
IRRs
Companies In
Deep Distress
Significant
Restructuring
Long-Term
Investment Horizon
High Target IRRs
Spectrum of Control

19. Opportunities in Illiquid Credit 25 April 2013
Implementation
19

20. Opportunities in Illiquid Credit 25 April 2013
Use of Illiquid Credit as Equity Alternative
20
40%
20%
20%
20%
Sample Equity Replacement Portfolio
Risk Parity
Long / Short
Credit
Direct Lending
(SMEs)
Distressed Debt
Sources of Funding
Developed
Equity
EM Equity
Private Equity
50%
35%
15%
Previous Allocation
25%
50%
25%
Replacement Portfolio
Portfolio Weightings: Return-Seeking Assets
• Overall risk in the return-seeking
assets bucket reduced by 20%
• Overall expected return on scheme
assets increased by more than 10%
Equities Credit “Alternatives”

21. Opportunities in Illiquid Credit 25 April 2013
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
David Bennett
Head of Investment Consulting
Direct Line: 020 3326 7147
david.bennett@redington.co.uk
21
Pete Drewienkiewicz
Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
Disclaimer
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22. Opportunities in Illiquid Credit 25 April 2013
Manager Research Team:
Division of Responsibilities Across Steps 2-7
   
  
  
   
   
  
22

23. Opportunities in Illiquid Credit 25 April 2013
13-15 Mallow Street London EC1Y 8RD
Telephone : +44 (0) 20 7250 3331
www.redington.co.ukThe Team
Pete Drewienkiewicz
Director | Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
23
Kenny Nicoll
Director | Manager Research
Direct Line: 020 3326 7111
kenny.nicoll@redington.co.uk
Huayin Liu
Vice President | Manager Research
Direct Line: 020 3326 7105
huayin.liu@redington.co.uk
Tom McCartan
Associate | Manager Research
Direct Line: 020 3326 7139
tom.mccartan@redington.co.uk
Aniket Das
Associate | Manager Research
Direct Line: 020 3326 7153
aniket.das@redington.co.uk
Kate Mijakowska
Analyst | Manager Research
Direct Line: 020 3326 7106
kate.mijakowska@redington.co.uk
Greg Fedorenko
Analyst | Manager Research
Direct Line: 020 3326 7122
greg.fedorenko@redington.co.uk