Cardano sifts capital stack for distressed investment gems


Pension fund consultant targets range of non-performing loans and CMBS, reports Jane Roberts

In 2008, eight-year-old pension fund consultant Cardano hired its first real estate expert and soon saw opportunities in the sector. “We did it by going right to the top of the capital structure,” says Richard Urban, at that time the London-based investment management team’s new head of real estate.

As part of what it calls its ‘solvency management’ approach, Cardano offers expertise in a diverse range of investments besides equities and fixed income, including real estate, private equity and hedge funds.

Urban: “When the market was in distress we bought senior bonds; now, at a different point in the cycle, we buy junior tranches with control rights”

The firm prides itself on investing in non-traditional areas for corporate pension fund clients. Urban was hired because of his varied background: a chartered surveyor, he’d also worked in real estate finance and, at Moody’s, rating CMBS.

Cardano has no set asset class allocations; real estate competes with other investment areas and Urban alone cannot cover his whole specialism. But the firm seeks at least mid-teen property returns to compensate for its illiquidity, which “helps filter out a large part of the real estate world”, he says.

This led him into a number of debt or distressed asset investments, ranging from discounted triple AAA CMBS to defaulted US construction loans, his choices moving through the capital stack as time went on.

Once a strategy is identified, Urban seeks out a manager, although sometimes managers come to him “with a good idea”.

The early strategies focused on mortgage- backed securities, buying discounted bonds at the top of the capital stack that were, or had originally been, rated AAA, but which the firm expected to pay out at par. Urban also went short on poor-quality mortgage- backed securities.

“We identified a lot of mispriced RMBS and CMBS that was less risky but was cheap because of widespread panic then – investors were flocking away from mortgage-backed securities,” he says. The investments were made via one European and one US fund; the latter has grown five-fold since Cardano first invested, to $2bn.

The next target was pan-Asian property debt, “but we couldn’t get comfortable with [the difficulties] of taking control of property if borrowers defaulted”, Urban says. Instead, Cardano invested with a bricks-and-mortar manager that puts rescue capital into financially stressed deals.

Buying distressed US debt

In the US, Urban spent years searching for the right manager before becoming a cornerstone investor in a non-performing loans fund that bought large real estate loan pools from regional US banks. “We were comfortable with obtaining property ownership; the US market is particularly knowledgeable about how to do it, following the 1990s savings and loans crisis,” he says.

“A lot of regional banks with real estate exposure needed to deleverage and the process of working through the assets was more organised. We invested with a very experienced team and, crucially, they had an in-house loan servicing team.” In addition to work-outs, they can realise capital through securitisations of non-performing loans.

Cardano owns 5-10% of this fund and of another that buys bigger defaulted construction loans “where you acquire a property at less than replacement cost. Few developers know how to buy and enforce on a loan, so your competition is limited.” In both cases, Urban is on the fund advisory boards.

More recently, Cardano invested again with the US non-performing loan manager in new US CMBS. “When the market was in distress we bought senior bonds; now, at a different point in the cycle, we buy junior tranches with control rights and the right for our manager to be appointed special servicer. The CMBS is originated at today’s values, with better covenants and lower loan-to-value levels, and we have control over our destiny.”

Cardano’s search for a manager in Europe with a similar non-performing loan buying strategy has so far been in vain. The firm chose not to invest with large, global funds “with a European sleeve -we want more control over where our capital is invested”.

In the UK it has backed a manager that buys assets worth around £5m-£10m from banks and receivers, which also invests in France, Germany and Sweden. “We’re also looking at Norway and at distressed debt in Japan,” Urban says.

‘Solvency management’ helps pension funds pay the bills

Cardano offers investment advice and ‘solvency management’, a comprehensive type of fiduciary management “involving managing pension fund assets against liabilities in a risk-controlled way.”

As well as advising and implementing investment strategies, from London, the firm trades billions of euros of tailor-made derivatives for clients. The aim is to ensure pension funds get what they need: enough money to pay the bills.

The firm was founded in Rotterdam in 2000 focusing on strategic risk management. The London office opened in July 2007 and has around 60 staff, including 12 research and investment management specialists.

Around £5.6bn of the money the London office invests is discretionary capital, “so we can invest faster and in niche strategies”, Urban says. It advises on a further £40bn of capital, but often recommends its discretionary ideas to these other clients.

In the three years to March 2013, Cardano’s solvency management clients’ average annual return was 14.4% net of fees – 300bps more than their liabilities grew. Those clients include The Pensions Trust’s Growth Plan, Asda and Pirelli.