Lessons from Traffic Jams

Sitting through India’s infamous traffic jams in its bustling cities has provided ample time to think about how to best navigate this market in all ways physical and financial.

India is unique in so many ways, not least economically and financially. It is simultaneously a significant player on the world stage and a somewhat self-contained economic island.

The opportunities are virtually limitless for institutional investors that are well set up, but the challenges we face tend, like the country itself, to be one of a kind. To operate successfully in this intriguing and diverse market calls for a deep-rooted knowledge that takes time to acquire. There are no short cuts.

For us, there are three drivers of the Indian opportunity set, each relating to areas in which the economy has encountered turbulence in recent years: high levels of non-performing loans (NPLs) that burden the banking system; lack of liquidity following serious difficulties for non-banking financial companies (NBFCs); and stress in the real estate market.

Let’s take those in turn. First, NPLs are a legacy of the period following the 2008 global financial crisis, when India was experiencing very rapid growth. In that timeframe, the amount of debt in the system grew as a result of fast economic growth and a need for capital expenditure (capex) to build industry and infrastructure.

Problems started when a number of projects encountered delays, such as waiting for approvals and a shortage of raw materials. Delays in these capex-heavy projects ultimately resulted in a longer timeframe to generate income, and loans became non-performing. It has led to a classic example of ‘good asset, wrong balance sheet’.

Second, NBFCs are institutions, sometimes referred to as shadow banks, that extend loans, but many do not take in deposits and instead rely on capital market financing. NBFCs have been an important source of lending in the Indian financial system for the last five years but more recently, in a hunt for yield, they tried to fund themselves with cheaper capital in the form of short-term commercial paper.

But commercial paper matures on average in three to six months, while NBFC lending runs anywhere from 24 months to seven years. And when one of the major NBFCs ran into trouble last autumn, this mismatch was exposed and the commercial paper market dried up.

Finally, the real estate sector, after years of high growth, is starting to show signs of stress in a country where local market dynamics are far more nuanced than in other developing nations. A great deal of development happened very quickly, particularly in high-end residential real estate, leaving a general over-supply of projects and a number of developers over-leveraged. The sheer rate of construction in cities like Mumbai and Delhi has radically changed their neighbourhoods, mandating a physical presence to truly understand the rapidly evolving and increasingly complex real estate market.

Set against the backdrop of bank lending hobbled by NPLs and NBFCs also reducing their role as lenders, you can see why borrowers – including those in real estate – need to find alternative sources of credit.

However, these and other difficulties elsewhere in the system should not be the only measure of the opportunities in India. That would be a very short-sighted approach, particularly given that the government is proactively trying to solve the problems the credit system is facing.

Take NPLs, for example. Under different circumstances, they could have posed a systemic risk to the banking system. While substantial difficulties remain, various policy tools, including the new nationwide bankruptcy code, are a step in the right direction to address this problem, and balance sheets are gradually being cleaned up.

In short, we anticipate continuing opportunities to present themselves and, as these become better known, for more investors to focus on India. However, we believe it is important to remember that being successful in the Indian market involves grappling with complexities on the ground, staying extremely disciplined in one’s approach, and spending a lot of time getting to know the counter-parties and players involved.

We have hired with that in mind, assembling Singapore and Mumbai-based teams with experience structuring deals in the region, local knowledge and language skills required to avoid certain pitfalls, and a global perspective to compare risk across geographies.

A last observation would be that much of our approach can be traced back to having, in the early years, sat in a lot of traffic jams. Our presence on the ground has positioned us to better understand and capture some of the best opportunities in the market while maintaining our global standards of doing business. We also came to know the times in which traffic was flowing in the wrong direction and therefore when we ought to stay put.

Not a bad model for doing business in this remarkable country.

Written by Haseeb Malik, Partner and Head of Asia Corporate and Traded Credit at Värde Partners. Originally published by Asia Asset Management. 

Why Getting Workplace Diversity Right Isn’t for the Faint-Hearted

I am living proof that diversity doesn’t just happen because you have diverse leadership. When my two male co-founders and I set out to build an independent investment business in our hometown of Minneapolis 25 years ago, we never thought that 33% would be our strongest showing in gender diversity for our investment staff. A few years ago, we looked back at the numbers and set out to change that.

When George Hicks, Greg McMillan and I formed Värde Partners in 1993, we did not dictate the culture, but our decisions set the tone early on. Before we even launched, we instinctively understood – and shared the belief – that we were stronger by leveraging our mix of capabilities, skills, and even personalities. In today’s diversity and inclusion parlance, we intentionally sought to maximize our Collective Intelligence and our Cognitive Diversity. We also chose to avoid the cult of personality that is so often associated with this business and, instead of putting our names on the door, we named the company Värde, which means “value” in Swedish.

As the business grew, those fundamentals evolved into a distinctive culture of which I am personally very proud. Being a woman in the male-dominated field of alternative investing never seemed to hinder my success. That success, however, may have led me to overlook the fact that we weren’t maintaining gender diversity among our own investing professionals.

When I transitioned into my current role as executive chair in 2016, we took a hard look at the data around diversity, both at Värde and within the industry. I was naturally drawn to the gender data, where it was evident that the rate of change in financial services has been nothing short of glacial.

Research suggests that, at the current rate of change, financial services globally will not reach that magical 30% critical mass of women in executive positions until 2048 – I hope to live that long! I was further disappointed that Värde’s numbers – in recruiting, hiring and retention of female investment professionals – were not much better than the industry averages, particularly in light of our enviable culture and my female leadership. I felt a deep sense of responsibility to improve that in an accelerated way.

My passion these days is the intersection of talent and organizations that are purpose-driven, performance-oriented and principles-led. One of my views is that there is a widening gap between the growing complexity and sophistication that is required in investing and the static approach the industry takes to its most strategic asset: the one that goes up and down the elevator every day. Another personal point of view is that good intentions are necessary, but not sufficient, to ensure a portfolio of talent that is diverse and inclusive. There is no substitute for purposeful actions to close the gap between aspiration and reality.

At Värde, we saw that we had to take deliberate actions in order to change things. Figuring out where to start felt daunting, but we benefitted from having a strong culture and a willingness to do an organizational reset. We realized that our core values of collegiality, excellence, humility, innovation and integrity could serve as guideposts in the process.

I often analogize creating an effective diversity and inclusion strategy with running a simultaneous “air war” and “ground war”. In other words, you need to start with the right tone from the top, while also ensuring policy changes are being practiced at the line manager level. You need leadership to walk the talk and make clear that diversity is a business imperative and not an HR initiative. You must also pay very close attention to every minority talent in your organization – and always know that your people will immediately see inconsistencies between messages and behaviors.

We scrutinized our recruiting, hiring, review, and promotion processes, and analyzed our retention of women in the investment side of our business. While some of this self-examination was admittedly painful, it helped shape our current views – and practices – toward developing a more diverse bench of investing talent.

While some changes were bigger than others, we saw that even seemingly small research-based changes we implemented could have an outsized impact. For example, we set a minimum of two female candidates per investing role. Of course, every candidate needs to be qualified, but making that demand often pushed our people to look beyond their immediate networks. We also review job descriptions to de-bias language, we review all resumes for a role at the same time, and we run a structured interview process.

In looking at reviews and promotions, it became clear we needed to better mitigate unconscious bias in these processes. In addition to individual managers being responsible for recommending promotions, we also conduct those assessments by committee. One change I advocate any organization to make is dropping self-evaluations from a review process. This behavior is not exclusive to Värde or investment professionals – but women consistently rate their performance lower than men do, which can certainly lead to unintended bias in reviews and talent performance rankings (and self-inflicted, no less).

Since Värde has focused on increasing female diversity among our investment professionals, I am pleased to report that we have doubled our women professionals to nearly 20%, and we are well on our way to an intermediate goal of one-quarter by 2020. It requires a long-term commitment.

I’m an optimist at heart and I love big opportunities. Increasing diversity in the alternative investing industry is one of them. Since we started to make progress at Värde, I wanted to extend my influence and assistance on this issue to other industry participants. I’ve met with numerous other firms – many of which have strong diversity and inclusion efforts – and there is no dearth of interest in this topic. The industry knows diversity matters to achieve the best business results. We need to do a better – and more deliberate – job of increasing the absolute numbers in the pipeline and ensuring that high-performing women have a fair shot at senior leadership roles.

Many organizations will need to reset their cultures to create workplaces that fully leverage their diverse talent. This starts by creating the conditions that influence behaviors and mindsets.

We saw the impact that moving from intuition to data-driven results could have, and I encourage others to hard-wire their organizations, including:

• Ensuring that your culture is truly inclusive and enables everyone to bring their “whole self” to work;

• Designing organizational processes to mitigate unconscious bias in hiring and promotion;

• Providing learning opportunities and leadership development to build a bench of leaders that are skilled and inspiring;

• Drawing out emerging talent and empowering them through sponsors and mentoring programs.

This is a demanding and competitive industry to work in, and the stakes are high. We are investing the assets of institutions that provide for the greater good: endowments, foundations, pension funds and more. Our ability to help fulfill their missions is dependent upon high-performing talent and inclusive leadership. We know that a team comprised of individuals with diverse backgrounds makes us better investors and better corporate citizens. I feel confident that driving this change will benefit our employees, clients and the millions of people they serve.

Written by Marcia Page, Co-Founder and Executive Chair of Värde Partners. Originally published in March 2019 by World Economic Forum.

Capital Markets in Asia Need Alternative Sources of Credit

Broader and deeper access to credit across Asian markets can provide a key building block in helping the region achieve its growth potential over the coming decades. While much is made of the expansion in credit in Asia over the past decade, in truth this growth has mostly come from traditional financing sources and been provided to traditional borrowers, such as banks lending to prime or “low-risk” borrowers. Continuing the evolution toward a more sophisticated and dynamic credit offering for a wider swath of corporates and consumers will be one of the keys to capturing economic growth and properly distributing its rewards.

The credit gap in Asia is most apparent for non-conforming borrowers, borrowers who do not meet the criteria for traditional financing due to credit quality or the nature of their underlying collateral. The gap is particularly acute in historically bank-dependent lending markets, particularly those that are seeing traditional lenders retrench under the burden of non-performing loans (NPLs) or from regulatory pressure.

Encouraging the growth and evolution of public credit markets provides one part of the answer. High-yield securitization and near-prime consumer lending markets remain significantly under-penetrated in Asia compared to Europe and North America. This is true even in more developed markets such as Japan and Australia, but more acute in developing Asia—with only China having seen meaningful growth in its public debt markets. Government policy has an important role to play in creating certainty around the enforcement process, ability to move capital on and offshore, and ideally standard processes across the region.

Alongside this evolution in public markets, there is a critical role for private “alternative” credit solutions across the region. The ability for non-bank lenders (hedge funds, private equity firms and other financial institutions) to provide flexible financing can boost access to growth capital for non-traditional borrowers or more complex structures. This is especially true in markets where the high-yield market is nascent. Alternative credit plays a key role in restructuring existing debt, acquiring NPLs and in supporting and helping evolve the regimes to enforce creditors’ rights. More broadly, there is a need for alternative credit providers to more systematically cover the gaps that resulted from bank retrenchment by either building lending enterprises or buying them from traditional lenders.

In North America and Europe, alternative credit has enhanced many efficiencies in capital markets, lowering the cost of borrowing in functioning markets and helping repair access to capital in disrupted markets. We saw this when traditional lenders pulled back in the wake of the global financial crisis. Many companies still had access to credit through this avenue and the industry played an important role in buying and proactively restructuring impaired credit from the banking system.

Progress has often been associated with a proactive focus on the functioning of credit markets by governments, and this can be seen in recent years in Asia. In India, for example, a focus on cleaning up the NPL problem in the state banking system led to recent regulatory and legislative changes to ease the historically cumbersome and time consuming bankruptcy process. The restructuring of impaired credit has been most publicly visible through the so-called “Dirty Dozen”—the 12 largest corporate debtors that were mandated by the government to restructure. More broadly, India has seen a step change in behavior and capital activity in a system that was previously mired in its troubled credit problem. The Indian approach is paying dividends both in dealing with the NPL problem and in promoting the development of more credit options for healthy borrowers.

Asia will be the economic growth engine of the world over the coming decades, and history has shown the role that a sophisticated credit market can play in accelerating that path. Markets and private alternative credit, along with governments driving regulatory change will be key players in this next evolution of the Asian market.

Written by Ilfryn Carstairs, Partner and Co-CIO of Värde Partners. Originally published in September 2018 by the Milken Institute’s The Power of Ideas.