Hamza Lemssouguer - Driving Alpha in Credit

00:00:06 [Hamza Lemssouguer]
Success is a straight line, has a lot of good news, but actually the good news don't happen if you don't go through stress tests and you don't go through issues and failures because those shape character, those shape teams, they shape style, they shape strategies. And I do think every positive thing we had comes from a lot of learnings, our own mistakes, other people's mistakes.
00:00:27 [Vincent Weber]
This episode is brought to you by Resonanz Spotlight, where we decode the DNA of successful investment strategies. What happens when you combine academic rigor with street-smart investing? Today's guest turned that question into a multi-billion-dollar answer. Stay tuned. From a passion for markets to founding one of Europe's most talked-about investment firms, our guest today embodies the evolution of modern credit investing. I'm Vincent Weber, and joining me is Hamza Lemtougar, the architect behind Arini Capital Management. Welcome to Resonance Spotlights. Thank you, Vincent.
00:01:03 [Hamza Lemssouguer]
Good to be here.
00:01:04 [Vincent Weber]
Great to have you here, Hamza. So just let's start. There's always a story behind name and I think your common name is very interesting. So Arini, so what's behind this?
00:01:16 [Hamza Lemssouguer]
Yeah, for sure. So basically Arini is a tribe of neotropical parrots, also known as macauls, very large parrots, colorful parrots from South America, conures, which are a little bit smaller. And the passion for parrots comes from a very young age. I've always bred animals since I was very young. I had a deep passion for wildlife in general. And a few years ago during COVID, my wife and I, then girlfriend at the time, started breeding endangered parrots in the purpose of reproducing them and hopefully get more numbers that we can then reintroduce to the wild further down the road. We do that southwest of London and we have multiple endangered species in our farm.
00:02:03 [Vincent Weber]
Wow, I would never have expected this. That's really interesting. And Hamza, you could have chosen any path in finance. So what was it about the credit market that put you in?
00:02:17 [Hamza Lemssouguer]
First of all, finance. I mean, luck got me into finance. It was an iterative process. I started as a mathematician and I ended up in finance really because I wanted to apply whatever I learned in university in a more professional setting. And learning about trading, I was very lucky to do all the internships that I need to do and graduate programs. And credit was very attractive because of the complexity. I found that it was multi-dimensional complexity, from financial complexity to legal complexity to game theory, which is extremely important in credit. And you're mixing fundamental analysis with portfolio construction. And the fact that no matter how much experience you have, you're still needed. to think and basically have a fair chance of getting it right. I really enjoyed the complexity and everything around it.
00:03:09 [Vincent Weber]
Right. And when you look at Arini's trajectory, what moments stand out as the game changer for you?
00:03:16 [Hamza Lemssouguer]
I think the biggest game changer for us as a new firm was straight after launching. We launched the firm end of 2021 and our funds in January 2022. It was a baptism with fire. It was a very volatile time. And the 2022 volatility, we invest in European high-yield credit, which was hit hard by the Ukraine invasion. 2022 was the first six to nine months we saw a relatively large drawdown. But we had the high conviction in our positions and we really worked well as a team. to focus on those high conviction position and see the returns through. We ended the year with a positive return and at a time when the high yield market lost around 15%. It was very good results at the end, a painful path and trajectory.
And what we learned from that is the need for a proactive, rigorous hedging program. And so I've built a team of portfolio construction and macro hedging, which is basically a team of quants and traders. working in a proactive risk management to make sure that all the stress testing are done and the portfolio is able to weather anything that is unlikely. The goal is that we realize the returns from our fundamental positions. But this team that we built around two years ago, the goal is to make the path and the ride as enjoyable as possible.
00:04:41 [Vincent Weber]
Right. So they say success leaves clues. What's the most counterintuitive lesson you've learned about building a firm?
00:04:50 [Hamza Lemssouguer]
The most concentrated lesson would be that you want failures. You want stress tests. You want real-life stress tests. I think we all picture success as a straight line, as a lot of good news. But actually, the good news doesn't happen if you don't go through stress tests and you don't go through issues and failures. Because those shape characters. Those shape teams. They shape style. They shape strategies. And I do think every positive thing we have comes from a lot of learnings. our own mistakes, other people's mistakes. So I do believe that stress tests, real-life stress tests, improve you as well as competition. These are not bad things. They are very good for the long-term success of the business.
00:05:32 [Vincent Weber]
I like that. This is a great answer. So let's fast forward five years, looking in the future. So what does success look like for Arini?
00:05:43 [Hamza Lemssouguer]
Five years is a hell of a long time. I would say, we don't have a number or anything in mind, but I would say we will need to achieve multiple things. We'll probably define it in three main points, I would say. One is have a scale suite of top performing strategies and be delivering a consistent top tier performance so our investors remains and will continue to be our top one priority. We will only be involved in markets and strategies where we believe we can be a top tier. investing class return generator. And we have to deliver that. There is no way around it. The second probably on how we define success would be to have a stable business.
We aim to have multiple strategies rooted in the same strength, in the core strengths, which is fundamental sector focused research. And backed by great partners, great LPs, because we do believe that the stability of our partners, the long-term alignment is extremely important for us and allowing us to take a shot and be successful. And I would say the last points on how we would define success in five years and not least would be, we would aim really to, and I think this is specific to us in Arena, we aim to maintain flexibility while being a consistent partner. A lot of our edge is rooted in our, resistance to putting ourselves in a box. A lot of allocators sometimes are pushing for that with questions do you invest in public or private credit?
Is it a long short? Do you do just RB? And my view and the firm's view is we firmly believe in the convergence of all markets, whether it's public, private, structured, or vanilla. And that in order to be good investors in a small, complex market like Europe, You need to build long-term relationships, partnerships, and also you shouldn't box yourself out of different strategies because that may be my opaque to better risk reward. So when you have a view of the whole capital structure and you can speak for all of the capital structure, you're able to pick the best risk reward at all times.
Whereas if you're focused on one single thing, whether if you're only a second lean investor, if you're only structured products, then one year out of three is really a bad choice to make. So the ability to look at different things. related to European credit, related to fundamental research, is our aim and the ability to get that flexibility in order to protect the risk-reward of what we're investing in.
00:08:16 [Vincent Weber]
Right. So we talked a lot already about Hamza as a trader, but I'm curious to learn more about the other Hamza, Hamza outside the office. So what's your antidote to market stress?
00:08:31 [Hamza Lemssouguer]
I think the biggest probably antidote to, market stress is not always negative, but I would say the antidote to that demand in life is for sure family, whether it's my home, my wife, my parents, my siblings and friends, the ability to be around people that knew me from a different age, from a different time before the recent, headline success is very important because it does remind me of different times. And more importantly, very importantly, the parrot breeding program. I spend as many weekends as I can in our farm in southwest London really to work with people there, improve the lives of the parrots who breed and think about how can we, how can I play a bigger role in conservation of these beautiful animals.
And further down the road, thinking about how we can expand that to other wildlife in different continents is extremely important for me. And it does take my mind off of day to day. I don't, I lose the notion of time when I'm with nature.
00:09:39 [Vincent Weber]
That's great. So let's talk a bit about the market and, I guess, the European credit market in particular. So European credit market, I often see that, at the complicated cousin of the U.S. market. So, what else am I missing there?
00:09:54 [Hamza Lemssouguer]
I think there is definitely quite a lot to unpack there. And these are a lot of the questions we tend to get asked on many, many meetings when we talk about the opportunity sets in the European market. I think the biggest priority thing to talk about is that credit is very different to equities. When you compare two geographies, you need to really think about what are you comparing? Are you comparing equities or credit? When you compare equities, the most important factor for equities is growth. And as such, the U.S. markets have always proved to see more growth, whether it's tech, lack of less regulation, relative ease of starting businesses and shrinking businesses. And so equity strategies, at least the long-only ones, have succeeded in the U.S. much more than Europe.
And I do think that tends to negatively impact the credit side. And we see a lot of wrong generalizations of, European credit is riskier than U.S. credit. Either than credit, and that's why I'm making a pause here, what matters is getting your money back. And getting your money back is not necessarily correlated to growth. Growth sometimes can be good for credit, can be bad for credit, if it's not priced correctly. And so really, European credit. are not, in our view, riskier than U.S. credit. They are different and they are complex, to your point. And they're complex because you're talking about many, many ways for filing for bankruptcy. You're talking about different languages. You're talking about different fiscal systems. And you're talking about different consumer behaviors and industries.
And so we think that that complexity is what excites us and what allows us to generate differentiated returns at the end of the cycle.
00:11:43 [Vincent Weber]
Right. And how has the European credit landscape transformed since you first started trading? I think that a lot has happened.
00:11:53 [Hamza Lemssouguer]
Probably the European market or the Latin market didn't necessarily exist in the current version 10, 15 years ago. It was a very small market. When I started close to 15 years ago, 13 years ago, it was a couple hundred billion. The leveraged finance market was something around 200, 300 billion. outstanding notional. Today, we're close to a trillion. And this is when we talk about the European credit market, what we're focusing on is really the leveraged finance, which is sub-investment grade companies in two different products, in bonds or loans. And today, both tend to achieve similar things. They're different instruments, different technicalities, but they tend to achieve similar things from an investment perspective, or at least from a company's perspective. We're seeing many, many issuers.
issue one versus the other, depending on the relative value and depending on the floating rate aspect of the loan versus the fixed aspects of the bond and preference of the company and its owners. But by and large, you're in a market now that's around a trillion notional outstanding debt that started just around 200, 300 billion 10 plus years ago, 13 years ago. And that growth, I started my career at a time when Rates started to be very low and then they became negative. And then QE became very impactful in the markets. Investment grade yields were below 1%.
And we saw that all the money that was put into credits from central banks, from pension funds, from insurance companies, forced many investors to think about high yield differently because there was really a need to generate 4%, to generate 5%. And there was a Hunger for yield that we read about everywhere, a pension deficit everywhere in Europe, and a lack of a market, a fixed income market that can deliver these returns. And so the growth that we saw was a direct result of QE, but also banks had a lot of balance sheets and had significant amounts of loans they needed to sell. They needed to refinance in the public market because of regulation. You post GFC. Banks globally, and particularly in Europe, needed to raise more equity, needed to have more capital.
And so naturally, you saw that supply-demand picture improving. You had banks ready to issue with businesses that needed funding or at least refinance into the public syndicated market. And at the same time, you had a buy side that was ready to buy anything that was yielding a reasonable return. And that's how we saw that market grow. That growth was not as orderly as the growth that U.S. leveraged finance saw, which was over multiple decades. So we saw a growth of 4 to 5x in 10 to 13 years. And that growth today is being unwound with the increase of interest rates.
00:14:52 [Vincent Weber]
Right, right. So talking about this movement in interest rates, so how are companies adapting to this new playbook?
00:15:00 [Hamza Lemssouguer]
I think first, slowly, we're seeing, in credit, in the market, again, that we're interested in, the leveraged finance market, the maturities tend to be short-dated. You're talking about four, five, six-year maturity. And maturities need to be refinanced. It is very unlikely that a company or a sponsor has the ability to just pay the debt in the maturity. Usually, the way the debt is extended is with the refinancing. And that exercise tends to happen. one, two, to three years before the final maturity. So we're going through that exercise today of all the debt that was issued over the last five to seven years is being refinanced or has been refinanced, and we're in the middle of that exercise.
And the impact on the company's financials is you're refinancing a 3% or 4% coupon into 7%, 8%, or 9% coupon. maybe six today, given the rally, maybe six and a half, maybe seven. But the point being, you're refinancing a very low interest with a much higher interest and you need to double or sometimes even triple your interest expense. And that is really causing some strain in the company's balance sheet. Some companies cannot afford it and you need a restructuring. And the companies that can afford it, that cash is coming from something else. So it's coming from shareholder distribution. It's coming from CapEx. It's coming from slowing down M&A. And we're seeing that we have a lot less M&A than what the equity market cap or how tight spreads are would imply.
So I think, yeah, we're in a very long cycle. We're in a very slow cycle. It is taking time for companies to refinance the debt that they issued at much cheaper levels. And as they pay higher, Dakar had to come from something else. So we're seeing a slowdown in investments. We're seeing a slowdown in M&A. And we're seeing a slowdown in exit and in shareholder distributions.
00:17:01 [Vincent Weber]
Right. So let's talk about what topic that's been puzzling me. So Europe's famous maturity wall. So we've been hearing it for years and decades, but it never seemed to materialize. So what's really going on in the asset surface?
00:17:20 [Hamza Lemssouguer]
I think, look, the maturity wall is a definition. It's maturity wall is a word that will always exist. It's not going anywhere. It's basically the fact that, you look at all the, if we talk about the high-yield maturity wall, it's you look at all the maturities of high-yield companies and you see how it's distributed. And as discussed just before, typically when issued a high-yield bond or leveraged loan, they tend to be between five to six-year maturity at issuance. And that usually means that the maturity wall, on average, is usually in normal times. Today is not normal times. It's three to four years away from today. What's different today is the maturity wall is very near-dated. It's very short-dated. So a lot of maturities are due very soon.
Numbers are jumping in the high-end bond market, which is half of the leveraged finance market. Around $300 billion of notional is due in the next three and a half to four years. There are similar numbers in the loan market. So multiple hundreds of billions of debt that needs to be refinanced soon. It means that the market is much more sensitive to earnings change, much more sensitive to growth volatility, much more sensitive to rates volatility, much more sensitive to geopolitical shocks or external shocks. And if you have two companies, exact same assets, but one with a 10-year bond and the other one with a one-year bond, The one-year bond will be much more volatile than the 10-year bond if the company goes through a rough time because the market tends to extrapolate the risk of defaults.
Whenever you have a small slowdown of earnings or cash flows generation, you tend to get a significant repricing higher of the default risk. So that is why the maturity wall now is more important, particularly in Europe, because companies have been taking their time to refinance. as they should, because the coupons that are being refinanced are very low. And that's why it doesn't incentivize the companies to really go and refinance much earlier, because it's two to three times more expensive than what they had on balance sheets. And the fact that they're taking their time means that we have a lot of debt, relatively speaking, that is due relatively soon.
It's all good when the markets are open, but the moment markets close, either because of an idiosyncratic when a company reports bad earnings, when the sector goes through a rough patch or macro, when you have an SVV type situation, it makes the markets and the system definitely more vulnerable, which presents opportunities for us.
00:19:57 [Vincent Weber]
Great. Thank you. So you're navigating a maze of different regulations, culture, language. So how do you handle that? What's your secret sauce there?
00:20:09 [Hamza Lemssouguer]
I think probably the most important thing there, I mean, to remind your listeners, Europe is a lot of economies. It's multiple ways, tens of ways for filing for bankruptcy, which is extremely important for credit. The rule of law is very important, but also how you go about it. In the US, which is the largest credit market in the world, you have Chapter 11, which has been studied and restudied. And, you have a playbook on how you go about these things. In Europe, not only you don't have one Chapter 11, but the rules keep on changing. And it's in different languages, a lot more complex. And that really has been a challenge for non-European investors investing in Europe because the logic of how Chapter 11 works does not necessarily apply here.
So how do we tackle it? First of all, it's team diversity. diversity of skills, diversity of upbringing, diversity of flow. language spoken, diversity of background. And you need to be local. You just need to be local. You need to be present in the market. You need to be connected. You need to understand the legal system. You need to understand the changes and be able to react and price things in the way they should without applying something that's completely outside the current.
00:21:30 [Vincent Weber]
Okay, cool. I recently came across the expression credit on credit of violence. So this sounds a bit like a financial thriller. So can you tell us a bit about it? What does it mean? And also try to understand, is Europe writing its own version of that story?
00:21:50 [Hamza Lemssouguer]
What credit on credit of violence means, probably in a non-financial analogy, it means, for example, let's say you buy a ticket. You buy a share of a pie, for example, and there are 10 shares per sale of a pie. 10 people buy them. And then in two years, when you come to eat your pie, they send you an announcement and they say, sorry, we only have eight pies. And we don't have 10. We know we promised you 10. We know all of you deserve a pie. But what? We cannot deliver 10 pies. The pie has shrunk. we have a lot smaller than what we expected. What do we do about it? What happens is, for example, they would say, does anyone want a discount on their pie?
Would you take half now instead of nothing later? And you start creating a sort of a prisoner's dilemma within the group of people that are owed this size of the pie. Creditor-on-creditor violence is exactly that. The fact that a lot of these capital structures do not have strong protections, do not have strong covenants, means that the company or the owner of the company might entice a group of creditors and tell them, I can give you more security, guarantee your claim today with what's called an up-searing, meaning give you more collateral package, make you the priority in the queue if you do some things for me. And those things for me could be give me a discount. Okay, instead of paying you $1, I'll pay you $0.80.
Or the creditor needs to provide more new money, et cetera, et cetera. So it's used as a technique really to work with one part of creditors against the other to create a sort of prisoner's dilemma situation and generate something that is favorable for the company, whether it's new money, whether it's discounts in liability, the capital structure, etc. When you think about Europe's situation with creditors on credit or violence, it is happening. It started to happen, albeit a lot less than the US. The US is always a lot more sophisticated, a lot more quick to adopt some of these technologies. Why has it been so slow in Europe and still slower? First is, I think, the director liability.
Is there a bit more fear in the investors and probably more of a challenge to do something and then maybe you file for bankruptcy? Will you see challenges of these as a director of a company? Would you as a board director? Would you be held liable depending on the country? Some countries are more serious than others. I do think that's definitely been holding some of these transactions back. And also the fact that the European market is still very much a relationship market where there is a long-term memory. It's a bank in the day-to-day. Europe 20 years ago was funded by banks. The European leveraged finance market, as we discussed earlier, has only been born about 15 years ago in a serious way. And in the U.S., it's been around for 60 years.
So the market in Europe did not have enough time to adopt and kind of fully integrate the technologies around. We started seeing them this year. In March and April this year, we saw tens of billions of capital structures losing value because of the fear of crypto and crypto violence. Some of them have started already. Some of them are threatening to start. But it's nothing as aggressive as what's happening in the other continent.
00:25:16 [Vincent Weber]
Okay, interesting. So let's talk about the elephant in the room. So loser covenants. Are we setting ourselves up for a different kind of crisis here?
00:25:29 [Hamza Lemssouguer]
I think, look, what is, we go back, what is covenant and what is loser covenant? Obviously, covenant is creditor protection. It's what allows a creditor to not lose their spot as priority payment. and of fairness between creditors. Covenants have started to be looser since the QE days. What happened is, first of all, when you have rate cuts, the yield drops. Second step, you had QE spreads tighten, but there's a point where spreads cannot tighten any further. You think about 2014, 15, 16, spreads were around 3, 3.5% for high yield, and rates were zero negative. it is extremely hard to imagine tighter spreads. So the next level of pushing the boundaries is not on math or financial kind of compensation. It's on legal package. It's on collateral package. It's on covenants.
And creditors, because of the competition for opportunities, there was too much capital competing for the same opportunities. After the yield dropped, the rates dropped, after the spread tightening, The third leg of it was giving up on some of your protections. So you say, I'm willing to take all this issue size. I'm willing to take a lot of this bond and I don't need as much protection as the next guy. And that created a market or a lot of capital structures with limited protection. It's being dealt with. That's giving birth to, again, creditor on creditor violence. If covenants are very tight, you're not going to see any creditor on creditor violence. But credit is cyclical. And so good times create.
loose terms and loose terms create problems and problems create stronger terms that create good times and there goes the cycle interesting if you had to bet one major shift in european credit market what would it be i would say the convergence i think that markets are converging in europe as we discussed the market in europe is not only extremely complex but it's very fragmented whether it's economies whether it's sectors And there is not enough space for too much specialization. The market is not that big or simple to have in a single focus industry or product. You do need to have a converged approach because the need for capital and the opportunities, they don't stay in the same area for too long.
So we do think that we're going to see convergence of public and private market, of structured and vanilla markets, structured products and vanilla credit products. and a convergence of corporate and asset-backed. Right.
00:28:13 [Vincent Weber]
So what's the one risk that's keeping you up at night that nobody's talking about?
00:28:20 [Hamza Lemssouguer]
I have more than one, but I have a few actually. If we have to pick one, it'll probably be inflation-backed with low growth. Because we saw inflation with strong growth, you can deal with it. You just have to tighten. tightened a lot. rates moved from zero to five and the economy was so strong. Demand was so strong. Coming out of COVID, it didn't hurt anyone. We didn't see the faults picking up. We didn't see any problem. And a lot of people expect at the end of the world, but when the economy is very strong, you can tighten monetary policy and you'll see a slowdown in inflation in the economy. When inflation is low and growth is low, you just have to stimulate and everything goes back. This is what we saw post-GFB.
When inflation is high and growth is low, it is scary because whatever you do can push the other one further and it becomes a very, very complex problem to solve. I do think we're closer to that because whether it's the results of the last election in the US, whether it's the full employment, whether it's currencies losing value versus, gold that we're seeing and all the weakness from tariffs, you look at the European case, we're seeing a possibility that we're heading into a world where inflation is under pressure to go up and growth is probably toppy. And I think that combination is a bit scary.
00:29:48 [Vincent Weber]
Thank you. So before we wrap up, I have a tradition on this show. So what's the one piece of wisdom you would share with someone just starting the journey in the credit market?
00:30:01 [Hamza Lemssouguer]
Probably credit market. Not sure if it's related just to credit market, but I would say that shortcuts are not good and that we you want to slow down take the time to learn things learn the plumbings learn the job learn the balance sheets whatever your job is whether it's sales trading research structuring take the time to learn things very well and then go for it i think the issue that i've seen whether it's me in the past or with some colleagues is Getting impatient, wanting to get promoted quickly, wanting to learn very quickly. You just cannot shortcut some things. So taking the time will help you go faster. And I would say the second advice probably is pick your firm and the culture of your firm very well. There's no good analyst or bad analyst.
There's no good trader, bad trader. There are a lot of talented people that can succeed or fail depending on the culture and match or mismatch. short-term driven versus long-term, whether it's collegial versus individual driven. So I do think that the culture match or mismatch can lead to a lot of success.
00:31:11 [Vincent Weber]
Hamza, thank you. Thank you for being here with us today. You've been tuned in to Resonanz Spotlight, where investment strategies come to life. I'm Vincent Weber, and we've been exploring the mindset move market. Special thanks to Hamza Lemsuger for pulling back the curtain on critic investing. Until next time. Keep your ears to the ground and your eyes on the horizon.