Damian Cilmi:
Welcome listeners to another episode of the Praemium Investment Leaders Podcast. I'm your host, Damian Cilmi, Head of Investment Managers and Governance from Praemium, one of Australia's leading investment platforms. Today we're talking about fixed interest, but not as you know it. We're going to head into the world of credit, that is lending to corporates.
Whilst a lot of focus within the fixed interest space is around government bonds, rates and duration management, within the credit space you find a host of other characteristics that complement government bonds and provide alternative return features. We will unpack some of the instruments used within the credit space and some of the main talking points for investors.
About our guest today, Samantha is Partner Portfolio Manager and Head of US Liquid Credit Research in the Ares Credit Group, where she is primarily responsible for managing Ares bank loan credit strategies. Sam serves as a Vice President and one of four Portfolio Managers for the Ares Dynamic Credit Allocation Fund.
And about Ares, Ares was founded in 1997 and headquartered in Los Angeles. Please. They have over 900 investment professionals found across 30 offices around the globe. The firm manages over U. S. 400 billion with more than half invested across the Ares Credit Group, making them a very large and experienced manager in the liquid and illiquid credit strategies.
Sam, welcome to the show.
Samantha Milner:
Thanks for having me.
Damian Cilmi:
And you're here from LA. I hope it was a good journey. Has it been a good time here in Australia?
Samantha Milner:
Always a good time. Definitely jet lag is, is the toughest part.
Damian Cilmi:
Yep. Yeah. And before we get into into the show just give us a little bit about your, your background, your, your early days.
How did you get into, into bond investing and credit markets?
Samantha Milner:
Yeah. You know, I guess it's always better to be lucky than smart. And I started my career actually at Holohan Loki in 2000, which is a. boutique investment bank, but they specialize in financial restructuring and distressed M& A. So when I graduated college, and we had this distress cycle I was very fortunate to be at this firm because I had great experience in terms of deal flow working out companies, and It's a great time to start in credit.
What goes, what can go wrong? So it was a great foundation in terms of my career.
Damian Cilmi:
I can imagine, imagine a lot of your other friends probably had nothing much to do at that time. But as you point out, you know, working out what goes wrong. And, and, you know, seeing that, and I suppose that, that really helps to sharpen your focus as an investor.
But you know, so, For the better part of 15 years since the GFC, you know, the fixed interest was very much forgotten about in many people's portfolios and equities were taking a lot of the focus. We've gotten our yields at decade highs and the sector, you know, gaining further attention and Ares a real specialist in this space.
So what are, you know, what are you asking investors to look at for solutions, you know, as non traditional fixed interest? And what do you mean by that?
Samantha Milner:
You are finally getting income and fixed income. Yeah. Like you said. So, when we think about the asset classes that we specialize in liquid credit, we're talking leveraged loans, high yield bonds, and CLOs.
And when you invest in these asset classes today, you can get current income of between 8 to 10 percent. And when you think about that versus traditional fixed income, whether that's Barclays Ag, whether that's you know, government treasuries, you think, okay, you're getting between two to four percent current income.
So if I can get, you know, call it north 8% current income, that really cushions a lot of the volatility that we see, whether it's from spreads, whether it's from rates. The funds that we invest in traditionally are shorter duration, so call it one to one and a half years of duration. So you're just taking that credit risk.
You're not trying to call rates, which everyone has been wrong on.
Damian Cilmi:
Yeah, that's that's interesting. And so Ares is very large asset manager by any measure. And when we, a lot of people would think about equities and they would say that, you know, huge size is considered a bad thing. Why is that different in credit?
Samantha Milner:
Yeah, scale is very important in credit and there's a couple reasons for that. I would say, you know, starting with sourcing, in terms of the new issue market, is much more important in, in credit rather than when you think about IPOs, right? In equities, a smaller part of that market. And so having that access and having an early look at the new issue market gives us an edge when we think about both diligence and getting better allocations, and in some cases we actually get better economics.
But when you have this scale, you're also able to have this research platform to get better information, and so your credit selection is better. And so what does that lead to is also lower defaults. And when you find yourself in a default, which again, Ares has significantly lower defaults in the market, You need the scale to maximize your recoveries.
So what happens is, when a company does default, there's certain committees that you can sit on. And so you want to be in the room. You want to be sitting on that super steering committee, driving the restructuring, getting better outcomes versus other lenders in the capital structure.
Damian Cilmi:
And I imagine with even within securitized spaces, well, you're, you're a whole lot of individual loans that you've seen.
You know, throughout your whole platform as well. So that's, you know, again, part of that scale bit.
Samantha Milner:
Oh, absolutely. By being part of this platform our CLO team is every name they're looking through every loan we cover on liquid credit side. So they have access to that. And then we have access to what's happening in the CLO market.
And then on the direct lending side, for the most part, they're getting monthly financials. In liquid credit, you're getting financials every three months. So we have an early read on what's happening with the consumer, what's happening with inflation. It gives us, you know, really good intel into what's happening.
Damian Cilmi:
Very interesting. So you talked about CLOs. So that's an interesting one. We'll try and unpack that one there. Cause three letter acronyms. Yeah. Post GFC, there's another TLA right there, but you know, people do get worried when, when they hear some of those acronyms, you know, tell us why I suppose CLOs are different, not the ones that a lot of people would remember through the GFC.
Samantha Milner:
Yeah, there's certainly a lot of misconceptions about CLOs or collateralized loan obligations which are quite different than the CDOs collateralized debt obligations that we saw during the Great Financial Crisis. First of all, the CLOs that we invest in held up very well during the GFC. And what you saw on the other side of that, the CDOs that really, you know, that blew up, were these mortgages.
They were blind pool of mortgages. Not only were they risky, they were correlated, and in some cases, they actually were the synthetic form of mortgages. You actually didn't even own the mortgages. So no one even knew what they were buying. With CLOs. It's very different because it's a transparent pool.
It's a pool of leveraged loans and that we can see every single loan that we're buying. And there is leverage entrenched. That's why it's called collateralized loan obligations. But it's very different because it's a diversified pool. It's very transparent. We can stress test every, you know, borrower that's that's within that pool of assets.
Damian Cilmi:
And is this pool, has it been appealing? Has it been a good space to, to operate in recently?
Samantha Milner:
It's been very attractive because when you think about, you know, triple B CLOs you can pick up, call it 9%, you know, current income and to, the default rate is essentially zero. And I say essentially, you know, just to, to provide some cushion, but it's the track record's been impressive because there's so much structural subordination that defaults would have to be even higher than we saw during the global financial crisis and more prolonged to even, you know, impair a triple B CLO.
So there is a lot of subordination beneath you.
Damian Cilmi:
Getting into some of the big themes that are going on at the moment. So what's the Ares assessment of the current economic conditions?
Samantha Milner:
Yeah, it's, it's, despite talking about a recession, right, a year ago the most talked about recession, things feel pretty good.
We had a, you know, good earning season fundamentals are very strong. You know, that being said, you know, we do see slowing growth which is a great environment for credit. But, you know, there has been yellow blinking lights in terms of whether it's the lower income consumer. You know, we do have our eyes on commercial real estate and the impact on regional banks balance sheets.
But overall things are very strong. What has happened is, is almost this phenomenon called a rolling recession, where we've already had recessions in certain subsectors. So you've had three of the 10 sectors You know, having stress the last couple of years, whether that's telecom manufacturing, housing.
And then those come, those sectors improved. And then you kind of have other sectors taking over. Chemicals have had some de stocking. Packaging has had some de stocking. So, it's not everything at once. So, it's, you know, It's almost as if we already had some stress. It was just masked by other sectors doing very well.
So we're not going to be too complacent. I don't want to say the world is perfect. You know, clearly we have a presidential election, you know, coming up and there's a lot of geopolitical noise out there. But what our job is, is to look at the micro, look at the bottoms up, pick the best credits and trade around that volatility.
Damian Cilmi:
And I mentioned then even within active that's What you'd call like a stock pickers market as well to where you get in the different sectors taking leadership I don't know if you want to use leadership in that sense
Samantha Milner:
Certain parts aren't doing well, right? So you have to you have to really dig in and the winners and the losers you're exactly right It's a credit.
It's a credit pickers market and then in our global multi asset products We can actually rotate between asset classes as well. So we're kind of changing our route. Like you look at relative value, high yield at the end of fourth quarter was really interesting from both a spread perspective and rates.
We had a big rally in December. And so now we've been rotating into more floating rate, getting current income in loans. And in CLOs because high yield bonds have spreads have been a little bit, you know, tighter.
Damian Cilmi:
Yep. And so we talk about, I suppose, as sectors in distress, then, you know, within the high yield specialist credit, people get very fixated on defaults.
So what, what are you seeing in this space?
Samantha Milner:
Yeah, we've Defaults have doubled, right? They were coming from zero to 1%, right? Now they're a little bit north of two. So we all kind of have a laugh about that, but defaults are increasing. That's, that's absolutely true. More toward historical levels of call it, you know, three, three to 4%.
What we have seen is the, the companies that have defaulted in the last, you know, year have really been the worst of the worst, right? It's companies like in the retail space it's half of those companies have actually have already filed chapter 11 before or had a distress exchange. So I think going forward.
The market has identified the companies that are likely to fall. Now, there are always going to be surprises, of course. But we don't think you're going to see that spike in defaults, and there's a couple reasons for that. You know, we just had a cycle, if you think about it, in 2020, where we had a high level of defaults.
Traditionally, there's more of a time period between cycles, right? Called six to seven years.
Damian Cilmi
20 to 22, you would think it's a bit tight.
Samantha Milner
Exactly, for things to kind of, the excesses to build up. So when you look at balance sheets, we've actually pushed out maturities. So the next couple of years is a very small percentage of, of companies that their debt is coming due.
And then the other way a company defaults is inability to service their debt. And interest coverage is really strong right now. Now if we're higher for longer, of course there's that tail of the loan market, in a couple of years, well you'll see signs of stress, right? That's not our, that's not our base case.
And again that comes down to picking the best credits, you know, winning by not losing. But when we look today, I mean things feel, feel pretty good. Yeah. I do think you're not going to see a spike in defaults, but you will see mark to market volatility, right? That that's really gonna be more of the theme
Damian Cilmi
and overall leverage, is it up or down across the market?
Samantha Milner:
So leverage has been coming down.
Damian Cilmi
Yeah.
Samantha Milner:
And that's both from you know, you know, EBITDA growth, of course, you know, even though we've had inflation companies have been able to pass along So, we're in a really good spot from a leverage standpoint, especially in high yield.
That has become a much higher quality asset class. So balance sheets are really strong and liquidity is strong. Because there's been so much capital raised the last few years. A lot of these companies have used that opportunity to shore up their balance sheets. Sure.
Damian Cilmi
Yeah. And then we'll talk about, I suppose, balance sheets there and, you know, kind of the new issuance market.
And I suppose Ares has a benefit that you can work with borrowers, with corporates and, and offer a number of solutions through there as well. So how are, you know, borrowers looking at these current conditions and how are you supporting them through their, their capital needs?
Samantha Milner:
Yeah borrowers have definitely come to market more to refinance their debt.
So we haven't seen a lot of new money come in, new supply we say, and that's because there's been this valuation gap between buyers and sellers. So you look at the equity markets, had quite a nice run. So if you're a buyer, do you really want to pay these prices, you know, heading into perhaps, you know, a presidential election or there's certain reasons why they may not want to pull the trigger.
But the seller doesn't want to transact at a lower price. Like, no, you pay me, you know, X price. So there's this gap. So things aren't transacting as much as they had to in the past. Now we expect that should pick up. We've seen a little bit of M and a pickup. We've seen some we call them dividend deals from sponsors.
So a little bit of, you know, companies selling some assets. We're seeing a little bit of new issue pickup, but it's been very muted. Now what's been an interesting theme. is there's been this kind of convergence between the liquid markets and the direct lending markets. So what you saw last year were the direct lending markets refinanced, like three to four billion issuers from syndicated loans.
And traditionally the, the direct lending markets smaller, right? It's more middle market. So we've seen these markets converge where an issue or a sponsor can go either direct. We've seen kind of a reversal in that large cap company coming more syndicated this year, actually. Now, Ares has a, has an advantage in that, in that sense, where either way that company decides to go, we can provide a solution.
We can use our 300 billion balance sheet to finance that business. Either they go syndicated or they go direct. And so not only are we having early access to information, when the company does come, let's say to syndicated public markets we can get better allocations, you know, better economics, things like that.
So it's, it's really interesting how these markets have.
Damian Cilmi
Yeah. No, no, that's very interesting. I think we might leave it there. Sam, thank you very much for coming on the show.
Samantha Milner:
Thank you so much.
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