Investors Dive Back into Opportunistic Credit
By Chris Larson
September 20, 2017
Investors and managers alike are sniffing out opportunities across the alternative credit spectrum. Flows are up, new products are being prepped, and managers are optimistic.
While credit strategies saw mega outflows in 2016, solid performance and a continuing tough yield environment for fixed income have drawn investors back this year, particularly in the past few months.
“Demand certainly is increasing,” says Kris Haber, partner and COO of Advent Capital Management. That applies to credit strategies in both the liquid and private fund spaces, he adds, and Advent is seeing increased flows to both types of products.
Sancus Capital Management, a multi-strategy credit hedge fund investing with long/short, relative value, and capital structure approaches, also sees more demand, particularly for opportunistic credit strategies – free-ranging vehicles with significant leeway to go wherever the portfolio managers think they can capture some alpha. “There is most definitely an increased level of investor interest,” says founder and CIO Olga Chernova.
And Diameter Capital Partners just raised $1 billion for a new credit hedge fund focused on company debt that just started investing this month, according to a Bloomberg News report.
Among the reasons for this increased demand is the ongoing quest for yield. “Investors do seem to be more open-minded about opportunistic credit strategies, due to their continued need to secure higher-yielding assets in a low-rate, slow-growth environment,” says Myles Gilbert, managing director and co-head of the credit investing group at Cambridge Associates.
The demand is coming hand-in-hand with strong relative performance from alternative credit strategies in general. Such funds returned an average of 5.9% in the first half of 2017, according to a mid-year report from Preqin, second only to equity strategies, which returned 6.4% over that same period. Credit strategies were up 11.7% over the 12 months ending June 30, Preqin says.
While credit funds took a hit with more than $46 billion in net outflows in 2016, according to eVestment data, this year has brought a sharp turnaround, with just shy of $7 billion worth of inflows to credit strategies in the first seven months of the year. The vast majority of that – $6.6 billion – came in during May, June and July, with the final month alone garnering $3.8 billion in net inflows, according to eVestment.
Some credit managers are already looking to expand their product rosters. “With positive inflows from investors at the start of the year, fund managers are seeing opportunities to launch new funds,” notes the Preqin report. A Preqin survey found that, as of mid-year, 34% of managers planned a launch over the remainder of 2017. The most popular type of strategy managers intended to launch: credit.
Those survey results square with what managers are reporting as well. “We have seen more strategies launched,” says Chernova. “Some of the most popular have been short-term bridge financing, direct lending, risk retention capital raises, and infrastructure assets.”
In addition to the search for yield, market conditions are playing a big role in pushing managers and investors to look at various opportunistic credit strategies. “Credit has performed very well in the past few years,” Chernova notes. “But with tighter spreads, credit beta strategies might have a tougher path to generate strong returns in the future, so investors are turning to more niche strategies.”
Opportunistic credit can be a good way to play the current unsettled market conditions, says Odell Lambroza, principal and chief strategist at Advent. “We live in a world where nothing seems cheap on a historical basis,” he says. “To have a strategy that is flexible and tactical in nature, that doesn’t look at one sleeve in credit, but can move across sleeves, leveraging research ideas and event ideas – that’s very powerful. I think that’s what’s driving it.”
Indeed, investors today appreciate “the enhanced capabilities of credit-oriented investment managers capable of sourcing both tradable and private lending opportunities,” Cambridge’s Gilbert says. “Opportunistic strategies are useful because they can toggle exposures by asset type, geography, position in the capital structure, and collateral base.”
Some pensions are getting set to dive into opportunistic credit for the first time or boost their exposures. This summer, for instance, the $25 billion Texas Employees Retirement System adopted a new asset allocation that includes a 3% allocation to opportunistic credit, its first foray into the space, according to MandateWire. Earlier this summer, the $16.9 billion Illinois State Board of Investment doubled its opportunistic credit allocation from 4% to 8%.
And there have been a number of institutions approving opportunistic credit mandates in the past few months, according to MandateWire, including the $24.7 billion Texas County and District Retirement System, which committed $100 million to the Sound Point Credit Opportunities Fund and $75 million to Davidson Kempner Capital Management’s Long-Term Distressed Opportunity Fund. Earlier this summer, the pension made a $200 million opportunistic credit commitment to Beach Point Capital Management’s TX SCF, and put $50 million in the Davidson Kempner Special Opportunities Fund IV.
The $13.4 billion Ohio School Employees Retirement System awarded $40 million to PIMCO’s BRAVO III vehicle. And PIMCO also won $80 million this summer from the $3.7 billion San Mateo County Employees’ Retirement Association, which agreed to invest in the PIMCO Diversified Income strategy, with funding coming from the opportunistic credit sleeve in the pension’s fixed income portfolio, according to MandateWire.
That list shows a broad range of strategies winning investor attention. Indeed, within the broadly defined space of opportunistic credit, numerous areas are seeing investor interest.
“We see interesting investments being made in commercial real estate debt, transportation assets, structured credit deals including non-performing and re-performing loan pools, consumer finance, and regulatory capital relief trades,” says Cambridge’s Gilbert.
There also is also renewed interest in collateralized loan obligation investments (CLOs), such as one backed by infrastructure assets that’s currently on offer from Deutsche Asset Management, Sancus’ Chernova says. It’s the first infrastructure-backed CLO since 2008, she adds.
Sancus itself recently received Securities and Exchange Commission approval for a mechanism that lets CLOs reprice individual tranches at significantly lower costs while remaining in compliance with risk-retention rules. This helps the process “substantially,” Chernova says. “We think the CLO market will greatly expand from the new transparency and liquidity created in this structure,” she adds.
Advent is taking a hard look at a product expansion as well, says COO Haber, likely through picking up a team. “We are considering and looking at various teams,” Haber says. “It’s possible that we’ll bolt on a new strategy to the firm.”