Invesco Private Credit’s bank loans investing platform

Good morning, I'm Kevin Egan, co-head of credit research and senior portfolio manager for Invesco Private Credit's $43 billion broadly syndicated loan business. Invesco Private Credit is one of the largest and oldest private-side senior loan managers in the world, with more than 100 employees dedicated to this asset class across four offices in the U.S. and in Europe. We are market leader in all the major distribution channels for senior loans, ETFs, CLOs, 40-act retail mutual funds here in the U.S., separate managed accounts, and commingled institutional loan funds.

Among this last group is our flagship $4.4 billion U.S. Zodiac Senior Loan Fund, which I have run since inception in 2006, and which we are here to talk about today. I joined Invesco in 1998. Before that, I ran the broadly syndicated loan business for Morgan Stanley Investment Management.

Invesco offers loan investors a number of unique advantages shown here. First, our market's presence and scale. As I mentioned, Invesco is a market leader in all aspects of the bank loan market, institutional, retail, ETFs, and CLOs.

At $43 billion in AUM, our scale enables us to obtain preferred allocations on new issues, and our ETF, the first and by far the largest in the asset class, has made Invesco the top trading counterparty in the market, allowing for better trade execution inside the market averages. Our Zodiac product is actually the first and still the only commingled institutional loan fund to offer daily liquidity. Secondly, we are a private side investor.

This affords us deeper access to management teams, as well as access to management's private projections as part of our underwriting process and throughout the life of the loan. It affords us an early look at new loan transactions, which gives us more time to do our due diligence, enables us to provide feedback on terms, and garner larger allocations and transactions that we like. Invesco is one of just a few loan investors that remain on the private side of the information wall, and this informational advantage can aid us in mitigating downside risk, which in turn helps to minimize credit loss.

Third, the breadth and depth of our resources. As I also mentioned, we are one of the largest and oldest loan managers in the world. We were one of the six original managers that began investing in this asset class in 1989.

We have 36 seasoned investment professionals focused solely on this asset class, one of, if not the, largest team dedicated to just the loan asset class. Our investment committee on which I sit has an average experience of 29 years. Finally, we have a suite of proven proprietary credit process tools.

We have a disciplined, fundamental research focus designed to measure risk and identify relative value across the universe of loan issuers. Our customized proprietary tool suite, including our rock bottom spread risk measurement tool, supports a quantitative and analytical framework, predictive credit research, which in turn has led to consistent outperformance versus the benchmark. Turning once again to our U.S. Zodiac Senior Loan Fund, as shown here, this is one of the largest and oldest commingled loan funds dedicated to institutional investors such as yourselves.

Launched in 2006, it is still the only institutional loan fund to offer daily liquidity. Investors get in and out at NAV, which we publish daily on Bloomberg, and strike using third-party pricing services, so you have complete price transparency. At $4.4 billion, it is broadly diversified with more than 400 senior secured debt investments.

The typical company in our portfolio is about $4 billion in enterprise value and is an EBITDA of approximately $425 million. Half the companies in the portfolio would be in the Fortune 1000 if they were public. Our investments are in well-established global brands, household names you would know like Burger King, United Airlines, Four Seasons Hotels, companies that are leaders in their segments.

These are all below investment grade companies with an average rating of B2, which in turn results in very attractive current coupon, right now 9.2%, a current yield of 9.9%, and a yield to three years of 12.3%. Just as importantly as shown in this chart here, the fund has outperformed in every period since inception. Our ability to build well-diversified portfolios while still turning down two-thirds of all the deals we see is critically important in an asymmetric asset class like loans where your upside is limited and your downside can be significant if the industry goes into distress or a company goes into default. So while credit selection is your first protection against default and loss given default, and I've described our approach to credit, diversification is your second.

Being senior and secure top of the capital structure means that loans typically recover 70 to 80 cents on the dollar in the event of default, as opposed to high yield bonds which are unsecured, subordinated, and as a result typically recover 30 to 40 cents on the dollar. We should note right now defaults are low at 1.4% versus a long-term average of 3.2%. However, as I mentioned, our portfolio construction and credit process have resulted in consistent outperformance relative to the benchmark, even in times of higher market stress. Now none of this would make a difference if there wasn't a compelling reason to invest in a loan asset class right now, and there are several.

The first is the high current income. As shown here, there are two components to our income, the base rate, SOFR, which is in the dark blue bar, and the credit spread, which is in the light blue bar. We came into the year expecting an 8% return down from 2023 returns of 13%, which was the second highest ever for the asset class.

While current coupons in the asset class were at 9.2% at the beginning of the year, the forward curve then suggested that the Fed would cut six times in 2024, which reduced the base rate, that dark blue bar, on our loans by about 150 basis points, and in turn cut the average coupon by 75 basis points. For that reason, we expected full-year returns to be approximately 8%. Now, almost six months into the year with inflation stickier than expected, these cuts have been pushed out and to the right, and now the forward curve would suggest that we're going to see perhaps one rate cut late this year, which means investors are going to clip that 9% coupon for most of the year, far longer than we expected.

That 9% is well above the long-term average for the asset class over the last decade, which is about 5.5%. Additionally, even when the Fed does start cutting, the easing cycle is expected to be far shallower than previously expected, with policy rates expected to bottom in 2026 at 4.25%. That would be 300 basis points higher than the average policy rate of the last 10 years of 1.25%. So, if the long-term average for loan returns is 5.5%, when base rates have been 1.25% on average, you can easily see how loan coupons remain well above historical levels, even at the bottom of the rate cut cycle. The second reason to invest in loans now is that loans offer one of the best yields in fixed income, despite their senior secured status, as shown on this slide here. As shown, loans are currently offering a yield of 9.8%, including the forward LIBOR curve, which is more than double the current yield from treasuries and 4% higher than investment-grade yields.

When compared to high-yield bonds, loans are providing both a better coupon, 472 basis points for loans versus 343 for high yield, and a better yield, that 9.8%, versus just 7.9% for high yield. Despite the fact that loans are senior secure, top of the capital structure, where again, high-yield bonds are unsecured and subordinated, and therefore you would expect that they would typically provide you a better yield to compensate you for the higher loss given default in high-yield bonds. However, we are in a highly unusual environment right now where you are getting paid more to take less risk.

This is not just true of today. Over the last 10 years, U.S. loans have provided the best median yield to worse of any traditional U.S. or European fixed income asset class at 6.33%, beating high-yield bonds at 6.25%, but with far less volatility than high-yield bonds. No other asset class is even north of 5%.

In short, we think there is a compelling opportunity today in loans for investors looking for high returns in a liquid asset class that also provides diversification away from traditional fixed income. As shown here, loans have returned 15.2% since the beginning of 2022, whereas long-duration assets like treasuries and investment grade are negative and high-yield barely positive.