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Stewart (00:35): My name's Stewart Foley, CFA. I'll be your host. I'm thrilled to have you with us today. As a reminder, InsuranceAUM is affiliated with The Institutes. I have a special announcement today. This is kind of interesting. We found out yesterday that we won five podcast awards, three golds, and one was for best host. And that's super humbling. I don't know what I've done to warrant that. We're just here to educate our audience on the most important topics. And what I think is, I'm the leader of the “insurance asset management is cool parade.” So I think this is a wonderful industry, and I've been super fortunate over the last 30 plus years to be a part of it. I'm deeply grateful for the success of this podcast and the dedicated audience that we have that listens to us. And I just want to say thank you so much. So with that, let's get at it. Today, let's talk about this. In markets like this, there's always tension between headlines and reality. Between what's loud and what actually matters, if you will.
Today's conversation is really about separating signal from noise in one of the most talked about areas of private markets: direct lending. And the title of the podcast is Direct Lending: Sorting Signal From Noise. Today, I'm joined by Ron Kantowitz, Managing Director and Head of Private Debt for Invesco's Global Private Credit Group. Ron leads the firm's direct lending platform and serves as lead portfolio manager, as well as a member of the investment committee. Prior to Invesco, Ron was Managing Director at Benefit Street Partners, where he built out the firm's direct lending origination network. Earlier, he founded the US Financial Sponsors and Leveraged Finance Group at Royal Bank of Scotland, growing it into a market leader. He has also held roles at Bank of America and Chase Manhattan, a name we haven't heard for a minute. Ron earned his MBA from the University of Chicago, a fellow Boothy, and an undergraduate degree from SUNY Albany. Ron, welcome to the program. We're thrilled to have you.
Ron (02:51): Stewart, thank you so much for having me. And by the way, congratulations on those awards. That's no small accomplishment, so congrats on that.
Stewart (02:58): I appreciate that. All right, Ron. So as you well know, we always have some icebreakers. And so I've been given some coaching and I've got a couple of questions for you today. Where'd you grow up? That's the first one. What was your first concert that you remember going to? And if you weren’t doing this job today, what job would you most like to have instead?
Ron (03:20): Okay. So I grew up on the East Coast. I'm a New Yorker. I grew up in Queens, New York, home of the New York Mets. And for the last 20 years, I've lived in Manhattan with my wife and my two daughters. First concert I ever went to was Aerosmith.
Stewart (03:35): Oh, that's a good one.
Ron (03:36): Yeah. And if I wasn't doing this today, what would I be doing? I mean, I've done this my entire career. If I wasn't doing this today, I think I might try my hand at managing a vineyard in Napa and likely losing all my money in the process.
Stewart (03:50): I think that's probably fair. It's funny because I live in Fredericksburg, Texas, which is the epicenter of the Texas wine movement. And there's been a lot of folks from Napa and elsewhere in California move here because apparently the climate in some regions here are similar. And so in looking at that economy, I think a lot of these folks are not ... It's not profitable or whatever. It's almost hobby-esque and people work their tails off at it. And I don't know if you know this, but alcohol consumption nationwide is down 15 to 20%.
Ron (04:31):
I absolutely know that. And we all know the reasons for that these days, but yeah, it's absolutely the fact. It's absolutely the case.
Stewart (04:37):
Absolutely. All right. So topic number one, headlines versus reality. Recent headlines from specific defaults to pressure on BDCs and asset manager stocks have fueled some pretty extreme narratives, including talk about death of private lending and death of direct lending and so forth. And for what it's worth, my own take on it is, be careful who's saying it because they may be talking their own book. And so what do you make of those headlines? And what I think our audience really needs is a real unbiased assessment of what's the condition right now.
Ron (05:18):
Look, I think the headlines are conflating a whole series of dynamics that don't necessarily drive to conclusions that reflect what's happening in the market. So, let's take a step back. The first big headlines we heard were late last year when we started hearing noise around companies like First Brands and Tricolor. And I would make the point, those were two highly visible credit events. Interestingly, they had absolutely nothing to do with direct lending, but of course they got painted with the same brush. And I think what's most noteworthy about that is, in the aftermath of those two transactions, Jamie Dimon came out with this concept of there’s cockroaches coming out of private credit. And unfortunately, that term has remained and continues to sort of resurface in the headlines.
I think more consequential issues really start when we start thinking about software. And the second issue starts in sort of late 2025 when certain credit lenders start to see stress across some of their software names. And as those issues carry into the new year and the market starts to catch wind of this, this narrative develops that AI is going to disrupt the software industry. And of course, if you recall, by February, we started seeing headlines talking about SaaSpocalypse. And the reason that that's particularly noteworthy is that some of the largest private credit platforms in the market today have a disproportionate share of their portfolios invested in software and technology. In some cases, as much as 30%. So not surprisingly, focus starts to be directed towards this group of asset managers.
And I think that leads to what's the third and most important issue at the moment, which is structural. Many of those same large asset managers that had significant software exposure had raised money from wealth channels in these vehicles, these non-traded BDCs and interval funds. And because those vehicles are targeted towards the wealth channel, those vehicles were structured to offer limited liquidity on a periodic basis, typically 5% per quarter. So what happens? You've got noise around cockroaches, you've got noise around SaaSpocalypse. We've got all the geopolitical events going on. And so, retail investors understandably start to get concerned, and they look to withdraw some of their capital from the funds. The problem is these non-traded vehicles are not designed to provide fuller immediate liquidity. And by the way, there's nothing wrong with that. They're designed that way. These are semi-liquid vehicles collateralized by illiquid assets. And so what happens is, as more investors seek to redeem capital, the liquidity demands start to exceed these 5% quarterly thresholds. And of course, then the headlines start coming out where they're talking about how these fund managers are not meeting liquidity demands. And that's not what's happening. If you actually look through it, what you see, is in virtually every case, the managers did exactly what they were contractually obligated to do. And in several cases, they went above and beyond.
So in my view, this is not a systemic issue. This is not subprime 2008. This is simply a liquidity mismatch that's concentrated among a specific group of large asset managers who happen to have excess exposure to one sector: software. So you ask—or you don't ask—but a lot of the articles talk about the death of direct lending. I think there's a perfect quote from Mark Twain that fits the bill here. The quote is, "The reports of my death are greatly exaggerated." This industry isn't going anywhere. You have one-off situations. This is not systemic.
Stewart (08:34):
Okay, that's good stuff. I think that makes sense. I mean, we had a call with about 30 CIOs and about half of them were concerned about the headlines and the other half saw it as a buying opportunity. And I'm with you, just my own opinion. This industry isn't going anywhere. But let's talk about AI and sector exposure, and you kind of touched on it before. So there's been a growing concern around the impact of AI on software. And I'd like to understand that better, frankly. In tech-enabled services—historically a big part of direct lending portfolios, you mentioned that—Invesco has taken a different approach here with no exposure there. What drove that decision, which seems very bright right now, and just talk us through that.
Ron (09:40):
Let's just level set. Why has software been so attractive broadly to the private credit space? Software has a lot of attributes that are very compelling. Let's just list a few of them. Number one, they have a recurring subscription base, so you have generally very good revenue visibility. They tend to be minimally capital intensive, so these businesses have very strong free cash flow. The better ones certainly are very embedded in their clients' workstreams, and so they're sticky. You don't wake up January 1st and decide you're going to switch your software provider out. And I think most importantly, this has been an asset class that PE have been very attracted to, and they've been willing to pay very high multiples for. So as a lender, you've got significant equity cushion in front of your debt position. So when you think about these attributes, you start to understand why software has been such an attractive segment for direct lending.
I think in terms of why we have not invested in this space. Look, I'd love to tell you seven years ago we were prescient enough to have predicted that AI might take over, and we should not participate in this space. I think unfortunately, and maybe not nearly as interestingly, our views and our decisions were much simpler. It starts with structure. For all the positive attributes I mentioned a moment ago about software, one of the challenges for us is that software businesses tend to garner very high leverage multiples. And just to give you context, in core middle market portfolios, average leverage multiples run around four and a half times. If you compare that to software, typical software deals can be leveraged six to seven times. And one of my partners likes to say nothing good happens when opening leverage starts at seven times. There's just not a lot of margin for error.
If you just think about what happened a few years ago when we saw interest rates run up 500 basis points, you saw stress play out across a lot of highly leveraged companies. So high leverage, higher risk. I think for us, the first thing is we just weren't comfortable with the leverage multiples that were being sought after. And then the second point for us is, because software businesses tend to be larger, they tend to often be structured more like large cap transactions. And in large cap transactions, you tend to have weaker credit protections. In some cases, they'll be covenant lighter, they'll be covenant loose. And so ultimately, the reason we chose not to invest in software and tech-enabled businesses really comes down to the fact that these are just not consistent with the markets we've chosen to invest in and the types of deals we've looked to deploy our account.
Stewart (12:04):
Well, you know what they say, there's nothing good that happens after midnight, and nothing good that happens after seven times leverage, right? There you go. You can tack that onto the nothing good happens list. So let's talk a little bit about where you are deploying capital. It's interesting that your discipline without regard to software, your underwriting discipline kept you out of trouble there, right? So where are you deploying capital and is there any place that you're cautious about?
Ron (12:37):
Let's start with where we’re deploying and let's talk about where we're cautious. For me, it starts with the fact that, as a team, we've been investing together for 25 years. And so I think we have a pretty well-defined strike zone that we start with. Here are the givens. At a high level, we're going to look for opportunities with businesses that have proven track records, that have strong market positions, that have demonstrated products or services within their marketplace. We're also going to look for businesses with strong management teams. And of course, we're going to hope to align with some of what we think are the smarter private equity investors in the US. And then of course, as we talked about a moment ago, structure and terms matter. All these pieces have to sort of fit together for us to decide that there's a compelling opportunity.
One of the things we like to do is we like to ask ourselves, when we're looking at something, does this business have a reason to exist? And does the fact pattern hold true going forward? And then on top of that, we're going to overlay what's happening in the current market environment. And as we know, there are just a host of issues you have to consider and evaluate and contemplate when you're making investments.
So let me just pick an industry that today we like and talk to you a little bit about why. So we've been very active in the residential services space, specifically in the non-discretionary segment. And I'll give you our investment thesis real simple. So number one, residential service is big market.
Stewart (14:00):
What would be an example, Ron? Give me some concrete examples of things that people would relate to that would be in that segment.
Ron (14:08):
Sure. So we've invested in a business that repairs garage doors. So if your garage door breaks and these things break fairly regularly, whether you back into it or you get hit by a basketball in the garage. If your garage door is stuck open, you have access issues. And if your garage door is broken and it's stuck down, you've got egress issues. So these are not deferrable problems. If your garage door doesn't work, you're going to need to get it replaced. I'll give you another example. If you have a water leak in your basement or mold in your basement, again, these are not things you can ignore. And the thesis really revolves around the fact that a home is typically your largest asset, and you live in it. And so these are not issues you can ignore, these are not issues you can defer. So that's how we're thinking about segments that are interesting and appealing to us in the current environment. Non-discretionary, when you think about the world and the K-shaped economy and the disparity around income, finding businesses that provide a service that is generally non-deferable and non-discretionary makes a lot of sense to us.
Now on the other side, you asked where are we drawing the line? I'll take one big step back. All my partners and I have been in this business for 25 years or longer. And so we all start at banks. And when you start a bank, you go through the classic credit training. And when you learn how to lend at a bank, you learn that there are just certain sectors and business characteristics that make sense and don't make sense. And so across our platform, certain sectors that we generally don't invest in: we don't invest in restaurants and we don't invest in retail and we don't invest in companies that produce single products or faddish businesses or products. We don't invest in energy. Obviously we talked about this earlier, we don't invest in software.
And again, those are just sort of the starting point for us. Then what we do is we overlay what we're seeing in the market. So if I think about what's going on in the market today, there are a handful of issues we need to think about. Again, I mentioned this a moment ago. It starts with the K-shaped economy. We are really cautious on businesses that are levered to middle income consumers that have a discretionary element to them. In addition to that, we're avoiding companies right now that have complex global supply chains, given all the geopolitical dynamics in the world. And of course, we touched on this, but I'll touch on it in a broader sense. We're also evaluating every business in the context of AI risk. We have an AI framework that we use to evaluate every investment. It's not just software. We need to be thinking about the impacts, the implications across the broader economy.
I'll tell you the other part of this for us, and what I think is equally—if not more important—is we need to maintain discipline around risk return. And we have a real simple philosophy around this. We don't believe you can fix a mediocre opportunity with price. Credit needs to be absolute. So if it doesn't meet our credit threshold, adding a hundred basis points of the spread isn't going to suddenly make it better for us. Again, everything needs to be, for us, absolute. My first credit officer at Chase Manhattan Bank used to say, when you lend senior debt, the best you can ever hope for is to earn your coupon and get paid back. So you kind of have to have a really high bar in terms of your risk tolerance.
Stewart (17:22):
I think it's sagely simple advice. I've had the good fortune of being in the room with Buffett a couple of three times. And Howard Marks is the same. He says things that are ... I mean, essentially you're saying we lend money to companies that are going to pay us back. And they're going to pay us an interest payment, and that's the best you can hope for. There's not a set of circumstances where the value of the debt doubles, and you hit a two bagger. It doesn't work that way. And so I think that what you're saying makes total sense. So at the end of the day, as a lender to private equity sponsors, and I think it would be helpful if you could explain sponsor versus non-sponsor, but how do you describe the health of the PE ecosystem today? Has it changed any? And how does that influence your view of direct lending risk?
Ron (18:24):
Why don't I do the first part, which is what's the difference in sponsored and non-sponsored, then we'll lead into what's going on in the private equity world. So you could overgeneralize direct lending and put it in two buckets: sponsored or non-sponsored. As the name suggests, one, you're financing deals where the equity is coming in from private equity firms. The other is there's no equity coming in beneath you. You're lending to family offices, corporate relationships. And there are platforms that are successful doing both. We exclusively focus on lending to private equity controlled companies, and we do that for a few reasons.
Number one, we value the governance, private equity provide. We value the industry expertise they bring. And I think most importantly, when you align with private equity, they're contributing equity. And so one of the metrics that you'll hear almost every direct lender talk about is loan to value. And we have a really simple thesis. If we're lending top of the capital structure and senior secured assets that are collateralized by all the assets and the IP of the businesses we're lending to, and we're aligning with some of whom we think are the smarter private equity investors in the US, and they're willing to contribute more than 50% of the value of these businesses in first loss equity, then our senior secure position should be in a fairly strong position regardless of whatever type of market headwinds we're lending and we're facing. And so for us, again, risk mitigant, aligning with smart private equity investors, I think is a formula for success.
Now, in terms of your question, what do we see as the health of private equity today? I think from our perspective, we think the health of the PE industry continues to be strong. But I think similar to what we're seeing on the private credit side, I suspect there's likely going to be greater dispersion around outcomes in the near term, and that's not necessarily a bad thing. I think one of the challenges that private equity has been dealing with over the past handful of years is that M&A value has been relatively muted. And that's simply a function of the fact that we've had so much volatility in the market, it's been difficult for buyers and sellers to sort of agree upon valuation. And I think the consequence of that is that many private equity firms have been holding assets far longer than they had anticipated. And frankly, some of them are having difficulty exiting at valuations that work for their returns. And so when we think about the market today, what we believe is those private equity firms that have done a good job returning capital to their LPs are going to continue to grow. And those that haven’t are going to likely find it more challenging, and there may very well be a weeding out of the bottom quartile. But again, this is no different from what you're likely going to see on the credit side. So for us, ultimately, this is a large market. These are incredibly sophisticated investors, and I would expect the industry's going to continue to grow and prosper.
Stewart (20:53):
I think that's really well put. And I think that you're getting at a point here, which is manager selection matters. So given the private and relatively opaque nature of the asset class, what should an insurer be looking at when they're talking with a direct lending manager? One of the things I would offer, and the point's been made on this podcast in the past, is that existing relationships with PE managers that you know, these firms have a personality, right? They have a reputation. They do things a certain way, and you learn that over time, which is something that is difficult to replace. That's a pretty big moat. Can you talk a little bit about not only manager selection, but also the relationship that develops over time?
Ron (21:50):
I think more than ever, it's incumbent upon the investor to do their work and to ask their questions. I think if the one thing we've learned is just following the herd isn't necessarily the best approach to picking the right managers. And so when we deal with potential investors, we try to guide them. Number one, if I were advising an investor on how to think about diligencing a manager, it starts with the team. Understand what their experience level is. Have they worked together? Have they been consistent in terms of their investment approach? But I think you got to go way beneath the surface to really understand what's happening at these managers. And what we tell them is, look, you got to ask for the data. It's available. And there's a long list of metrics that you need to start to look at to sort of understand what the real performance of these managers are.
I'll give you a few examples. So one that everybody talks about, but it's important is look across portfolios for bad PIK. Bad PIK, just for anybody that's not aware, these are companies that initially were structured to pay current interest and, for whatever reason, they no longer can meet those current interest needs. And so they've converted some of that, if not all of, that interest to PIK, and that's bad PIK. Contrast that with good PIK were maybe, right out of the blocks, you structured the deal that had a PIK element because there were reasons for it. So if you see a lot of bad PIK in a portfolio, clear indication of deteriorating quality.
Stewart (23:09):
Just to step in for a second, PIK stands for payment in kind, which means that they're not paying cash. If I understand it correctly, and please guide me here, that basically the interest is tacked onto the balance at the end. And what I think you're saying is pieces of the portfolio that didn't start in PIK that are now in PIK. As opposed to, at the beginning, they were structured that way all along and it isn't that it didn't. It is essentially an indication of financial stress on the borrower. Is that fair?
Ron (23:50):
Stewart, I couldn't have said it better myself. That is exactly the case.
Stewart (23:53):
Well, we are an award-winning podcast over here, Ron. What the heck?
Ron (23:57):
Again, the reason we call it bad PIK is because you can structure deals initially with a PIK component. Perhaps you have a company that's got significant capital needs right out of the blocks, and so you want to give them a little bit more leeway. But when it doesn't start that way and it ends that way, that is a clear sign that the company just doesn't have sufficient cashflow to service their debt.
Stewart (24:16):
Well, I mean, if you're a buyer of it upfront and it's structured that way, you know that. When you buy something that's got coupon income and then suddenly doesn't, you essentially didn't sign up for it. I mean, I don't want to put words in your mouth.
Ron (24:30):
No, that's exactly right. You nailed it. So I'll give you a few more things just to think about. And again, there's a long list of them, but look for diversification. So we talked a little earlier about the overindexing to software. Look, a fundamental tenet of an asset manager, of portfolio management, is diversification. So you want to diversify by sector, but, equally, and we talked a little bit about this, look through to see, is there a broad base of private equity firms that you're supporting? There are a lot of lenders that will say, oh, private equity firm X, we do all their deals. The problem when you do all of certain private equity’s deals is you have to do all of that private equity’s deals. And that may not necessarily be the best course of action. So look for diversification.
Look for leverage creep. Another metric, right? Look at where opening leverages are. Look at where leverage is today. If those numbers have creeped up, that tells you something about performance. That tells you perhaps businesses aren't doing what they thought they would. Look through for documentation. Ask, do you have maintenance covenants in all your deals? And if they're maintenance covenants, are they real? Are they maintenance covenants? Are they these terms covenant loose, covenant light, covenant wide? All ways to tell your investor, "I've got financial maintenance covenants, but at the end of the day, these are not covenants that actually can provide the type of protection that you're looking for."
And look, I can go down the list. I'll give you one more that I think is important. Understand how managers are valuing and marketing their portfolios. Are they using arms-length third-party entities to provide those valuations or are they doing them in- house themselves? That matters. And then lastly, look for style drift. These days, it seems like everybody I talk to and everybody I hear is focused on the core middle market, lending senior debt. But go back and ask, what were those guys doing three years ago? And you'd be surprised how many of them had an entirely different investment strategy then. So find the managers that have been consistent in their strategy and aren't just providing or going down a path today because the winds have changed direction.
Stewart (26:34):
Yeah, it's super interesting. Those are some really interesting practical suggestions to look at. So you've kind of covered this. I mean, the aspects of your platform that are proving valuable in today's environment. If I'm an insurance investor, let's say that I have capacity for private credit and I have capacity for direct lending and I see all these headlines and spreads have widened. Now, some of these folks have better relationships with their investment committees than others, and there's also a regulatory component here. But from leaving that aside, how would you look at the opportunities that you're seeing today given the recent ... I don't know about dislocation. There's been some volatility. Let's just say it that way.
Ron (27:35):
I think the one thing we know, having been investing across this segment for the past 25 years, is markets are constantly changing and evolving. My team that has been together has invested across credit cycles, market dislocations, the GFC, geopolitical conflicts, wars, interest rate spikes. I mean, you name it. And if there's one thing we've learned across the last 25 years is that markets will, with some regularity, dislocate. And if you understand and you can recognize those situations, there could sometimes be tremendous opportunities to generate real alpha then. So when markets start to get a little bumpy, that's the time to sort of, if you've got the discipline, if you've got the capability, if you understand what you're doing, that's when you're supposed to step in and you can really generate compelling opportunities in alpha for your investors.
At the moment, I think the market's still trying to find its footing. As we talked about earlier, there's a lot of headlines, there's a lot of confusion. I think the markets will gain footing over the next couple of quarters. We'll likely continue to hear noise around redemptions. But in the meantime, if markets back up, if they dislocate, if you can continue to find great opportunities, you're able to get slightly better terms, just given what's happening in the market, I think that's what we're supposed to be able to do. That's the skill we're trying to bring to our investors.
Stewart (29:01):
Yeah. I mean, and you're looking at it versus investing when it's priced to perfection, which was the case not that long ago.
All right. So I've gotten a tremendous education. I love doing these podcasts because I learn so much, which is great. And I hope our audience does too. You've been in this business for a minute. I mean, I've got a bunch of gray hair and you've got some too. What characteristics do you look for when you're adding to members of your team? I'm not talking about the school and the, can they code, but really more characteristics of what kind of people are you looking for?
Ron (29:40):
That's actually an easy one because we literally talk about it all the time. The term we love to use is intellectually curious. And the reason we use that term, look, we're in the business of evaluating investment opportunities. And typically the way the process works, we're given an opportunity, we're shown a company, we're presented with a story. And it's easy to just take the facts on face value and say, oh, this makes a lot of sense. And they're selling memorandums. So guess what? They generally tend to be fairly positive in terms of how they're presenting it.
Stewart (30:14):
You've seen a hockey stick or two in your life, I'm sure.
Ron (30:17):
Yeah, more than a few. And so what I want is I want our folks to challenge the state, challenge the assumptions, dig in, question the underlying premise for why this is going to happen or that. And I think, again, this is all about how do you protect your credit, how do you protect capital? And so it's intellectually curious for us, that's what you have to be. You got to challenge the statements, you got to dig deep, you got to identify your own risk concerns, and you got to figure out if you can mitigate them.
Stewart (30:45):
That's awesome. All right, last question. You can have dinner with up to three people. One, two, or three. You don't have to have all three, you can have one, two, or three. These people can be alive or dead. Who would you most like... By the way, I always say this, dinner's on us. We'll use our podcast award money.
Ron (31:06):
I love it.
Stewart (31:06):
Which we didn't get any, by the way. But anyway, who would you most like to have dinner with?
Ron (31:12):
I think right now it'd be pretty easy for me. I would love to have dinner with Presidents Bush, Obama, and Clinton. What's that term in the UK, Chatham House Rules, where you can say whatever you want. I would love nothing more to sit with those three guys over the course of a meal and get their take on what's going on in the world today.
Stewart (31:34):
It's interesting. The environment and rules seem to be very different than they were in those times. And I think that would be an interesting perspective. So I really appreciate you being on. You did a great job of educating our audience and I learned some stuff as well, and I really appreciate it. Ron, thanks for being on.
Ron (31:55):
Stewart, thank you so much. It's been a pleasure, and I very much appreciate the time.
Stewart (31:59):
My pleasure. Ron Kantowitz, Managing Director and Head of Private Debt for Invesco's Global Private Credit Group. Thanks for listening. If you have ideas for podcasts, please shoot me a note at podcast@insuranceaum.com. This is a video podcast I'm holding up on the screen. Check out that Rubik's Cube with six of the aspects of insurance asset management. We'll send you one if you give us a podcast idea that we use. Please rate us like us and review us on Apple Podcasts, Spotify, or wherever you listen to your favorite shows. We also have a YouTube channel at InsuranceAUM Community. In case you want to see what we're up to, you can check us out there. We look forward to seeing you next time. This is the home of the world's smartest money at the insuranceaum.com podcast.
Investment Risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Many products and services offered in technology related industries are subject to rapid obsolescence, which may lower the value of the issuers in this sector.
Direct lending involves providing loans to private companies, often without the same level of transparency or regulatory oversight as public markets. Borrowers may experience financial distress or default on their obligations, leading to potential loss of principal and interest for investors. Additionally, these loans are typically illiquid, making it difficult to exit positions quickly, especially during adverse market conditions.
Investments in private credit and private debt—including leveraged loans, middle market loans, mezzanine debt, and second liens—are speculative and involve significant risks. These securities are generally illiquid, lack a secondary market, and may need to be held to maturity, which can result in liquidity constraints and difficulty exiting positions. Borrowers often have high leverage, increasing default risk, particularly in adverse economic or interest rate environments. Competitive pressures and excess capital may lead to weaker underwriting standards, raising credit risk and reducing potential recoveries. Private market investments also carry risks related to limited transparency, higher fees and expenses, longer investment horizons, and regulatory considerations. Additionally, these securities may be sold or redeemed at values different from the original investment amount and are considered to have speculative characteristics similar to high-yield securities. Issuers are more vulnerable to changes in economic conditions than higher-grade issuers, and investors may face liquidity strain from capital calls during periods of market stress. These factors can materially impact investment performance and principal value.
For Institutional Investor Use Only
Invesco Senior Secured Management, Inc. and Invesco Advisers, Inc. provide investment advisory services and do not sell securities.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions as of April 15, 2026 and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Invesco is not affiliated with InsuranceAUM or Mark Twain.
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Invesco’s Head of Private Debt, Ron Kantowitz, addresses what's actually driving stress in direct lending, why leverage and documentation standards matter more than ever, and where he sees compelling opportunities emerging.
Invesco’s Head of Private Debt, Ron Kantowitz, addresses what's actually driving stress in direct lending, why leverage and documentation standards matter more than ever, and where he sees compelling opportunities emerging.
Gary (00:00): Welcome to Compound Insights, a podcast by CFA Society in New York. I'm your host Gary Farber. Today, we're very fortunate to have with us Peter Miller of Invesco. Peter is the Head of Client Investment Solutions for North America. His focus is on asset allocation strategies and comprehensive portfolio solutions across institutional and private clients. Prior to joining Invesco, Peter was a Senior Vice President with PIMCO's Financials Institutions Group. You'll also be moderating our upcoming Insurance Investment Officers Roundtable event on December 4th, which will include investment professionals from Principal Financial, Genworth Financial, Alliance Bernstein, Apollo Global, and Neuberger Berman. Peter, welcome to the podcast.
Peter (00:41): Thanks a lot, Gary. It's great to be with you.
Gary (00:44): Currently, when you're interacting with clients, what are some of the top of mind topics that come up as far as investment challenges regarding their strategies?
Peter (00:54): A lot of the clients that we work with now, the continued trend is ever more private market exposure and really looking to find additional return wherever they can – of course in a risk managed way – and really trying to underwrite everything that they're doing.
It's just really fascinating, watching markets evolve over the last several years, and I don't really see that stopping. I think that's just going to continue and a big part of that, again, is just sourcing private market exposure and diversifying and complementing a lot of traditional exposures that they still have, especially when we're talking about institutional clients. As part of that, the technology and analytics that go around that are a big part of that. So, I think it's both sourcing the exposure that our clients want and then quantifying, monitoring, risk managing, all of it goes hand in hand with that.
Gary (02:00): Are you seeing an increasing shift towards outsourcing from the insurance companies and their decision making?
Peter (02:07): Yes, I would say specifically for insurance companies, there's definitely a long history of managing a lot of their portfolios in house with their own in-house investment teams. That is still very prevalent. But, there's no doubt that outsourcing has been an increasing trend, really since the crisis and that has not stopped. Even the most sophisticated and largest insurers out there, who have significant resources, significant ability to manage a lot of their portfolio exposures internally, even they are outsourcing more and more. That may not be half of their assets and maybe a relatively small percentage, but that percentage continues to increase. And, it kind of ties back to the first question around private markets and ever more specialized, ever more esoteric exposures, where it really makes the most sense to work with an outside partner who may specialize in that particular area of the market. So, that outsourcing does continue, and I think it will only increase over time.
Gary (03:24): Once that outsourcing decision is made, what's the process of determining the optimal asset allocation for a client in the insurance sector? What are the key considerations and how does that translate into the proper mix between equities, fixed income and alternative assets?
Peter (03:40): The framework and the process there, that's something that really hasn't changed – at least it hasn't changed in any fundamental way. That's been consistent for many years. It's always been a multifaceted or multivariable kind of process where insurance companies start with the economic risk-return considerations and examining the trade-offs and making sure that, on the one hand, they're seeking return. They want to get paid an attractive return on their assets. But, of course, want to be mindful of the risk they're taking and ensure that they're not exposing their balance sheets to any undue risk.
For an insurance company, once you consider the economic profile of any allocation, you certainly have to consider a lot of other things such as risk based capital: how much of your capital do you have to set aside to cover potential unexpected risk, to cover a potential loss – that's a regulatory thing. There's also a rating agency element to that. And then there are oftentimes accounting considerations as well, whether it's GAAP for international carriers or IFRS, even tax considerations. So, there's just so many additional variables that insurance companies have to consider when they're making these portfolio allocation decisions that go beyond just the economic risk and return. So, that’s what I mean when I say that fundamentally hasn't changed.
I think what's changed is there are now so many ways to invest. This is going to be a recurring theme, but private markets, things that aren't traded on a screen, things that are sourced maybe in a bilateral private relationship driven kind of construct. Examining the risk, understanding the risk, being able to quantify what's under the hood and then track that over time. And then how that looks through regulatory risk based capital lens or how that looks through different accounting lenses, that's what's going to continue to evolve. But, I consider that to be on the edges and really that fundamental multivariable framework that's something that's been around forever, and I think will continue for a long time.
Gary (06:15): How do you determine what's the right mix between public and private market exposure? What are some of the variables that go into that?
Peter (06:23): That's always a tough one because I don't know that I would necessarily characterize it as there being a single optimal solution. A couple of key things come to mind that everyone has to consider when they're evaluating public versus private market allocations. One of them, of course, is liquidity. A lot of people rightfully associate private markets as being relatively less with liquid than public market exposures. Oftentimes, your money is locked up for a period of time or, even if it's not locked up, it's just harder to unwind, harder to exit positions. So, there's a liquidity consideration there for sure.
There's also a consideration around data availability and insight into what the underlying exposure is in the fund or in the portfolio for a private market allocation. So, when insurers or any investors are trying to evaluate what's the right mix between public and private exposure, you really need to consider all of those elements. It's not to say that adding or increasing private market exposure or less liquid exposure is wrong. It just means you need to really go into that with eyes wide open and really have a good understanding of where things can go wrong, where things may get stressed, what types of scenarios are you going to have to really prepare for and be conscious of going in. And if you do your homework, if you do that right, then there certainly is nothing inherently wrong with tilting ever more towards that private market or less liquid allocation.
Gary (08:12): You just touched on it, doing your homework. How much has technology as it's evolved been helpful in figuring out the right mix? And particularly AI, is that much of the equation at this point or is it still sort of early using AI to do some work in this area?
Peter (08:26): Technology no doubt has been hugely beneficial when talking about portfolio construction, when talking about combining public and private market exposures. A big thing, something that we do a lot here, is think about modeling and quantifying private market risk and private market exposure and thinking about things less in terms of asset class labels and more in terms of risk factor exposure. So, what types of investments are exposed to interest rates and credit spreads, Or different equity factor exposures. I think it's helpful to think about exposures or portfolio allocations in that way because it does lend itself to being a little bit agnostic to what the label is, whether it's public or private. So, technology has been hugely beneficial along those lines because there's so much data out there where you can quantify public and private exposure to those different types of factors.
I think on the AI side of the technology question, that one is certainly newer and certainly early days. We haven't really seen widespread adoption of AI in a way that has really fundamentally changed what our clients are doing or what we're doing on behalf of our clients when it comes to portfolio allocations, asset allocation. I think very early days. But, there's no doubt that AI, when used properly, could be a massive asset and a really helpful tool just to make things much more efficient for users who know how to deploy it, who know how to get the most out of it and take a lot of the time consuming, kind of manual aspect of their jobs and automate that and leave it to AI to synthesize information on their behalf and then use their time and their energy where it's most beneficial. I think there's no doubt that AI is going to help along those lines, but it's going to take time. It's going to take probably years before it becomes really ingrained and used in a really widespread way, I would say.
Gary (11:03): Some of the outlooks for these insurance companies, how they manage their portfolios, I'd assume it's sort of longer term in nature, but how does the macro environment factor into when you're making decisions in the shorter term? How important is that?
Peter (11:16): Well, it is very important. You're right that most insurance companies, certainly for life insurance companies, they’re generally dealing with fairly long-term obligations, long-term liabilities. You could certainly frame it as they have the luxury of thinking over a longer time horizon than maybe some other investors. Property and casualty insurers and even health insurers have relative to life typically a shorter time horizon or shorter liability profile.
But, I think regardless, even for life companies with longer term liabilities, there's just no question that you have to be mindful of what's happening on a day-to-day, month-to-month, quarter-to-quarter basis. You can't take your eye off the ball and ignore what's going on around you in the near term because a series of short time horizons becomes the long term, right? And so, you have to kind of think about sequencing. You have to think about the progression of shorter time horizons and what that might mean over a multiyear time horizon. So, whether that's interest rates – which are probably the single biggest variable affecting insurance portfolios given the heavy allocation to fixed income – inflation, the broader macro-economic growth outlook that certainly has implications for risk asset performance.
Even if you have a very long-term horizon in general, in the short term, you could be presented with some very real opportunities. You could get find yourself in situations where maybe there's a market dislocation and you have the ability to buy attractive assets on the cheap that wasn't in your long-term plan. Or, conversely you could have a near term drawdown or risk off move where maybe you do need to consciously take some action in the short term, even though it may not necessarily fit perfectly with your long-term view.
So, the short answer to your question, Gary, is while insurance companies are typically long term investors – that's true. The short term is still very consequential to their portfolios, to their investment decisions, and there's no insurance CIO out there who is not very closely monitoring what's going on every day, every week, because they all recognize that there's risks to manage and there's opportunities that they may want to pounce on when the market presents that opportunity.
Gary (14:06): You mentioned earlier, back on the private assets, I'm assuming stress testing, scenario analysis are a significant part in constructing a portfolio. How has that changed that process? Has it had much impact?
Peter (14:19): I think stress testing and scenario analysis have been around for a really long time, but it does kind of dovetail with our earlier topic around technology. The ability to, for example let's say Monte Carlo Simulation, where you can model something over thousands, tens of thousands of scenarios to get a really good handle on not just what is my base case or my central tendency or my central expectation, but really look at what are the tails? What are the extreme outcomes that are unlikely but plausible? And getting a feel for what's the distribution of outcomes or thinking about things in probabilistic terms rather than very discrete finite terms. It's been around for a number of years, but certainly didn't necessarily exist, and wasn't so readily accessible when I started my career, at least. So that's something that's been relatively recent.
And then thinking about stress testing, it used to be the case that maybe you would look at a small handful of historical scenarios and look at, ‘OK, what if my portfolio were to experience this repeat of this scenario, whether it was a ‘94 rate hike or you know 2008-9 financial crisis.’ Now technology allows you to look at really an infinite number of historical scenarios. Or you could create your own hypothetical what if scenarios and kind of stress some of those things that we talked about earlier, some of those variables like rates like credit spreads, like equity markets, inflation, you can stress test a lot of variables at once, kind of look at the interaction of those things. So, I think that's where stress testing or scenario testing has really evolved and where technology has really helped just make that super accessible really fast and really customizable. So, it just allows insurers to be creative and think about, not just what's happened in the past, but even kind of dream up a lot of hypothetical what ifs that maybe haven't happened, but it's a good thought exercise to think through.
Gary (16:46): Peter, what about climate risk, which I would think would fit into that category a little bit? Stress testing because we've got hurricanes, wildfires, just severe weather events. How is that affecting the insurance industry? It seems like it's more prevalent now. And how is that being integrated into risk modeling?
Peter (17:03): That's a great question. Think about hurricanes, it's something that this industry has gotten very, very good at modeling. There's some amazing technology centered around modeling for that type of risk and quantifying likelihood and risk and again thinking about probabilistic frameworks. I think that's something that's been around and always continues to get better and better. But, maybe some other types of climate risk, to your point, are a little bit newer or maybe a lot more prevalent in the coming 10-20 years than they have been in the past 10-20 or even more years.
I think again, that's something where AI, to tie back to that, could be incredibly powerful. Just taking loads and loads of data and synthesizing that and then modeling potential outcomes and adjusting as experience unfolds, then adjusting and incorporating that experience. I think that's going to continue in prevalence.
But, I think, again, hurricanes is probably the single best example that I could think of in terms of climate-related events that have been around for a long time. There is a wealth of data and a wealth of modeling already out there. The industry has really done a very good job of capturing that, which is more of the liability side of the house, an underwriting consideration. But then of course that has knock on implications for investment decisions and portfolio allocations and how you allocate money, how you invest in light of those underwriting risks. So, the investing side, to kind of bring it back to that, it certainly is important. But, I think it starts on the liability side. It really starts on the underwriting side and then it kind of enables asset allocators to then invest accordingly.
Gary (19:24): And shifting to their regulatory environment, which is I would think another key aspect of this. Where does this stand currently and is there anything significant on the horizon that bears watching for insurers?
Peter (19:35): On the regulatory side, there are a lot of things that they're monitoring. When we think about US insurers, the NAIC, of course, is the body that really drives a lot of the regulation. The states work with NAIC closely, implementing their own regulatory policy. Nowadays, if not number one on the list, certainly very high on the priority list, and something I think is going to continue getting a lot of attention, there's a couple of elements of private markets investing. One is the increasing prevalence of private asset managers, alternative asset managers, who own or have a lot of influence over insurance companies. That is certainly a big topic of conversation. Whether it's from the other side, looking at insurance companies who are increasing their allocations to alternative investments. And from the regulatory perspective, questions around are they being risk managed properly, is there enough risk based capital being set aside for those? Should that framework change? Should the way that the regulator examines that change? I think there's a lot of work to do. I think what's almost certain, in my view at least, is that there will be a lot of increased disclosure, a lot of increased reporting that happens. Whether that follows through with increased capital requirements or greater limits on certain allocations or certain types of investment activity, I think that's too early to say. But, I certainly think around disclosure that's very likely to happen.
And then a topic we've talked about a couple times: AI, things around cybersecurity. On the underwriting side, for insurance companies who are underwriting risk and taking on risk from their policyholders, what kinds of exposure are insurers opening themselves up to when it comes to these very new, nascent technologies? And again, I think it's early days. I think it’s too early to draw any real conclusions. But, I suspect that regulators are going to be very attentive and very focused on watching that unfold too. So, I think there's no shortage of things that regulators are going to be paying a lot of attention to in call it the next 5-10 years. And, there's been a lot of changes just in the last few years. But, I think the things we're talking about going forward, those are very wide-ranging and very far reaching and that's why it's going to be a multiyear kind of journey.
Gary (22:44): Looking at other issues out there, what would be some of the emerging trends that are top of the list items that you think will affect portfolio construction in the next few years that you're discussing with clients that maybe isn't front and center today, but will be at some point?
Peter (23:00): Something that is probably fair to say more front and center, but I would characterize as maybe an emerging trend is around private asset-based lending. It's been around for a handful of years, depending on how you look at it. It's a relatively recent phenomenon, but I think what it really underscores is insurers are very sophisticated investors. They are constantly on the lookout for ways to diversify their portfolios, which are generally significantly exposed to corporate credit risk, and investment grade corporate credit risk in particular. So, anything they can do to source other types of spread, other types of return and diversify their balance sheet exposures, that's going to continue.
And so, while private asset-based lending has been around for a few years, and it's maybe not new to a lot of folks per say. The emerging part of it is what other exposures will they start accessing, what other structures, what other types of collateral can you source and structure and compile in a way that provides that diversifying spread, the diversifying source of return for insurance companies. So, things like right now music royalties, aircraft finance, a lot of real asset underlying exposure. There are so many different asset-based lending collateral types out there today. But, who knows what will be new exposures five years from now. That's kind of the emerging part. I would imagine there will very likely be things that we haven't even heard of today that 3,5,7 years’ time could be more prevalent and ultimately reach a point of maturity where it just becomes almost plain vanilla at a certain point. So, that's kind of what I personally think about a lot, what we look at a lot, what we consider. I think that'll just be a constant evolution.
Gary (25:40): Given the volume of potential transactions that you see over time, in your mind, what differentiates insurers that are consistently successful in navigating their environments? What qualities do they have, what insights do they have, what's their point of view that makes them successful?
Peter (25:55): I think the number one thing that comes to my mind is not just a willingness, but almost an eagerness or a very proactive, almost aggressive desire to evolve and change with the times. And, I think those that are successful, certainly when you're talking about successful insurance investors, I think what stands out to me in terms of their approach, their mindset, their framework is the desire to be at the forefront of some of these things. The not only willingness, like I said, but the eagerness, the genuine desire to be on the leading edge, to be out front and uncovering new investment opportunities, And, looking for ways to make something work. Looking for ways to, ‘OK, here's an investment opportunity. It's off the run. It's something that not many people have done. Maybe nobody has done yet. Rather than saying no, we're not going to do that. No, it's not going to work. It's too risky. We’ll look for a way to make it work.’ And, actively seeking out ways to optimize it and frame it, maybe structure it in a way that works for them. That to me is a sign of a very successful insurance investor.
Of course, a very risk management-oriented mindset is critical and that doesn't mean avoiding risk. It doesn't mean you're not taking risk. It just means you're constantly evaluating: am I being paid? Am I being compensated for this risk? Is it an appropriate tradeoff between the return that I can achieve and the risk that I'm taking? I don't think that would take anybody by surprise. We're talking about insurance investors. But, I think those two things: that real desire to evolve and be on the cutting edge and then that real ingrained risk management mindset are the two things that are prevalent across the most successful insurance investors that that we see.
Gary (28:20): You touched on a few of the items here that you know factor into, I would think, the investment style right now sort of interest rates, private assets, climate related issues. When you're advising chief investment officers or portfolio managers navigating that dynamic environment, what's sort of the overall message in just approaching the whole process?
Peter (28:43): If there's one message to draw from that is really you have to be flexible. You have to be willing to not only acknowledge, but embrace the fact that things are just constantly changing. The ground is always shifting under your feet. We talked about regulatory developments. We talked about technology developments in AI. And, we talk about not just regulatory insurance regulation. We talk about broader financial regulation and the indirect impacts that the things happening to two or four retail investors, of indirect implications for institutional investors like insurance companies.
It's just a constant state of flux. Things are constantly changing. We could be having a conversation with the client today. We could be doing some analysis on their behalf, doing some work, giving them some asset allocation advice or what have you. Something could change in a week, in a month, in a quarter, in a year. Not that you expect that work be to completely rendered irrelevant. But, when new information arises you have to be ready and willing and able to adapt. I think that's really the number one thing we talked about a lot. We really encourage our clients to, like I said, embrace it, not only accept it, but embrace it. Because if you're able to do that, if you're able to embrace it, you're setting yourself up for success. You're setting yourself up to be ready to act and take advantage of some opportunities ahead of your competitors. So, I think that flexible mindset is really top of mind for us and what we talk to our clients about.
Gary (30:41): Peter, thank you for joining us today and for sharing your perspective and valuable insights. And, to our listeners, thank you for tuning in to the Compound Insights from CFA Society in New York. I'm Gary Farber, and we look forward to bringing you more conversations with leading voices in finance.
Investment Risk Warnings
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
For Institutional Investor Use Only
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
There is no guarantee that the investment objectives of the strategies will be achieved.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any in-vestment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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Pete Miller discusses key trends driving insurance portfolio construction, including exposure to private markets, regulatory and macro challenges, and the evolving role of technology.
Pete Miller discusses key trends driving insurance portfolio construction, including exposure to private markets, regulatory and macro challenges, and the evolving role of technology.
Stewart (01:11): Hey, welcome back to the ‘home of the world's smartest money.’ I'm your host, Stewart Foley. This is the InsuranceAUM.com podcast, where our focus is on educating insurance investment professionals. Today our topic is Senior Loans: A Closer Look for Insurers, and we're joined today by Invesco's Kevin Egan, CPA. You are a Managing Director, Senior Portfolio Manager, and Co-Head of Credit Research for Invesco's Global Private Credit Team. You're also a member of the Investment Committee, which is a big deal at a place like Invesco. You are a product of Georgetown University undergrad with an MBA in finance from the Wharton School. Kevin Egan, welcome to the show.
Kevin (01:56): Stewart, thank you very much for having me. Really appreciate the opportunity.
Stewart (02:00): Well, okay, so the breaking news today is that Taylor Swift and Travis Kelce got engaged. So I see this hit on my newsfeed, and I immediately text my daughter. Her response back in two words: “I know.” That's it. I couldn't scoop her. I got news all over my screen, Kevin, and I still couldn't scoop her. Any thoughts on the engagement announcement before we get going here?
Kevin (02:26): This is going to be the American equivalent of a royal wedding. I mean, the attention is going to be huge. I did the same thing you did. I texted my friends who I thought would be interested, and all of them told me the same thing, “Stay in your lane. I already knew all about this.” So, it's going to be a media sensation. It really will be.
Stewart (02:42): Well, here we are, and we're in our lane. Let me ask you—you've been on before—let's talk about this. Where did you grow up and what was your first concert? Different question this time.
Kevin (02:54): Okay, so I grew up on the North Shore of Long Island, a very small town called Greenlawn. Huntington is the closest town to that. My first concert was actually here in the city, not Taylor Swift, although I did see her on this tour. It was The Cars, back at a place called the Palladium, which no longer exists. It was down on 14th Street. We told my parents it was at the Garden because the Garden was right upstairs from the Long Island Rail Road. They just thought we'd just come in, go right upstairs, and go to the show, and then head back out. They would not have let us go if they knew we were getting on the subway and heading 14, 16 blocks south to a small club. It doesn't exist anymore. But it was a great experience, and I've been a lover of live music ever since.
Stewart (03:33): You are speaking my language with The Cars. When I was in high school, The Cars were a big deal, and I had a friend named Eric Osteen that was a real music aficionado, and he passed at a really young age, but always really loved The Cars. So, let's start off by level setting a little bit, and I think that a lot of these terms get tossed around, Kevin, and sometimes people know what they mean, and sometimes they just act like they know what they mean. So, what exactly are we talking about when we're talking about senior loans?
Kevin (04:12): You're right, there are a lot of terms: senior loans, secured loans, and broadly syndicated bank loans. They all mean the same thing. These are loans—loans to large corporations here in the US and in Europe—made for purposes of making acquisitions or dividends to private equity sponsors or capital markets activity, expanding your CapEx, your working capital. They're issued by big banks, and then they're syndicated to investors such as ourselves who invest in these on behalf of third parties, mutual funds, pension funds and insurance companies.
They offer a number of attractive characteristics. They are senior as the name would imply, which means we're first in right of repayment. They are secured—secured by all the property, plant, equipment of the company. So, if something goes sideways, we can foreclose and take the assets of the company, in the same way that the bank has a mortgage on your house and can take your house if you fail to make the payments. The good news about that is senior secured loans typically recover about 70 cents on the dollar in the event of default, where high yield bonds, which in many cases are below us in the capital structure, same issuer in many cases, typically recover 30-40 cents on the dollar.1
They’re floating rate obligations. So, what we've seen over the last couple of years is that, as rates have risen, yields on bank loans have risen to where they are today. Just about a little bit less than 8%.2 So, they provide a very attractive yield.3 Because they are floating rate, they have no duration. Very little correlation to other fixed income securities. So, negative correlation to govvies, very little correlation to high yield bonds. And then it seems counterintuitive, but even in the rate environment that we're in currently—obviously we're anticipating further rate decreases this year. Senior secured loans, while still offering about a 7.8% yield currently,2 if we look at the forward curve over the next three years, senior secured loans are still expected to return somewhere between 6.5 and 7% on a coupon basis.4 So, that's why the asset class has been so popular over the last couple of years.
Stewart (06:13): It's super helpful. Let's talk a little bit about who the players are here. How would you describe the profiles of the companies that participate in the bank loan market, and are there certain segments within that market that your team focuses on in particular?
Kevin (06:33): These are all household names: United Airlines, Burger King, PetSmart, Virgin Media. These are large, what would be Fortune 500, Fortune 1000 corporations in many respects. And in many cases, these are public corporations, and those that aren't are still of considerable size. These are not mom and pop companies. These are not startups. These are not in the province of the middle market. These are all large multibillion dollar corporations. The average loan in our market is a little bit less than $1 billion. 5 The loans that we invest in are generally north of $250 million, but they can be loans as large as $5, $7, $10 billion.6 The loan market in the US is actually a little bit bigger than the high yield bond market. Most people are not necessarily as familiar with senior secured loans, but this is one of the largest capital markets in the US.
With respect to sectors, it is broadly diversified. Every sector that's in the S&P 500 is also in the bank loan market. There are certain sectors that we favor currently. For instance, right now, leisure, travel entertainment. Anybody who’s been on a plane this summer or been to a hotel or a theme park, knows that the demand for entertainment has been unabated. There was a brief pause around Liberation Day, but demand has resumed quite strongly. So, we're very favorable in that sector, which continues to perform quite well. These companies have a lot of pricing power. They've not added a lot of capacity, and, so as you know, airline fares and hotel rates have only gone one way. So that's a sector we're very significantly overweight.
On the opposite side, sectors like technology. There's a sector where valuations have really been stretched. A lot of the loans that came to market in 2018, 2019 were done at 50% loan-to-value, but that's when value was 14-15 times. And so, you can have a 50% loan-to-value company that's levered 7-8 times. Well, if interest rates go up by 500 basis points, that's a 35-40% cut in the company's free cash flow. That will really put stress on a lot of these borrowers, and that's what we've seen in this space. So, that's a sector that we're significantly underweight, even though it is the largest sector in the index overall. And then healthcare, another one that we're underweight. Obviously, the government's the biggest payer. And even if the government's not the payer, it's paid off the government reimbursement rates. The government's been reimbursing healthcare providers at 1-1.5% labor,7 which is the largest input cost there, has gone up much more rapidly than that. So, these companies are being squeezed on a margin basis. Really tough when you can't control your revenue line, and that's a sector which is also one of the largest in the loan index that we're underweight as well.
Stewart (09:07): That's super helpful, and I understand the reasoning there. You mentioned high yield a couple of times, and that's the comparison that often comes up, right? So, how do you compare the two, and how do you assess the relative value between bank loans and high yield?
Kevin (09:24): As I mentioned before, the reason why the comparison comes up is, in many cases, they are the same issuer. United Airlines issues both loans and bonds, and for different reasons if you're a corporate treasurer. 50% of the loans we issue actually have bonds below us in the capital structure. But that's one of the key differences right there, is below us in the capital structure. Loans are senior, so they're first in right of payment. Secured by all the assets of the company, so if there is a default, senior secured loans are going to have a much higher recovery rate than high yield bonds.
Now, historically, bank loan investors have been willing to accept a lower rate of return because of that seniority and security, that protection. We're in the very unusual situation right now where loans, as I mentioned before, are yielding just about 7.8%. High yield bonds are yielding about 7.2%.8 So, you're getting a better yield and a better coupon. Loan coupons today are about 425 basis points. High yield bond coupons are about 100 basis points behind that.9 So, you're getting a better yield and a better coupon to be senior secured, top of the capital structure. So, the relative value really favors loans.
It's a pretty unusual situation, and the reasons for it really have to do with who the buyers are in each of the markets. The loan market is dominated by institutional buyers who have a minimum cost of capital. And so, therefore need a minimum yield to invest in the asset class. The high yield bond market is really dominated by ETFs and retail investors who don't have a minimum cost of capital and therefore can really accept lower yields. Loan spreads right now are just about their long-term average. High yield bonds, after the blip of Liberation Day, are actually close to their all-time tights. That really favors the loan asset class currently.
Stewart (11:04): It's interesting because on the other side of that, you see direct lending getting larger. So, at the upper end of direct lending and the lower end of bank loans, are those two touching yet? Are they colliding? Can you talk a little bit about the upper end of the direct lending market versus bank loans?
Kevin (11:28): They used to be two completely separate markets, but, to your point, direct lending has gotten so popular. So much has flown in the way of AUM into that asset class, that at the upper end of the middle market, which is not where we play. Invesco is invested in what's called the core middle market, the $150-$250 million loans. But at the upper end, you've seen funds raise $10-$20 billion. So huge funds because the demand for the asset class has been so strong, and that's brought the two asset classes into competition with each other.
You think about it, you have a $20 billion direct lending fund. Loans are freely callable, so a direct lender manager and a broadly syndicated loan manager are going to get about a third of their portfolios repaid or prepaid every year. So, if I have a $20 billion direct lending fund, that means I have $6 or $7 billion that I need to put to work at the beginning of the year before I invest an incremental dollar. That's a lot of money to put to work. And you can't do that in the $150-$200 million loan that used to be the province of direct lenders. So, what's happened is these large direct lending funds have moved up into $1-$2 billion loans. As I mentioned before, the average loan in the broadly syndicated market is $1 billion.5
So, the two markets have come into competition with each other. And what does competition mean? Well, a couple of different things. One, the spread differential, which direct lenders used to enjoy 200 basis points over where spreads in the broadly syndicated market are. That's collapsed. 125, 100 basis points in some instances. So, that spread differential that really used to differentiate the direct lending market and made the market so attractive. As two markets have come into competition, obviously, borrowers won't pay 200 basis points more to have a direct lending deal versus a broadly syndicated, so the spread differential has come down. You start layering on top the performance and other fees for direct lenders, and the net return differential collapses even further.
The second thing is that direct lenders used to always advertise, well, we have covenants in our deals, and the broadly syndicated market does not. That is still true at the lower end of the middle market. The $150-$200 million loans, 70-80% of them do have maintenance covenants. But for loans that are $500 million or more, which now again is where a lot of these direct lenders are playing, only 10% of them have covenants. So that whole idea that they have covenant protections, at the smaller end, still true. At the larger end, not true anymore—only 10% of the loans. And where there are covenants, used to be they were set 25% above or below company plan. Now, that's widened out as well. They're 35-40% below the company plan. If you have a company that's missing its plan by 40%, you have a problem, and no covenant set that wide is really going to protect you. So, you put all those together, and you're really seeing a convergence of the markets as they start to compete with each other.10
Stewart (14:19): I think a lot of times folks who are listening to this podcast are looking for an update on a particular market. So, if we focus on the bank loan market today, on Tuesday, August 26th, at 1:24 PM Central, what is your outlook? What can you tell us about the bank loan asset class right now?
Kevin (14:44): A couple of different things. I think if you focus first on fundamentals. Fundamentals remain strong for the asset class, in fact, have been improving. A lot of companies obviously levered up during COVID. We saw leverage in the market peak at a little bit less than 8 times. Companies have been using the very strong performance that they've seen, resulting from the very strong US economy, to delever. So, leverage today is a little bit less than 5 times overall. It's actually lower today than it was pre-COVID. So, we've seen a complete round-tripping in terms of leverage levels. That's obviously a positive for us.
Similarly with the lower rate environment, we've seen interest coverage ratios, the borrower's ability to service their interest costs, start to move up. So, we were very fearful that during the rate hiking cycle, borrowers would not have sufficient free cash flow to cover their debt and cover their interest payments. That ratio bottomed about 3 times, let's call it 18 months ago. But with the 100 basis points and rate cuts that we've seen last year, interest coverage ratios have now improved to about 3.4 times. They were expected to be closer to 4 times by the end of the year. Borrowers typically don't get into trouble unless their interest coverage ratio is below 1.5 times. So, we've seen the average borrower in the market have more than sufficient free cash flow to cover their interest expense.
Now obviously there's a tail that's still below that 1.5 times, but it's only about 3% of the market currently. That 3% is probably a pretty good indicator of potential defaults in the market going forward. But it's really a much smaller portion of the market in general. If we look at revenues for the first quarter, up 2-2.2% EBITDA for our borrowers, up 3.3% year over year. So, this is on tougher comps. We're still seeing positive growth from our borrowers. I saw this morning that 85% of the S&P 500 has also surprised to the upside for earnings. So, we're seeing that as well.
And then maybe the last thing to point out is the maturity wall. Two things can cause a default: inability to service your interest expense and your debt service. And also, if you have a looming maturity that you can't refinance. Less than 2% of the market has maturities between now and the end of 2026. So, no maturity wall, not really concerns about interest coverage ratios. So, fundamentals are strong across the board.
The technicals have really been the driving story for the market. CLOs, which again represent 70% of the market overall. Demand for them—there’s been $120 billion of CLO issuance this year.11 That’s on a record pace. So, despite all the volatility we saw around Liberation Day, CLO demand, which is the primary driver of demand in the market, remains unabated. The supply side has been relatively muted. That's where we've seen the impact of Liberation Day. Supply in the form of acquisitions, companies making acquisitions, and PE firms making acquisitions. That really was put on pause. We're starting to see that resurge, but we've had this huge supply-demand imbalance, which has really buoyed the market. And prices today are the highest they've been all year. So, we've seen the average price in the loan market close to 97 cents on the dollar. 60% of loans are trading above par. So, the technicals in the market remain very supportive. And while we do expect more supply post Labor Day, I still think that we're going to see a very strong technical in the market overall. Demand is returning to the asset class, even from regular way investors, the retail fund investors, the ETF investors, are all coming back to the asset class after that dislocation we saw back in April.
Stewart (18:18): Super helpful. So, the rule of thumb in lending people money is you need to get paid back, right? So, the old saying goes, you make it in basis points and lose it in percentage points. So, with that in mind, I mean, default risk is always at the top of mind for our insurance audience. And just touching on that for a moment. A good friend some time ago, a guy by the name of Phil Titolo was talking about this at an event we were attending and he said, you're likely to see, and this kind of goes to the question, a decrease in Defaults, but an uptick in LMEs or otherwise known as liability management exercises, which is kind of a polite way of saying workouts. What's your take on this trend with workouts? There's been talk of lender-on-lender violence. I'm not even exactly sure what that means, to be honest with you. How does this typically play out? What can you tell us about this topic here?
Kevin (19:19): I would say one, I think it's correct, Defaults continue to move down. Defaults right now, payment defaults as we define them, are about 1.1%. That was 1.4% at the beginning of the year. So, we continue to see payment defaults decline in the market. Similarly, if we look at loans trading, as I mentioned before, below 80 cents on the dollar, which is typically a sign of future defaults, that's 2.8% currently.12 That was 4% at the beginning of the year. So, stress in the market and actual defaults in the market continue to decline.
It is true, however, that we've seen a trend over the last 18 to 24 months away from in-court restructurings, Chapter 11 filings, to out-of-court liability management exercises. And that's an opportunity in a lot of respects for lenders like ourselves, where we can provide additional liquidity to a corporation, to a business we like—we're not obligated to do so—but we can provide additional liquidity to a company we like. A company avoids Chapter 11, the costs and time associated with that, and gives the company additional runway to hopefully recover and right size their business plan. And we get that additional liquidity or provide that additional liquidity in return for uptiering our obligations in the capital structure. So, we get fees associated with providing that additional liquidity, and we get an uptier in our existing debt.
Now, the outcomes can be different for lenders that originally had the same security. Those that are able to participate in the liability management exercise are able to provide that additional liquidity. Generally speaking, they are able to exchange their debt at much more favorable rates than those that are not. And so, it can result in different outcomes for different lender groups. Those that are able to participate, that sit on the steering committee or the ad hoc committee that is driving the transaction, will, generally speaking, have a more favorable economic reimbursement for making that additional liquidity extension. So, those firms like Invesco that are large, that have the ability to provide additional liquidity, provide additional capital, have the legal resources, the relationships. And importantly, when these groups are forming, generally speaking, it's the largest lenders that are able to be participants in the ad hoc and the steering committees. So, an investor of size is important, and Invesco, given our size in the market, is almost always large enough in any transaction, where a liability management exercise is contemplated, to be on the steering committee, be able to provide that additional liquidity and, as a result, have better outcomes in those situations.
Stewart (21:54): That's an important point when those unfortunate situations come about. I think it's a great point. So, bank loans have been tested across a multitude of cycles. I look at stuff that nobody reports on, which is I see tons of stuff getting sold. Folks are selling toys, you're seeing motorcycles getting sold and trailers getting sold, and all kinds of stuff getting sold. I kind of look at those markets. And the economic numbers don't reflect weakness, but I think to some extent there's uncertainty. There's just a feeling of a little bit of an uptick of uncertainty. So, historically speaking, how has this asset class fared during downturns, in particular, and how does that potentially apply to what we see right now as a little bit of ongoing market turbulence?
Kevin (22:50): I think the good thing and, some of what I alluded to before, bank loans have remained remarkably stable over time. Over the last 33 years, since the inception of the asset class, bank loans have only had three negative years. So, 2008, not surprisingly, bank loans were down 29%, which again was a lot less than other asset classes, and were up 44% in the next year. 2015, sort of the industrial slowdown, bank loans were down 30 basis points or so, but the next year they were up almost 10%. And then with COVID, bank loans again were down about 100 basis points, were up 13% the next year. So, in any period, one: the absolute level of decline in bank loans, relatively modest, with the exception of the GFC. And in each year, the next year, rebound was quite sharp and quite positive. So, bank loans have generally been insulated from a lot of the volatility by two things.
One, that high current income. As mentioned before, on average, we're getting about 6% a year, right now that’s closer to 8%. That buffers a lot of market volatility. Also, being senior and secured, top of the capital structure, by definition, that portion of the capital structure is going to be less price volatile than high yield bonds below us and equity below that, because those are in the first loss position. Senior secured loans are in the last loss position, so there's less volatility around that. And then if you look at sort of a traditional recession, 2001, 2002, bank loans had positive returns in those years.13 During COVID, bank loans had positive returns.14 So, in each year, you've seen bank loans in most cases have positive returns even in periods of market volatility.15
So, we look going forward and saying, okay, even with all the uncertainty you mentioned, bank loans back in April were down at their bottom. Down 2.5% from April, from their peaks in early March to April 7th, which was the low. By the end of April, it had recouped half that loss. So, it was a short and quick comeback. Since then, loans are up more than 4% year to date.15 So, we completely round-tripped that and more at this point. I think that sets us up going forward for one: strong returns this year. Both on an absolute basis, as we talked about before. And then relative to high-yield bonds, which are our closest competitor, you're getting a better yield and a better coupon on an asset class that's less risky. So, I think time has really tested this asset class and the results sort of speak for themselves. In periods of recession, loans have offered positive returns.15 During COVID, loans offered positive returns.14 So, I really think that that should give investors some comfort that this is an asset class that is far less affected by market volatility than many others.16
Stewart (25:28): That's super helpful. I really appreciate that. We've had a phenomenal education on bank loans this time around, Kevin. I appreciate you being on. Got a couple of ones on the way out the door. One really speaks to the culture at Invesco, and you've been an institutional investor for a long time. You've seen a lot of different folks come and go over the course of your career, when you started out, now when you're more senior. What characteristics are you looking for when you add folks to your team? And a kind of related way to look at it is what characteristics of folks have you found are particularly successful in your specific genre?
Kevin (26:10): I think for young people coming in, intellectual curiosity, first and foremost. We can teach you the modeling. We can teach you our credit process, but if you don't like to dig in, discover things about businesses, which I always thought was the most fascinating thing. Sometimes I'll tell my friends about, oh, we're looking at this company and they're like, I didn't even know there was a company that did that type of thing. I mean, you have to sort of love that and dig into that, trying to uncover rocks. Be curious. Don't make assumptions. I think that that is the type of thing that we really look for. The technicals we can teach, but the curiosity, the joy of investing and trying to discover things, that is something that you can't teach, and that's what we look for in people. And listen, this is a collaborative environment. You want to learn from your peers. No one's going to do it by themselves. I certainly didn't get here by myself. So I think that that’s important, that intellectual curiosity. And a love to invest. I mean, I still get tremendous joy out of picking up a new credit memo and saying, “okay, I didn't know this was a business.” And it's just fun to learn, and I think those people who really love that, they're going to succeed in this business.
Stewart (27:14): That's very helpful. Alright, last one. You can have dinner with up to three people, one, two, or three. They can be alive or they can be dead. Who would you most like to have dinner with?
Kevin (27:27): Alright, well, I think I would go back to what we started talking about, the output. I love live music. I still see two or three shows every month, so I'd have to go with sort of a round table of deceased musicians because obviously that's a unique opportunity. Three is so hard. John Lennon, Prince, David Bowie. I think that that would be a really eclectic conversation.
Stewart (27:52): That would be amazing.
Kevin (27:53): That would be so much fun. Well, Prince, I got to see live. The other two I didn't. So that would be such a unique opportunity. That would be a great dinner.
Stewart (28:06): I remember seeing, I got a chance to see Ray Charles live at the very end of his career, and I can imagine that it's similar like Prince and whatever. You just go, this is a special time right here. It's not every day. So I really appreciate you being on, Kevin, and thanks for a really good education today. Appreciate you taking the time.
Kevin (28:29): Not at all, Stewart. Thanks for having me. Always fun to discuss loans and music with you.
Stewart (28:34): We've been joined today by Kevin Egan, CPA, Managing Director, Senior Portfolio Manager, and Co-Head of Credit Research for Invesco's Private Credit team. The title of today's podcast is Senior Loans: A Closer Look for Insurers. We appreciate you listening and would really appreciate you rating, liking, and reviewing us on Apple Podcast, Spotify or wherever you listen to your favorite shows. We also have a brand new YouTube channel at InsuranceAUM Community. If you have ideas for podcasts, please shoot me a note. It's Stewart@insuranceaum.com. My name's Stewart Foley. This is the home of the world's smartest money at InsuranceAUM.com.
1. JPMorgan as of 12/31/24, Annual Update. Full set of data not available for S&P UBS Leveraged Loan Index. Past performance does not guarantee future results.
2. Source: S&P UBS Leveraged Loan Index as of June 30, 2025.
3. Around four years ago, loans were yielding ~4.80%; loans recently have been yielding ~300 basis points more than that. Source: S&P UBS Leveraged Loan Index as of June 30, 2025.
4. Source: PitchBook Data, Inc. as of June 30, 2025, updated quarterly; Morningstar LSTA US Leveraged Loan Index. Uses average trailing 4 quarters spread levels and forward 3m SOFR rates as of July 11, 2025. There can be no assurance that any projected returns can be realized.
5. PitchBook Data, Inc. as of November 11, 2024.
6. As of July 31, 2025.
7. As of June 30, 2025.
8. Sources: S&P UBS Leveraged Loan Index & Bloomberg US Corporate High Yield Index as of June 30, 2025.
9. Source: S&P UBS Leveraged Loan Index & Credit Suisse High Yield Index as of July 31, 2025.
10. Source: S&P UBS Leveraged Loan Index & Cliffwater Direct Lending Index as of June 30, 2025.
11. Source: S&P UBS as of July 31, 2025.
12. PitchBook Data, Inc. as of July 31, 2025.
13. Total returns of 2.65% in 2001 and 1.2% in 2002. Source: S&P UBS Leveraged Loan Index data.
14. Returns of 2.78% in 2020. Source: S&P UBS Leveraged Loan Index data.
15. Senior loans have generated positive returns in 30 of the last 33 years. Source: S&P UBS Leveraged Loan Index data through December 31, 2024, updated annually. An investment cannot be made in an index. Past performance is not a guarantee of future results.
16. Source: S&P UBS , Bloomberg L.P., and Barclays Data as of 6/30/15 – 6/30/25. Yield to worst data as of June 30, 2025. US Senior Loans is represented by the S&P UBS Leveraged Loan index, US High Yield is represented by the Bloomberg US Corporate High Yield Index, US IG is represented by Bloomberg US Corporate Investment Grade Index, US Aggregate is represented by the Bloomberg US Aggregate Index, and US Treasury is represented by the Bloomberg US Treasury Index. An investment can not be made in an index. Sharpe ratio utilizes annualized total return of 90-day T-Bills for the 10 years ending 3/31/25. Sharpe ratio: US Senior Loans, 0.59; US High Yield, 0.63; US Investment Grade, 0.14; US Aggregate, -0.04; US Treasuries, -0.16.
Investment Risk Warnings
Many senior loans are illiquid, meaning that the investors may not be able to sell them quickly at a fair price and/or that the redemptions may be delayed due to illiquidity of the senior loans. The market for illiquid securities is more volatile than the market for liquid securities.
The market for senior loans could be disrupted in the event of an economic downturn or a substantial increase or decrease in interest rates.
Senior loans, like most other debt obligations, are subject to the risk of default.
The market for senior loans remains less developed in Europe than in the U.S. Accordingly, and despite the development of this market in Europe, the European Senior Loans secondary market is usually not considered as liquid as in the U.S. The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested.
Invesco Senior Secured Management, Inc. is an investment adviser; it provides investment advisory services to individuals and institutional clients and does not sell securities.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Invesco is not affiliated with InsuranceAUM or Phil Titolo.
NA4786927
Following the volatility around Liberation Day, loan market activity has surged. Against this backdrop, Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research, discusses his current outlook for the asset class, diving into sector views, default trends, and relative value versus other fixed income alternatives.
Following the volatility around Liberation Day, loan market activity has surged. Against this backdrop, Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research, discusses his current outlook for the asset class, diving into sector views, default trends, and relative value versus other fixed income alternatives.
Stewart (01:30): Hey, welcome back. We've got a great podcast for you today. I think you're really going to like it. We're talking about real estate credit, the latest on lending markets and opportunities for insurers, and we're joined today by Charlie Rose, who's Managing Director and Global Head of Debt at Invesco Real Estate. Charlie leads the firm's commercial real estate credit lines of business globally. As a managing director, his primary focus is setting strategy, overseeing portfolio management, and leading the firm's credit investing initiatives in the US. Charlie is a member of the North American Credit Investment Committee and the European Credit Investment Committee. You are a product of Stanford and Wharton, two powerhouse schools. Charlie, welcome back to the show.
Charlie (02:19): Stewart, thank you so much for having me again. It's a pleasure.
Stewart (02:23): This is great. I'm glad you're back. It's going to be fun. We did change our intro question a little bit, just a little, and it goes like this. So where'd you grow up? What was your first concert, and then just talk a little bit about how you got into your seat today.
Charlie (02:43): Stewart, I grew up in a very small town that no one has ever heard of called Fall City, Washington. Fall City is probably, with no traffic, about an hour east of Seattle, up in the Cascade foothills. At the time, it had been the inspiration for the Twin Peaks TV series, if you remember that. But Fall City got about twice as much rain every year as Seattle. So pretty rural, quiet, and wet place to grow up, but a lot of good memories with two brothers and a very simple childhood there.
Stewart (03:26): What was your first concert?
Charlie (03:27): Oh man. Well, so I'm going to reveal some of my deep secrets.
Stewart (03:38): That's what we're trying to do, Charlie. This is the good stuff. This is what people tune in for, this kind of stuff.
Charlie (03:44): When I was in middle school, I suppose it's not all that surprising, I was a pretty geeky kid. I definitely was not one of the cool kids, and my friends and I loved a band that was, I think really targeted at geeky middle school kids, called They Might Be Giants and we went to They Might Be Giants in concert when I was in seventh grade. And man, I thought I was really cool when I did that.
Stewart (04:14): Listen, you are, and here's the good news, right? You are in a long line of podcast guests that would also proudly claim being a geek. I'm one of those people, too. Talk a little bit about how you got into the chair, where you are today, just where you started, and how you've gotten here. You've got a really big time seat in a fairly short period of time, so I think it benefits people who are earlier in their careers just understanding what your path was.
Charlie (04:46): Well, listen, there are a lot of different ways to achieve success, but I would characterize my path as being a combination of the result of a lot of hard work and a lot of luck. But when I talk to people earlier in their careers about the luck piece of it, luck only benefits you to the extent that you're willing to see those opportunities when they come in front of you and pursue those opportunities when they're made available to you. So I was an English major in undergrad. I had no idea what I wanted to do, and when it came time to start thinking about what to do after undergrad, I went and asked my dad, because I had no money, if he would pay for the LSAT so I could go to law school, and he said no. And so then I really had to figure out what to do, and there was a guy in my neighborhood growing up who drove a Range Rover, and I was really impressed by his Range Rover.
So I asked around, and he was doing something called commercial real estate. I had no idea what that meant, but I started to apply for any job that said commercial real estate and landed in a research role with a UC Berkeley professor who was looking for someone who could write. So really luck, that at the right time there was someone looking for someone who could write in the commercial real estate industry, and I was graduating from Stanford with an English degree.
From there, I worked with a lot of different clients, insurance companies, REITs, investment management firms, private equity firms, banks, and we provided research services to these different participants in the commercial real estate industry. And I realized that I wanted to be doing what our clients were doing. First off, the research guys weren't driving Range Rovers, and I think our clients were driving Range Rovers and they were making decisions. They were putting money at risk, and they were hiring consultants like us. So I decided to go back to business school to pivot within the industry and have been in investment management in various different capacities within the commercial real estate industry ever since.
Stewart (07:23): That's super cool. You know what, I can relate to that. I didn't know, had no background. I thought, “Every business has money, so I'll major in finance,” but I can completely and utterly relate to the Range Rover start. It's great to have you back on. It's been a few years, but we stay close. You've had a number of your Invesco colleagues on. We have some great speakers lined up at our Annual Symposium. And just to re-anchor the audience, can you do a quick refresher on Invesco Real Estate and, more specifically, your global debt platform, and then we'll get into the finer points here quickly.
Charlie (08:01): Our private markets business is probably a little bit less understood within the industry, but is a business that's been around for 40 years. And today the real estate part of that private markets business has AUM of right around $87 billion,1 making us one of the top 15 largest real estate investment managers globally.2 What does that mean exactly? Historically, most of our clients have been various institutional clients, some insurance, some public pensions, some sovereigns, some foundations and endowments, although that's a smaller portion of our client base. And today, we're increasingly offering these products to the high net worth channel as well. Our credit business is an offshoot of the real estate equity business that's been around for 40 years. So I joined Invesco a little less than nine years ago to take all of the expertise, information, and relationships that we've developed in the real estate equity space and apply that to underwriting and originating loans secured by commercial real estate. Today, our commercial real estate lending business is just around $10 billion of AUM.3 We originate loans secured by institutional-quality real estate, the type of real estate that we would own on the equity side throughout the United States and on a pan-European basis.
Stewart (9:51): That's super helpful. So it's my understanding that Invesco has a strong focus on transitional or bridge lending, and to be honest with you, I mean I would struggle to define that. So what would be helpful, I think, to kick us off, is if you can define the bridge loan market, what are the typical structures to look like in terms of term fixed versus floating borrower types, and other features that make Invesco's approach differentiated?
Charlie (10:26): So first off, commercial real estate debt is a $6 trillion asset class in the United States, which makes it the fourth largest fixed income asset class, about 50% larger than the municipal bond market here in the United States.4 In Europe, it's a little bit smaller, it's about a $2 trillion asset class,5 but collectively, our universe, our addressable market for our business, is an $8 trillion market. So you have a lot of variety within that market. You have core lending, construction lending, what we characterize as core plus or bridge, all the way up to high yield and distressed lending opportunities. Our bread and butter historically has been, as you mentioned, bridge lending. We focus on the institutional segment of the bridge lending market. We have a motto here: credit over yield. So we're generally trying to originate the highest quality bridge loans in the market. But to your question, what exactly does that mean?
We are first and foremost almost always a floating rate lender, and we are financing business plans, which Jon Gray has characterized as buy, fix, sell business plans. Our borrowers are typically institutional sponsors, just as you would see in some private credit strategies, where you hear folks talking about being sponsor-driven lenders. We are making loans to institutional organizations who look and think, and operate like ourselves. Typically, we are financing that institutional owner's acquisition of a very high-quality property with some disruption in the cash flow at the time of acquisition. So an example of that would be one of our borrowers buying a large multifamily property, call it 300 units, for around $100 million. They may be buying that property shortly after completion of construction. They may be buying that property after there's been some mismanagement of the property, or it may be a property that's 10 or 15 years old and was absolutely class A product when it was built, but is a little bit tired around the edges. And regardless, their business plan is to buy, fix the cashflow, improve and stabilize the cashflow, and then sell to a core buyer. We on that $100 million acquisition would generally provide 65% leverage, so call it a $65 million senior loan with a three-year initial term and then extension options to the extent that their business plan is delayed, giving them a maximum of five years of term under our loan.
Stewart (13:44): Very helpful. The next topic for bid is the current macro backdrop. I know you're like me, you're a news junkie, you see all the geopolitical tensions, the tariffs, the elevated rates. Where do you think we are in the real estate credit cycle today? How do you see tariffs and global uncertainty impacting volumes and valuations, and how would you characterize the current spread environment across CRE debt?
Charlie (14:18): CRE debt should be, as we apply the strategy, a very defensive low-volatility through cycles strategic investment. So we try to look past the noise in the market, and candidly, we know that we are doing things right when there are periods of volatility, and our investors don't call us. They're focused on other problems or portions of their portfolio that are experiencing volatility. So today, we think that we are probably in the second inning of the commercial real estate credit cycle. I say that because our industry has just gone through a recession. Real estate is generally a levered asset class, and so when the Fed hiked rates, we saw a significant correction in commercial real estate values. Between 2022 and 2023, commercial real estate values dropped on average by 22%.6 The market has since found a floor, and we've started to see values come off the bottom, but we haven't seen liquidity return in full into the market, which will be necessary for us to see a full recovery in commercial real estate.
From a spread perspective, it has been truly a credit pickers market for the last two years. The banks are roughly 51% of the $6 trillion commercial real estate market, and for the last two years,7 the banks have pulled back substantially on their participation in the market. And so that's created a supply-demand imbalance between demand for commercial real estate loans and supply from traditional lenders. We've started to see spreads come in this year as the banks have started to reenter the market.
Stewart (16:34): That's super helpful, thank you. The office is something that a lot of folks just don't want to talk about on the real estate side, and it's interesting, I think that people get sort of a historic view in their head about a particular asset class, and it doesn't really reflect what's going on right now today. So it would be helpful if you could tell us what the fundamentals really are, how they're shaping up, how does office compares to other sectors, and what do you like and what are you cautious about?
Charlie (17:11): Over the last couple of years, our lending activity has been almost exclusively focused on what we call beds and sheds. Multifamily properties, and similar property types that may be student housing or age-restricted 55-plus communities, that's beds. And then on the other hand, sheds would largely be industrial logistics properties with a small allocation to self storage in there. Today, you are starting to see some firming in valuations for other property types and, in fact, a little bit of the exuberance for industrial has come off and the tariff environment has created some additional near-term headwinds for the industrial space. Office was an asset class that experienced a value decline that was really unprecedented both in scale but also pace. Historically, we've seen close to similar valuation issue in regional malls, but that took place over a decade-long environment. The office correction happened very quickly. But as happens with a lot of investible asset classes, the baby was thrown out with the bathwater in office, and we've consistently been seeing a pretty healthy demand and occupancy for the very best office assets.
I sit in Southern California, and I couldn't think of a better example of the bifurcation that we're seeing in the office market than here in Los Angeles. Downtown Los Angeles is littered with effectively zombie buildings that are in some stage of foreclosure, are unable to sign leases, and tenant demand is very weak, leading to very high vacancy. There are a number of reasons for that, but part of it is the office stock is generally older product in that market, whereas Century City on the west side and Newport Coast in Orange County are effectively fully leased markets with record-high rents. And those are some markets that are characterized by the absolute best live, work, play amenities and generally newer office stock that is favored by tenants today. So there is opportunity in office to be certain, but as a lender, the most important thing that we can do is avoid uncertainty and avoid downside risk. And so until this stabilization of values started to firm up, really office had to be off the table for us because there was simply too much uncertainty around the underwriting.
Stewart (20:43): That makes sense. So the next talking point we've got here is integrating equity and credit views, and you're a leading global credit shop. Invesco is also, and you mentioned this earlier, a heavyweight in the real estate equity space. How does your team partner with the equity side of the house, and how do you collaborate when it comes to evaluating markets, property types, or individual deals?
Charlie (21:10): I mentioned earlier that we follow a credit over yield strategy on the debt side of the business. The other fundamental pillar of our strategy is what we call property first lending. And that means that we're only lending on the type of real estate that we either already own or would own in our equity portfolio. We have a very distinct culture at Invesco where we truly have no stars. It's a collaborative, flat organization where our employees are rewarded for supporting each other and supporting the business broadly. We then layer on accountability for that. So while we have a dedicated credit team that is responsible for managing our proprietary sourcing relationships and ensuring that we offer swift and certain execution for our borrowers. Once they bring an opportunity in-house, their process fundamentally is a partnership with their equity colleagues who provide input on the physical characteristics of the building, the viability of the business plan and the assumptions in the underwriting itself. And then those colleagues who are both asset managers, those folks who are operating buildings, and acquisitions officers, those hunter-gatherers out there sourcing new equity investments for us, they're expected to speak at our credit committee and be held accountable for their support of the transaction.
Stewart (23:01): That all makes sense. It's interesting, earlier in the call in the podcast, you had said there's about $6 trillion in the US, the size of the market, and it's about $2 trillion in Europe. You've got a mandate that spans both of those markets. What are the similarities and, maybe more importantly, the differences between the US and European CRE markets right now, and are there any relative value insights that you'd share for our insurance audience that's deploying capital globally?
Charlie (23:35): We're constructive on both markets, and we are actively lending in both markets. Historically, Europe has been characterized by less transparency in the market, a higher concentration of traditional bank lenders in the market, and materially lower volumes. But you've also historically seen that the lack of transparency has led to wider spreads in the European market. A lot of investors within our stable of investors have been fairly negative on Europe for a number of years, despite what we have been seeing as relatively attractive risk-adjusted returns within the debt portion of the capital stack.8 Europe has been perceived as being a slow-growth market with declining populations, fundamentally difficult regulatory environments, and, accordingly, a less attractive place for global capital. And there is truth to all of those concerns, but over the last six months, we have seen a notable renewal in interest from global investors in Europe.
Europe is now perceived as a very stable macro economy, an economy that potentially could benefit from some higher-than-historical growth in the coming years, in part because of the remilitarization of those economies. So we're seeing more capital look at Europe, and that has led us, in part, to increase our relative activity in Europe. I mentioned that we're a sponsor-driven lender, so we do tend to follow our top institutional sponsors to where they are more active, and we're seeing a number of the big-name private equity firms buying more real estate in Europe today than they have been in prior years. So Europe is screening very favorable, and yet given the size of the US market, the liquidity of the US market and the transparency of the US market, we don't think Europe will ever surpass the US in terms of the volume of business that we're doing.
Stewart (26:21): So now this is the part, Charlie, where we ask you to dust off your crystal ball and look at forward-looking opportunities. Where do you see the most attractive opportunities in real estate debt over the next, call it 12 to 18 months? I've got a couple of fun ones for you on the way out the door, but this is our last business focus here.
Charlie (26:44): I'll assure anyone listening to the call that I don't routinely consult my crystal ball to make investment decisions. But as we're looking at the environment today, I think a couple of things are clear to us. One, real estate credit continues to screen very attractive relative to many other investment alternatives. We are often compared to direct corporate lending or traditional private credit and real estate credit, is screening attractive to direct lending today by virtue of the fact that our industry has just gone through its recession, and we haven't seen anywhere close to the inflow of capital into real estate direct lending strategies that you've seen into corporate direct lending strategies. Layer on to that, historically, real estate credit and corporate direct lending had a very low correlation, roughly 0.2 correlation.9 So real estate credit is a great complement to a direct lending strategy.
We also see real estate credit screening favorably compared to real estate equity in many instances. We are still in a fundamentally elevated base rate environment, and our macro outlook is for relatively slow growth in the near term, which does indicate that potentially you'll see a more muted recovery in the near term for real estate equity than we've seen in some prior cycles. So, if I can deliver to my investor an equity-like return in the debt position of the capital stack as a result of the elevated base rates today, that is very attractive. I think we are going to see a continued increase in our lending activity over the next 18 months. We have fairly ambitious originations targets and you're going to start to see us expand into some of those other property types where you've seen a firming up in valuations, whether that may be other multifamily and industrial property types, or maybe even on a very selective basis, some office or retail investments. You're also going to see us doing more in Europe than we have historically as a result of some of the factors that I previously mentioned.
Stewart (29:30): Very cool. It's been a great education on real estate credit. I really appreciate you taking the time. I've got a couple of other ones for you in the way at the door, and one really speaks to the culture. You mentioned culture at Invesco. The question goes, what characteristics are you looking for when you're adding members to your team? It's not what school they go to, not are they Excel wizards, but what characteristics do you think are important when you're adding members to your team?
Charlie (30:01): First and foremost, we're fiduciaries. We have to hire individuals with the utmost integrity, and if there's any indication of anything but that utmost integrity, that's going to be a disqualifier. We are a very collaborative team, so we look to hire people who we’ll enjoy working with, but we're also a very hard-charging team with high expectations. So we're looking for folks who have grit, determination, and ambition. Our business is growing, and we're fortunate to be able to offer a lot of opportunities for those people who work hard, but our expectations are going to be very high. And I think one thing that is really fundamental to me, I have come up in this industry being a little bit of an outlier as a gay man in an industry with very few people like me. And so I'm always looking to hire people who have varied backgrounds, varied perspectives, and complementary skillsets. I don't want to hire people who think exactly like me or who have experience exactly like me. I want people who are going to push me, push my assumptions, and help me and our existing team make better investment decisions.
Stewart (31:39): Yeah, that's great. I mean, that's a great answer. Alright, last one. Fun. You get to have dinner with up to four people, including yourself, so you can have one, two, or three guests, who would you most like to have dinner with, alive or dead, Charlie Rose?
Charlie (32:13): I would first have dinner with my husband's grandmother, who I never met but was so formative in his life and experienced a type of adversity that I could never imagine. I would have dinner with one of my investing heroes, Warren Buffett, and I think I would have dinner with someone who deeply understands the political economy and has been deep in the trenches. So I'm not going to make a political decision. It would be either George Bush or Barack Obama, someone who has sat in those rooms and had those conversations and has an insight into the way that leaders around the world in the political economy are thinking today.
Stewart (33:18): That's awesome. Thanks so much. The title of the podcast, Real Estate Credit: The Latest on Lending Markets and Opportunities for Insurers. Our subject matter expert has been Charlie Rose, Managing Director and Global Head of Debt at Invesco Real Estate. Charlie, thanks for being on. Thanks for taking the time.
Charlie (33:35): Thank you, Stewart. It's been a pleasure.
Stewart (33:38): Thanks for listening. If you have ideas for podcast, please shoot me a note at stewart@insurance.com. Please rate us, like us and review us on Apple Podcasts, Spotify, or wherever you listen to your favorite shows. Tune into our new YouTube channel at Insurance AUM Community. We are the home of the world's smartest money at InsuranceAUM.com.
1. As of December 31, 2024.
2. Institutional Real Estate, Inc. Data as of December 31, 2024. Real Estate Managers Guide 2025 report ranked IRE in the top 15 real estate managers by total gross value of real estate AUM. Invesco pays a standard subscription fee to obtain these third-party rankings. Any reference to a ranking provides no guarantee for future performance results and is not constant over time.
3. As of December 31, 2024.
4. Source: U.S. Board of Governors of the Federal Reserve System (Z.1 Financial Accounts of the United States) Q3 2024 for Commercial Real Estate Loans $’s Outstanding (as of March 31, 2025, most recent data available).
5. Source: Bayes Business School, City University London as of December 2023.
6. GreenStreet Commercial Property Price Index as of October 1, 2024.
7. Source: Federal Reserve. Data as of December 31, 2024.
8. Sharpe ratio: CRE whole loans, 3.20; CRE equity, 0.67; DM equities, 0.61; HY corp bond, 0.42; IG corp bond, 0.45; Infrastructure, 0.30; REITs, 0.02; Govt bond, -0.17. Source: Bloomberg, EDHEC, MSCI and Invesco. REITs = FTSE EPRA Nareit Europe REITs Index; Govt bond = ICE BofA Euro Gov Index; IG Corp bond = ICE BofA Euro Corporate Index; Infrastructure = EDHEC infra300 Index; HY corp bond = ICE BofA Euro High Yield Index; DM equities = MSCI World Index; CRE whole loans = MSCI Pan-European Quarterly Fund Index; CRE equity = NCREIF Fund Index Open End Diversified Core. The risk-free rate is the Bloomberg EUR Europe Govt 5yr benchmark. CRE whole loans are until Q3 2024, the most recently available data.
9. Source: Invesco Real Estate using data from the following indices: Private Real Estate Debt – Giliberto-Levy High-Yield Real Estate Debt Index (G-L 2), Direct Lending – Cliffwater Direct Lending Index. Trailing 5-years of data, last 5 years of quarterly returns annualized 2020Q1-2024Q4. An investment cannot be made into an index. Past performance is not indicative of future results. Diversification does not guarantee a profit or eliminate the risk of loss.
Investment Risk Warnings
Property and land can be difficult to sell, so investors may not be able to sell such investments when they want to. The value of property is generally a matter of an independent valuer’s opinion and may not be realized. The value of investments and the income from them can go down as well as up (this may partly be the result of exchange rate fluctuations in investments which have an exposure to foreign currencies) and investors may not get back the amount invested.
For strategies invested in a particular sector, you should be prepared to accept great fluctuations in the value of the portfolio than for a strategy with a broader investment mandate.
Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date.
Generally, real estate assets are illiquid in nature. Although certain kinds of investments are expected to generate current income, the return of capital and the realization of gains, if any, from an investment will often occur upon the partial or complete disposition of such investment.
Investing in real estate typically involves a moderate to high degree of risk. The possibility of partial or total loss of capital will exist.
Investing in commercial real estate assets involves certain risks, including but not limited to: tenants' inability to pay rent; increases in interest rates and lack of availability of financing; tenant turnover and vacancies; and changes in supply of or demand for similar property types in a given market.
For Institutional Investor Use Only
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities. Invesco Distributors, the US distributor for Invesco’s retail products and private placements. Both are indirect, wholly owned subsidiaries of Invesco.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Invesco is not affiliated with InsuranceAUM, Jon Gray, Warren Buffett, George Bush or Barack Obama.
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Charlie Rose, Global Head of Debt at Invesco Real Estate, outlines where we are in the cycle for real estate credit, where he’s seeing attractive opportunities, and how his team is approaching the space.
Charlie Rose, Global Head of Debt at Invesco Real Estate, outlines where we are in the cycle for real estate credit, where he’s seeing attractive opportunities, and how his team is approaching the space.
Stewart (00:00): My name's Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you and thanks for listening. We hear a lot of really nice comments from folks about what we're doing and our podcast and whatnot, and we really appreciate that. Right? So we've got folks on the LP side, the GP side, and then some folks in between. But I just wanted to say a big shout out and thank you to everybody who listens. And if you like us, tell your friends. It's a small audience, small group of people. Money's huge, but the number of people, the community is relatively small. So it's interesting that the idea for our podcast originally came out of someone at Invesco, and we're joined by someone from Invesco today and we're going to be talking about something that hasn't gotten nearly as much attention as it used to, which is opportunities in public markets, finding relative value in fixed income. And we're joined by Matt Brill, who's the Head of North America Investment Grade Credit at Invesco. Matt, thanks for taking the time. Thanks for being on. I look forward to hearing what you have to say today.
Matt (02:34): Thanks for having me. Happy to be here.
Stewart (02:36): We always started off with a little get to know you. We'd love to know where you grew up and what was your first job, not the fancy one.
Matt (02:44): I grew up in Norcross, Georgia, which is just outside of Atlanta, suburb of Atlanta. So I grew up here pretty much my whole life. I did go to school, but in Virginia, Washington, Lee University in Lexington, Virginia. And then I graduated in 2002, so it was right after September 11th in 2001, and the economy had a recession. Things were a little harder in the job market right then, and I had a few offers on the table and they all kind of got postponed. And so I came back home and took a job working actually in the mail room of a company. So I worked in the mail room for several months, and if you've ever seen the Michael J. Fox movie Secret of my Success, I kind of pulled a little bit of that, of working out of the mail room right into the finance department and then other areas from there. So yeah, that's how it all began.
Stewart (03:25): That's interesting. I worked in a mail room too, for a minute, and here's a really weird reference, but I think there's a really interesting BMW motorcycle dealer in Norcross that deals in old race bikes and stuff like that. They're like a specialty BMW dealer. And when you said Norcross, it reminded me of that. So can you talk to us a little bit about how you got from the mail room into the job that you're in today? And the reason I ask is that there's people out here that are earlier in their career and sometimes when you're early in your career, it's hard to figure out a path to getting to be someone as senior and successful as you are. So what was the path?
Matt (04:12): I always had an interest in finance and wanted to take classes in it, and obviously I got a finance degree, got out of college, and then you realize that a lot of other people have similar things to you, so you have to start separating yourself and how can you do that? Studied for the CFA, took the CFA, eventually got the CFA designation that I know you have. That's a great way to separate yourself. But then I also just went to individuals within the company I was in. Once I got my foot in the door, I said, “Hey, can you give me a project to work on? I'd love to do something for you. I'll do it for free. I'll work extra time learning this.” And they see somebody's willing to do that, trying to get their hands dirty, if you will, in the finance department. And they realized that they can trust in you and start giving you extra things and they say, actually this guy's pretty good. Maybe we'll hire him full time. So just asking for more and then trying to get any kind of credential that can separate you versus the rest of the competition.
Stewart (05:01): Yeah, that's a great point. I mean it's a little bit like Matt Damon in Goodwill Hunting, right? It's like, Hey, wait a minute, this guy's really smart. I want to switch over to Invesco's platform. We've had a number of your colleagues on before. Invesco clearly brings a deep bench across public and private markets. Can you give us a sense of where you and your investment grade team sit within that broader Invesco ecosystem?
Matt (05:26): Invesco, talking big picture, has a little less than $2 trillion of total assets under management. Within fixed income, we have about $500 billion, so almost a quarter of the company's assets. My team, which is the investment grade credit team, has about a $100 billion dollars in total assets. We manage money in core strategies, core plus, corporate bonds. We also manage short-term strategies. We manage institutional as well as retail. Within the institutional space, we'll manage for pension plans, banks, sovereign wealth funds, and last but not least, insurance. So we can kind of do a little bit of everything. I think what we really try to do is focus on customizing for the client because, at the end of the day, the foundation of what we're going to do is the same, but then each client's going to need different things, different parts of the curve, different asset classes, different risk tolerance, and then also different accounting metrics for each client that we work for, which can somewhat drive what we're going to invest in for them.
Stewart (06:22): Yeah, you've got a great distribution team led by Chris Mechem over there and I think he just joined, I think Blake Mock just joined over there. So obviously making a big commitment into the insurance space. Let's talk macro for a second. There seems to be a tariff a day announced or taken away. It has certainly created some volatility. What's changed in your outlook recently and how has that influencing how you're positioning your portfolios today?
Matt (06:51): It's obviously been a long month, long year early in April, so a lot going on constantly. I try to listen to the administration with an unbiased approach. I think it's always very difficult with politics, but there are a couple of things that I've heard out of the administration recently that I'm taking some comfort in, but also just trying to position the portfolio potentially around or try to understand if it's accurate or not.
This first one is going to sound a little bit silly. It's simply out of Trump's mouth is “The bond market is beautiful right now,” and that was a true quote by him. What does he mean by that? It basically meant that it was dysfunctional before and now it was acting appropriately. I'm going to get to that in a minute, but that's important because if the bond market is going all over the place, it's really hard to invest. And so the fact that the bond market kind of got Trump to pause on those tariffs rather than the stock market or even I would say versus FX or even the dollar, it was all about bonds. And at the end of the day, if the bond market needs to function in the eyes of the administration, that's very good for us.
Another thing that I've heard out of administration is the quote from Trump that “I'm flexible,” and what does that mean? We heard the narrative that he may be even trying to engineer a recession. We've heard things that he may be wanting a slower economy, and I never really bought into that. But when he was saying that he's flexible, it gave me a little bit of comfort that he's not just purposely going to drive the economy in recession, he's not going to drive the car right off the cliff on purpose.
So the flexibility I think is key because we're going to own things other than treasuries. The treasuries are important from the bonds that are beautiful or the bond market is beautiful, that's treasuries. But credit is going to matter on whether he's flexible or not. Is he going to allow certain exemptions? Is he going to set up an economy that is going to be able to get through this, even with tariffs maybe at a higher level than a lot of people had expected?
So I'm trying to evaluate all this. I'm trying to figure out from a credit standpoint, can we buy things other than treasuries? And then, from a treasury standpoint, is the US economy losing its favorite nation status? The strength of the dollar and the place that everybody can always go to in the worst of times, it's usually been the dollar and right now has been acting very strange. So a lot going on there, but overall it's going to be volatile, we know that, but we'd like to try to glean some things out of the mouth of administration.
Stewart (09:04): Yeah, it's interesting. When I taught there was always a lot of focus on equities and my experiences in running money is that when you go into the investment committee, if there's 1% equities, that's what you're going to be talking about. Not the bonds, not the 99% bonds, but when it gets down to it, the bond market is a very, very important market and a very important indicator of economic activity in the way that it forecasts inflation, really. I mean it's just an interesting point that you're making about the importance of watching the bond market and how it's anticipating all of the news coming out. Let's just talk about sector preferences in IG for a second and just zooming in, right, in the corporate investment grade space, are there particular sectors that you're leaning into or steering clear of right now?
Matt (09:59): Yeah, so there's been a dispersion of late. Pre-tariffs, everything was pretty bunched together. There really wasn't a large dispersion between sectors within the investment grade world or even within high yield, but that has created some opportunities. Just generically though, let me just state a couple of stats, which I think are interesting. So we were at a period of time where we had high yields but low spreads. So if you were looking at spreads coming into this year, they were basically in the bottom five percentile over the last 10 years. Now you've got yields that are still in the 90th percentile, meaning they've only been cheaper 10% of the time. So we know yields are good, but they've been generally good most of the year. But spreads have kind of gone from that low 5th percentile, they've been cheaper 95% of the time, to now around 40th percentile.
So basically they're in the middle, the median there. So I'd say you're in now an environment where you have high yields, very attractive yields, and you also have semi attractive spreads versus really attractive yields and not attractive spreads at all. So I think a lot of investors, to start the year, were thinking, “Should I just simply be in treasuries and not buy anything and not buy consumer non-cyclical or whatever part of the economy?” Even if we go into recession, it didn't make sense to really buy a lot of credit, in a lot of people's eyes. So now that we've got values that are I think pretty decent everywhere now, we can kind of pick through them and find the best value within that.
So, this situation we're in right now is I think atypical, or normally, when you have a crisis you think, okay, it's going to be the banks. The banks are going to be the ones that are going to have problems. I need to sell the banks first. You saw that in 2023, you saw it a little bit in 2022. Obviously, COVID was really quick, but the banks really got beaten up quickly then and all that stemmed from the great financial crisis. So everybody was always thinking that if there's a problem in the US economy, I need to sell the banks.
But we look at the banking space and it actually seems really, really solid. We think there's going to be some deregulation that's going to occur that will help in some capacity. We think companies or banks specifically have been preparing for a recession for a number of years. You go back to 2022, Jamie Dimon was talking about a recession. It never happened, but the bank balance sheets are in really good shape because they thought this recession could occur. So overall, we would, in a normal crisis, be fleeing from banks, but we actually think they're a bit of a safe haven within it right now. And post SVB, you saw another round of increase of capital and defensive mechanisms out of banks. So overall we love the banks. We think there's a great value there. They've all backed up 30 to 50 basis points, so that's a pretty good spot.
We do also like the utilities. You think about the AI revolution, which maybe a little bit slowed down with what's going on with tariffs. We're talking today, there's some news around Nvidia and them not being able to sell into China, but in general, you still are going to see a huge AI revolution out of the United States and one of the things that's going to fuel that is power and power from utilities. So we like the utility space. We think if you go into recession, utilities are firing. We think if you have an AI revolution, utilities are going to do even better. So we like that.
An area that I would've told you or that I've kind of generally been negative on for a while here has been energy. A lot of people think that energy is a Trump trade and you hear things like “Drill, baby drill,” that's going to be great for energy. Well, not necessarily in our opinion because if companies are drilling more, exploring more, bringing more out of the ground and you've got, with that, more supply, you're going to potentially have lower prices, which may not be good for those credits. So we're not necessarily thinking that that is an immediate get-behind-it-type trade because the administration is going to be all for it. We think it actually could have negative effects, especially if you go into recession, energy may be hurt.
Now all that being said, one of the things we've been seeing recently is because energy has underperformed, we're seeing some dollar prices that are really interesting on bonds. I think that that's a different dynamic than we could normally have. There's some energy bonds that are trading in $60 - $70 range that are investment grade rated, and their spreads are still 250 over. So they're not distressed, but they have lower coupons. They have coupons of call it 4% and given where long end yields are on the 30 year treasury, that has created a dynamic where you can buy 30-year energy at between 65 and 80 cents on the dollar for high quality investment grade companies that even if oil prices get beaten up, we think that will actually do okay. So, I've been negative on energy, but now we're getting to the point where we're finding specific value and that's why fixed income is interesting. It's not just one company. It's not just one part of the curve. It's all the thousands of different bonds that are out there, and we can find interesting ways to play every sector or even individual companies.
Stewart (14:29): That's super helpful and it reminds me of discussions that we would've had running fixed income. It feels very comfortable to me to have that conversation. Let's talk a little bit about credit quality trends and we've seen a couple of high profile downgrades. Are these isolated events or do you think we could be on the front end a broader trend in investment grade credit?
Matt (14:49): When you hit COVID, the rating agencies kind of, I don't want to say panicked, but they definitely got very negative very quickly. And you saw downgrades of companies like Ford and Delta, Occidental Petroleum. I think you even saw Continental Resources. So there's a slew of downgrades that occurred and then when you got in 2021, which is a little bit of recovery, and then 2022, even with the inflationary aspects, we had to go along with the Fed hiking, we're seeing a huge ratio of upgrades versus downgrades and that's what we often try to take advantage of in our funds is finding those BB credits. They're going to get upgraded to investment grade. You can usually can predict them, especially if you have good analysts, you can predict them. But when the tide is rising and you have the wind at your back, like you did the last several years, we actually saw a ratio of around four to one.
So four times the amount of upgrades, rising stars, versus downgrades, what we call fallen angels. So those are great opportunities for us to add alpha to the portfolio because there's a lot of investors, whether they're on the pension side, sometimes insurance side, even a lot of the banks, they can only buy investment grade and so they can't even buy it. Even if they were 100% certain that something's going to be upgraded within the next six months, they can't go buy it. Usually the bigger buyers are going to be your institutional investors. So the broader base that you have of buyers and the bigger the pool that you have that can buy investment grade bonds, that's going to drive prices up and spreads down. So we can pick these high yield companies that come and then once they get more eligible for a large buyer base, it's very, very good for them.
So the wind was at your back, you had four to one, but recently you've had names like Celanese and Nissan. Celanese is a chemical company. Everybody obviously knows Nissan, and the auto space and interesting enough, Nissan was kind of having troubles pre the tariff situation, so it wasn't really a tariff thing there, but they were a little bit idiosyncratic. I would call it basically poorly managed at both of those companies. So that was not indicative of the market. Now the next legs forward are really going to be what we're worried about. Autos is in the crosshairs, you've got chemicals now in the crosshairs. Consumer cyclicals certainly will be in the crosshairs of tariffs. So that has me concerned that there is going to be, this four to one is certainly not happening anymore. We've kind of gravitated closer to one to one and we might actually probably, we're not predicting this yet, but I would say 2026 will very likely have more downgrades than upgrades.
But what's interesting is the market adjusts, right? The market is out in front of this to a reasonable extent. The pick as we call it, or the additional yield you get to buy BBs versus BBB-, which is the lowest portion of the investment grade space, was around 50 to 60 basis points just a couple months ago. And now today as I speak to you, it's around 125 to 130 basis points. So you are now getting paid a lot more to go buy a BB versus a BBB- than you were to start the year because the market is expecting there to be more downgrades because the market is expecting more volatility.
So, in my space as an active manager, that's great. It gives me more opportunity, bigger sandbox with more opportunities to do something with. But I'll go back to the comment I made about the banks earlier because I think it's important for the rest of these companies. Because companies have been expecting a recession in 2022, 2023, they kind of paused a little bit in 2024 and thought maybe it's all clear, but they didn't go out and lever their balance sheet. They were in much better shape; they've got great liquidity profiles. They were in very, very good shape for a recession that is likely to come. It's 30%, 40%, it's a decent chance we're going to get a recession. But if it comes, I don't think these companies are going to be hit nearly as hard as they would've been in the past because they've been waiting for it and the proverbial winter is coming. It hasn't come yet, but they're prepared for it.
Stewart (18:20): Yeah, it's super helpful. So just changing over to timing risk versus being defensive and you mentioned spreads being wider. For insurance CIOs and portfolio managers, and some folks run fixed inside, some folks outsource, it just depends, but they're watching the spreads widen the same as you are, and the natural question is when do you go risk on versus staying defensive? How are you thinking about that trade-off in today's market? And essentially, are the spreads reflective of a recession and that this is a good opportunity?
Matt (19:01): The way I’d phrase that is spreads have widened from very tight levels out to median levels as I stated earlier. So you've got about 35 basis points wider, call it from mid 70’s to 110. Now normally – this is spread over treasuries – normally investment grade bonds in a recession would have at least a spread of 150 basis points. So, we are not pricing in a recession. We have widened considerably, but we're not pricing a recession. I'll say there are other things, there's lower dollar price than normal. If you go back to 2022, the adjustment of 400 or 500 basis points caused a lot of bonds to be worth a lot less to par. Less dollars put in, you should have to get paid less spread. So the dollar price of the index is lower, which should be adjusted for. The liquidity of the market is much better. Portfolio trades are being able to be used, using ETFs to offset risk at the banks. Liquidity is better than ever. Your quality within this space, so investment grade as well as high yield, there is a much greater percentage of higher quality rated credits within IG. And then even within high yield, you've got more BBs than ever before or for a very, very long time at least. So there's a lot of mitigants to why spreads maybe shouldn't be all the way to 150. But again, if we do go in recession, you are probably going to have to go wider.
The one thing I'll point out to people is that it's very obvious, and it's very easy to avoid risk, and it doesn't necessarily make it the right call. So historically the market will bottom about nine months before earnings bottom. And so, if you were to sit here today and say, well Matt, I know that these companies are going to miss their earnings over the next 6 months and we're obviously going to go into recession, then why would I buy anything? Why would I buy stocks? Why would I buy credit? I can obviously buy them cheaper later.
But you go back to 2020, the market bottomed 9+ months before any earnings did and GDP did. You go back to pretty much every historical recession, the market bottoms before the market looks through. So that's the hard part about adding risk. It's hard to convince yourself. It's also hard to convince your boss and your shareholders that you should be adding risk, or your risk management committee. Because you have to say, well, I know things are bad and they're probably going to get worse, but guess what? We have to do this before everybody else does because the market's going to start to price it in. So if I look out to 2026 and I say, I think all this is going to be over by 2026. We're going to have tariffs, but maybe they're not going to be at the extremes. I think the economy might've hit a recession.
This is 2021. If I think that that's too early, if the market will identify this well advanced of 2021, and I think you actually start to have to invest now, which sounds crazy because you know you're going to go through some volatility over the period of time, but you cannot wait until the river card is played. You cannot wait until the earnings start to show up and they've improved. And so that's the balance, and that's why it's really hard to have this job because you going to kind of look like an idiot for a little bit and it's impossible to be exactly right, but you have to have this idea where there's value and then trying to look through and realize the world will not end. So there's going to be dislocations and try to keep enough liquidity to take advantage of those.
Stewart (22:07): It's interesting too that when I managed money back when the earth was cooling, there was something called core plus, but I don't think it means the same thing today. And you manage both core and core plus mandates. Can you unpack what plus means today? What's in scope for that sleeve and where are you seeing the most compelling relative value right now?
Matt (22:33): In the technical definition of core plus, the plus generally would mean non-investment grade rated securities, having the ability to buy non-investment grade securities, which historically has generally been being able to buy high yield and emerging markets. Now the market has evolved. It has enabled us to buy other areas of the structured credit market. We generally don't buy very low within the stack, within structured credit, we're generally AAAs, but there are opportunities there. There's other things called whole business securitizations. There's things within CLOs. There's a lot of different areas that we can add kind of spice to the portfolio that would not be directly down the middle. When most people think of core, they're thinking of treasuries, agency mortgages and corporate credit, IG corporate credit, to be specific. So we can add different asset classes in small size and they add yield, but they actually will zig when the rest of the market is zagging to a certain extent, so they're not a hundred percent correlated and some might even have negative correlation.
So you can reduce your overall volatility by having a small amount of these different asset classes within the portfolio while getting more yield. That's what we try to do. And so that's what core plus enables us to use these expertise for multiple different asset classes. Again, it's going to look and act like a bond fund at the end of the day. We don't really want to take equity-like risk in a bond fund because I always tell people, if you have enough time, you want to own stocks. Stocks will outperform bonds over 50 years, probably over 10 years and certainly over 100 years. But not everybody does, and not everybody has the willingness to sit through that volatility as we've seen over just the last few weeks. So you need to have something in your portfolio that's going to be that damper of volatility, which is what fixed income is, but we can get you a little bit more yield and a little bit more spice by having the plus components to it.
Stewart (24:09): Matt, I can't thank you enough for being professor for a day today. I've learned a lot and I know our audience has too. I've got a couple of fun ones for you on the way out the door. One of the things is when you are adding to your team at Invesco, what characteristics are you looking for when you're hiring folks, not the school they went to or are they skilled at Python or whatever, but what characteristics are you looking for when you're adding members to the team?
Matt (24:38): The number one thing that I want to see is do they actually want to do this job? Meaning would you do this job for free? Now we are going to pay them, but at the end of the day, do you like markets? Do you think this is interesting? And so usually the question I'll ask most people that I interview is, can you tell me a book that you've read recently, an article that you've read? Now, podcasts are much more in vogue, so I'll ask podcasts that you've listened to that talked about investments, that you learned something about investments. Because if you're doing this on your own time, this means that it's actually interesting to you and we go through this and I honestly really enjoy coming into work. I don't love when the markets are going crazy, but I do love watching things happen real time. We have a scoreboard at the end of the day, we know we did well or we know we didn't do well. It's very, very easy to know and that's quantitative aspect of it, and I like that people that come in and could just see the markets every day and say, this is really interesting and here's how I could try to make money off of it. That's what I love and that's why we try to hire people that have that mindset.
Stewart (25:34): Yeah, that's super interesting. I mean, if you get a chance, you can mention this podcast. We would certainly appreciate that, Matt. And the last one for you is lunch or dinner with up to three guests, you included. Don't have to be three, could be one, two, or three. Who would you most like to have dinner with, alive or dead?
Matt (25:55): Yeah, that's a great question. So I'm a pretty simplistic person. I'm sports and markets almost exclusively, and the family, I suppose. So those are kind of the three components of my life. So I'm going to start with sports. My Spanish isn't great, but it's not bad, but I'd have to have Lionel Messi at the table. My wife’s Argentine. He's the GOAT. I definitely would need to have him at my table and possibly have a little Google translator in my ear or something if necessary. But I'm also an investment guy and the greatest, the GOAT there is Warren Buffet. So I have a Warren Buffet at the table as well. And then because I have two daughters, I have a son as well, but because I have two daughters, I'm going to have to have Taylor Swift at the table. And so Taylor Swift is going to be the envy of my children to have had lunch with her would be next level. So that's where I'm going.
Stewart (26:43): Yeah, my daughter, I swear to you, would think I was cool for the first time ever if I managed that. That would be very cool. I really appreciate you being on, man. Thanks for taking the time. You did a great job of covering this market and really appreciate you, you stopping by.
Matt (27:00): Yeah, thanks for having me.
Stewart (27:02): We've been joined today by Matt Brill, who's the Head of North America Investment Grade Credit and Senior Portfolio Manager at Invesco. Thanks for listening. If you have ideas for podcasts, please shoot me a note at Stewart@insuranceaum.com. Please rate us, like us and review us on Apple Podcast, Spotify, Amazon, or wherever you listen to your favorite shows. My name's Stewart Foley. We are the home of the world's smartest money at InsuranceAUM.com.
For Institutional Investor Use Only
All data sourced to Invesco unless otherwise indicated.
Investment risks
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Non-investment grade bonds, also called high yield bonds or junk bonds, pay higher yields but also carry more risk and a lower credit rating than an investment grade bond.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
All material presented is compiled from sources believed to be reliable and current, but accuracy can-not be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any in-vestment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an in-vestment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
NA4437266
What’s next for the bond market? Matt Brill, Head of North America Investment Grade Credit, discusses his latest outlook, including sector preferences, credit quality trends, and what it means for portfolio positioning.
What’s next for the bond market? Matt Brill, Head of North America Investment Grade Credit, discusses his latest outlook, including sector preferences, credit quality trends, and what it means for portfolio positioning.
Rob: Welcome to Compound Insights, a podcast by CFA Society New York. I'm your host, Rob Rowan. I'm glad to welcome a repeat offender here at CFA Society New York Compound Insights podcast, Peter Miller. He is a CFA. He is Head of Institutional Client Solutions for the Invesco Solutions team, which develops and manages asset allocation strategies and portfolio solutions across institutional and private clients. And today where we're going to be speaking mostly about is insurance company allocations. Prior to joining Invesco, he served as a Senior Vice President with PIMCO's financial institutions group where he focused on general account investments and risk managed fund solutions for their insurance clients. And, before that, he spent nine years in variable annuity hedging and risk management as well as insurance portfolio management and pension liability investing with The Hartford. So Pete, welcome back to the podcast.
Pete Miller: Thanks a lot, Rob. It's great to be here.
Rob: Since you were on the podcast almost a year ago, we've had an awful lot of things change. We want to drill into a few of them later, but how would you say the allocations have shifted for insurance CIOs over the last year?
Pete Miller: Well, you're definitely right. A lot has changed in the last 12 months, no doubt about that. If you think about the broader market backdrop, lots of movement in interest rates. Just looking interestingly, the 10-year Treasury is actually very close to where it was 12 months ago about 4.40.1 But a lot of movement around that. Some of that is kind of economic conditions and developments, but a lot of it, especially the last couple of weeks, has been around the election. Of course that's a big event here in the US. And I think with Trump being reelected, there are certainly expectations that his tariff policy could drive some more inflation. Tax cuts and fiscal deficits could also drive more inflation. And so we saw an initial, major increase in rates. It's since then kind of ebbed a little bit. Certainly that's I think the number one story of late.
In terms of allocations you mentioned with insurance companies. The interesting thing is I haven't necessarily seen a lot of major changes. I know we'll get into some specific asset classes shortly, but I think it just speaks to the long-term mindset for really most, if not all, insurance companies. And generally not reactionary to kind of near-term market changes, but more, on the margins, making adjustments with their portfolios in light of current conditions. That that's certainly what we've seen historically and it's been the same story over the last 12 months.
Rob: I do think this makes this sub sector of the asset in our world, if you will, exceptionally interesting to watch because the only organizations that have longer time horizons than insurance companies are endowments, which are probably comparable, and single family offices. That's it. So it's a wild old thing. And by the way, we are recording this – in case anyone's listening to this after the fact – on November 14th, 2025. So God knows where we're going from rates here. But now one of the things I do want to speak with you about, that's also been – well, it's started being hot. I think we did talk about this in the last podcast was private credit, the real hit. How are insurance companies allocated given their longer term view that we're just talking about?
Pete Miller: Yeah, you're spot on. Private credit has been a huge theme for insurance and I think for institutional clients broadly speaking, but certainly for insurance. And as you noted, some of that demand is because private credit tends to be longer term in nature. Oftentimes it's accessed through, LP fund structures where the capital may be locked up for a period of years. For most insurance companies that's perfectly fine because as you noted, they have very long time horizons typically.
But I would say that the new developments of late has been there's been a continued demand for corporate credit and private corporate exposure, whether that be through kind of middle market or larger direct lending strategies, even syndicated bank loans. What we've seen very notably over the last year or so is a very meaningful increase in demand for non-corporate private credit. So you know asset based lending, private strategy specialty finance, you know things where insurance clients and other institutional investors are in many cases they're trying to get closer to or maybe even do direct origination themselves to sort of cut out a lot of the intermediation you typically see with traditional mortgage bonds or ABS bonds. And by doing that, the idea is to capture and retain more of the spread that you get in those private credit exposures and ideally not take on more credit risk.
So generally speaking, we're talking investment grade exposure, but that incremental spread that the investor, and insurance investor in our case here, the incremental spread that they're able to capture is really a function of more complexity, maybe more structuring work that needs to be done, but it's really not just a matter of going down in credit quality and taking on more risk to get that incremental return.
So that that's been a very notable theme in our insurance conversations over the last year and you've certainly seen a lot of activity. You've seen a lot of interest. I think it will continue to see a lot of interest. Many managers are really working hard to deliver that exposure for their clients and it's such a huge opportunity set. It's a massive market that encompasses so many different types of exposure that I think there's no shortage of opportunities. So I think it is a secular trend that's going to continue for many years.
Rob: Right, non corporate, private credit is enormous. Are they looking at any particular sub sector on that side?
Pete Miller: The short answer is yes. But the interesting thing is different insurers will have different views on which sub sectors they like or they're particularly interested in. And it could be a function of their liability profile. Are they looking for the longer dated structures that might align nicely for asset liability management purposes? Or maybe even if it's a somewhat tactical view on something that might be particularly attractive from a near term valuation standpoint? But we're talking about things like in a residential mortgage loans maybe not qualified mortgages that that don't typically go into the traditional bonds packaging, if you will. You could be talking about student loans. You could be talking royal music royalties. You know, different sorts of almost infrastructure type projects. There's almost an infinite number of underlying collateral types that that we've seen. And insurance companies gravitate to, so not one in particular. I think that the different sub sector demand does kind of vary across insurers. But again, I think that's one of the things that makes it a likely long term, secular trend. It's such a broad universe of potential exposure and it's so large that I think it's just going to continue evolving.
Rob: Yeah, I mean, you're talking about a massive difference in the risk profiles of those things. You know, non QM2 mortgages to student loans. They have a lot different things going on with each of them. And you know it's exceptionally interesting and I presume that some of those are connected to macroeconomic things too. So it is pretty interesting.
Well, the other thing I am curious about is how they're handling the long-term secular changes in rates. Have they shifted their asset allocation to either handle some of the long-term risks to those long-term investments? Or are they kind of keeping everything because rates aren't that much higher than they were or they're sort of historically normalizing, if you will?
Pete Miller: Well, it's a great question because in short, I would say yes they are adjusting on the margin. But as a general rule, we haven't seen a lot of meaningful shifts in terms of duration positioning or expressing interest rate views or bets, for lack of better term. And I think part of that is, as you noted, we've talked about the fact that as we were talking today, longer term, rates have actually stabilized where they were roughly speaking a year ago. But even if we had this conversation a few months ago when rates were even higher, we didn't necessarily see a lot of meaningful shifts in insurance portfolio allocations or duration positioning. And I do think it really comes back to what we talked about a few minutes ago. Most insurers are very long term investors. And they have, generally speaking, a large stock of assets that are already invested with a certain liability profile in mind. And what they're really doing is making adjustments on the margin. So it could be with new business flows coming in. It could be the reinvestment of principal and interest coming off their existing portfolio. But what that means is shifts tend to be gradual. It tends to take time to really see that show up in their broader portfolios and even then it's still by and large a function of liabilities that they're onboarding today. And that's kind of what drives their interest rate positioning and their duration view. So not really a ton of, at least from what we see, not a ton of what I've described as tactical, meaningful shifts or bets on the direction of rates.
An interesting thing too is higher rates, especially a rapid increase in rates take a lot of investors with fixed income exposure, which is, you know certainly the bulk of investment insurance company portfolio exposure… You tend to think of a sharp increase in rates as negative for portfolios, right, and kind of a shock to asset values when rates go up, bond prices go down, of course. And that's true, but by and large, the insurance industry’s broader exposure to rates, you know, rates rising is actually a good thing and maybe they prefer to see it happen a little more gradually. But it does ease a little bit of the pressure on some minimum guarantees on a lot of life and annuity products. It does allow for a little more headroom that way. And again, if you're the CIO at an insurance company and you're looking at reinvesting principal and interest rolling off of your existing assets or looking at investing new money for new business coming in the door today, higher rates is actually your friend. So, I think the bottom line for all this is it's a very nuanced picture and with that long term view, you don't really see a ton of tactical duration positioning. It's really, kind of the proverbial oil tanker that takes a long time to kind of change course. I think that's a fair way to characterize most insurance portfolios.
Rob: Yeah. Although it is, as you say, easier when one portion of your oil tanker is paying, you know, civil corporate debt is paying in excess of your long run goal. That does give you a little headroom. So those things for sure.
Well, let's shift gears a little bit because life companies were often stalwart, very regular investor in commercial real estate. And that investment level has declined overtime as the risks have risen in commercial office but there are a lot of other sub sectors. So let's talk a little bit of that like that. Would you like to start with office or one of the other sectors?
Pete Miller: Yeah, absolutely. You're exactly right. Real estate, especially real estate debt, is a staple. And many insurance portfolios, especially life insurance portfolios where high quality, low LTV,3 low risk mortgage loans comprise a pretty healthy proportion of a lot of life company portfolios. But even real estate equity is something that has been reasonably popular as part of the alternatives allocation in a lot of insurance portfolios. And you're right, office I think is the poster child for a lot of the stress that we've seen in the real estate market really since COVID. And it's kind of a combination really of higher rates. It's difficult to finance real estate exposure when you’re coming off base rates of virtually zero to call it 5% in relatively short period of time. That is of course a headwind. And then certainly really more COVID driven with so much of the working population either fully remote or hybrid remote working situations where the demand and the need for office space has diminished. And there's still are real questions around what will the long term demand for office property look like or office space look like. We share a lot of our clients’ reluctance to really kind of dive back in in a meaningful way. We're still certainly in a wait and see approach and I think that's true for a lot of our clients.
Sectors that we are more constructive on aside from office, things like single family rentals where housing, residential housing, is a still very significant need for the US and really a lot of parts of the world. So we think that the need there, the demand there bodes well for that as a forward-looking real estate allocation. Self storage, certain industrial exposures, think about data centers, ports, areas where there may be a little more insulated and where some of the dynamics affecting office property exposure don't have the same sort of sensitivity in those sorts of sectors. So there are pockets where we are constructive and where we think there are some interesting opportunities going forward in the near term.
Rob: In the office sub sector?
Pete Miller: Right. It's really important to not paint the whole real estate or commercial real estate market with a broad brush. It really is a matter of differentiating based on sectors and themes because there are opportunities to be had. And I think it also bears repeating that debt, real estate debt I think actually is attractive. And we've seen certainly for Invesco, we've seen very real demand from our insurance clients for either increasing or kind of getting back into real estate lending, CRE lending. And I think that's a simple matter of, right now you can get pretty attractive returns on a debt strategy4 where you're by definition, you're higher up in the capital stack. So you kind of get that downside protection with pretty attractive absolute returns.5 So again, it's just important to differentiate and not kind of take real estate as this monolith because there really is a lot of opportunity depending on where you look.
Rob: Yeah, that's actually a message that we're going to be hammering home a little bit over the next 5 weeks on this podcast when we begin commercial real estate month. And I've already recorded a few of those, so I know what they're going to say. We have two people on there who've been doing a lot of shopping in the office space here in New York City. And they have some exceptionally interesting locals, so you can't paint the whole thing. Maybe a week, the office building is in trouble. But there's always a good shot out there to take. So are there any other risks that you've been talking about more recently with your insurance company clients that people in this podcast should hear about?
Pete Miller: I think going back to the very beginning, we talked a little bit about the macro backdrop and expectations around interest rates, inflation and things like that. I think we still have a lot of conversations, a lot of I wouldn't necessarily say concerns from clients, but you know questions around recession risk and is the Fed maybe behind the curve. They've started easing recently and we didn't really talk too much about that. But at this point they've already cut 75 basis points and certainly market expectations for further cuts over the coming months. But a lot of times we'll get questions and maybe some modest concerns from clients around, have they waited too long? Is it likely that high policy rate will be detrimental to economic growth? Could we see a bit of a turn in the credit cycle? Could we see an uptick in defaults or downgrade activity?
And certainly it's understandable that would be a concern or at least a big question from insurance clients just given how much corporate credit exposure comprises their asset portfolio. But in a word, we don't see a near term, meaningful recession risk. But it is of course important and always prudent to be very vigilant and to be proactive on that front because it's a fact that the public market spreads are relatively tight. And it arguably wouldn't take a lot to see some spread widening there and potentially even an uptick in defaults. And so while we don't expect that's on our base case, we kind of share a lot of our clients focus in terms of just monitoring that and being extra vigilant to kind of be ready to act if you do see a bit of a turn in the cycle.
Rob: Yeah, from the long run perspective, which is where a lot of these folks start thinking about their portfolios, we are very long, so late, late, late in the cycle for all those things that's right. So yeah, it's good to think about. Well, thank you again, Pete. This has been very good stuff to think about.
Pete Miller: Thank you, Rob. It's great being with you.
Rob: And thanks to everyone who listened to this podcast. Until next time. I'm Rob Rowan and this has been Compound Insights.
For Institutional Investor Use Only
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
There is no guarantee that the investment objectives of the strategies will be achieved.
All material presented is compiled from sources believed to be reliable and current, but accuracy can-not be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any in-vestment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an in-vestment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
NA4036006
Pete Miller shares his outlook on the latest trends shaping the insurance portfolio landscape, including rate cut expectations, private asset based finance and real estate markets.
Pete Miller shares his outlook on the latest trends shaping the insurance portfolio landscape, including rate cut expectations, private asset based finance and real estate markets.
Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Welcome back. And I have to say it's great to be back, back from a little time off and in a brand new location. The InsuranceAUM.com podcast is coming to you from none other than Dripping Springs, Texas. And today's topic is strategic asset allocation for insurance companies with Pete Miller. Pete is the Head of Insurance Solutions, Multi-Asset Strategies with Invesco. You hold a CFA and an FSA. Both of those are high hills to climb. Pete, welcome. We're thrilled to have you. I've known you for a long time and just now getting you on the podcast. So welcome.
Pete Miller: Yeah, thanks very much, Stewart. Great to be with you.
Stewart: So can you talk a little bit about what you do at Invesco in particular, because you are a media figure. I mean, you were just on with the NASDAQ in the last day or so. So can you talk a little bit about your role before we get going into the SAA portion of the program?
Pete Miller: Yeah, yeah, absolutely, Stewart. So my role here at Invesco, within our insurance solutions effort, it really spans a lot of things. So one of the things that I love about it is I do get the ability to work on both what I think of as the institutional balance sheet side of the insurance house, but also the annuity, retail, if you think of that wayside of the house. So we work on mandates where we're managing general account assets for our clients. It could be fixed income, could be real estate, could be public equity, it could be any number of things. But then the other side of that coin is a lot of the especially annuity business in the last several years has really been indexed products, indexed annuities, fixed, FIAA, RILA, et cetera.
So we've really, last couple of years, made a lot of great strides at building out custom indices for our clients and being involved in that part of the business. So really it's just, for me personally, it's really interesting, but it's an opportunity to kind of sit in the middle of our investment teams, our client-facing teams and just help the firm get an idea from its inception to practice. And it's been a lot of fun.
Stewart: And this is a very small community, very tight-knit, a lot of great people in this business. And I mean, I think the work is extraordinarily complex, but the people, at least the people are smart and nice. So that makes it a whole lot better. Before we get going too far, I want to cover my usual ground, which is: what is your hometown? Where did you grow up? What was your first job? Not the fancy one either. And what makes insurance asset management so cool?
Pete Miller: I love these questions by the way. So I grew up in Omaha, Nebraska. No, I do not know Warren Buffett. I wish I could say that I did, but I grew up there. I went to school at Nebraska, so I'm a Cornhusker through and through. My first job, I had a bunch of random odd jobs in high school and college, which really make me appreciate what I do now. But the first one, I worked at this huge wholesaling warehouse, basically this massive warehouse where every day at six in the morning I'd be in there. It's like assembly lines, you're picking items from these boxes, packaging things for shipping. Very, very not interesting, but definitely a good lesson in terms of showing up and putting in the time and a good lesson in what I didn't want to do forever. So as I said, I'm very happy with what I do now.
Stewart: A precursor to Amazon, it sounds like. And, what makes insurance asset management so cool? I say this and sometimes people laugh, but hopefully you agree with me that you think it actually is cool.
Pete Miller: I absolutely do. And what I immediately thought of when you were asking the question was the people side of it. I just think back through my whole career, I've worked with not only really smart people, but really just fun people to work with and be around and obviously you spend so many of your waking hours at work that it's been really interesting, really intellectually challenging. I've gotten to see and do a lot of different things, even though my whole career has been within insurance and insurance asset management, there's still a huge variety of things that I've had exposure to, which has been great. And I think investing in finance is interesting on its own, but then you incorporate the extra technical challenges that come with insurance and accounting considerations, asset liability management, capital considerations, all that stuff that a lot of our clients that are pensions or endowments or others maybe have different considerations. I just find it really interesting. And so I do think it's fun and I do think it's cool.
Stewart: Yeah, it is. And one side note, I will tell you, I went to Mizzou and it was during the time when Nebraska won seemingly every game every year, and I think we lost to Nebraska 31 years in a row or something. But whenever you go to Lincoln, everyone was so nice. I mean, your fans were the nicest people. And I was at a home game where Nebraska came to Mizzou and somehow or the other one of our students set one of your RVs on fire. So I just want to say publicly that I'm sorry for that, and I'm sorry for that experience. I feel somehow oddly responsible. I'm not sure why, but…
Pete Miller: Well, yeah, I appreciate that.
Stewart: Yeah, I mean it was a very different crowd at Mizzou at those days, but part of the program here we're trying to do is we want to talk to people about how their backgrounds fit into what they're doing today. And in your case, you worked for an insurance company, The Hartford, and one of the questions I have is what did you do there and how did that influence your experience in your role now with Invesco?
Pete Miller: Yeah, well, as you mentioned in the intro, I’m an actuary by training, I started my career at The Hartford. In a more traditional, I would say, actuarial role. And it was on the life insurance side. So I started there in a rotational program, and it was really my second rotation where I moved to the investments team. At the time, it was supposed to be on a temporary basis, and I loved the work, I loved the people, and I decided that I wanted to stay as a part of that team permanently. And I did eventually still have a variety of roles within the investment function at The Hartford. So I did a lot of work on the general account, so both from the portfolio management side, working with that team, managing the balance sheet assets. I did some work with more of the risk management side of the house, and I did a lot of work on the variable annuity business. Again, both liability side, so looking at modeling of GMWBs and GMDBs, and then also on the hedging, the derivative hedging side of things.
So even just at one insurance company and even just within the investment function at one insurance company, I had the opportunity to see a lot of different things and do a lot of different things and get exposure to a lot of different people. And that was just invaluable because that has certainly come in useful here at Invesco. I did a stint at PIMCO, which a lot of the stuff that I learned was extremely valuable there as well. And I think of course the technical stuff is sort of the foundation of what I do now at Invesco, and my solutions are all here. But more than that, I think is the kind of... for lack of a better term, the softer skills.
So learning how to present and modulate a message depending on the audience. You're talking to somebody who's in the weeds and can really nerd out on every last detail, or you’re talking to somebody who's never heard of this topic and has 30 minutes and you need to really distill that. Those sorts of lessons, professional lessons have been really helpful. And nowadays, as I said the technical stuff really serves me well because I can genuinely say I've walked the walk, I've lived in our client's shoes, and I've done and faced a lot of the same issues myself from their perspective at one point or another in my career. So I think that really, it helps both in terms of relating to clients, but then also articulating to our management here, why we should do this, why this is important, why we need to be very flexible, all those sorts of things. So really all of my experience at The Hartford has really proved to be just super, super helpful.
Stewart: I want to geek out with you for a second because when you first started talking about variable annuities, you threw out a couple of acronyms and I'm not sure what they mean. So can you for our audience, unpack those two, please?
Pete Miller: Yeah, GMWB. So guaranteed minimum withdrawal benefit or DB for death benefit. I mean, those were two that were, this was going back to the... I hate to date myself, but early 2000s, and this was around the time that withdrawal benefits in particular were very new and posed a very novel challenge in terms of hedging the exposure. So you think about, again, it's guaranteed. The insurance company is making a guarantee to its customer saying, in the case of a GMWB, regardless of your investment performance, you're going to get at least X percent in withdrawals for life. And so obviously that means by making that guarantee the insurance company is taking on some risk and how do you hedge that? How do you hedge it efficiently and cost-effectively? That was a big part of what I did there, but certainly still relevant today. As I mentioned, a lot of that business has moved to more of an indexed kind of product lineup, but still those guaranteed products are absolutely still present in the marketplace too.
Stewart: Yeah, that's super cool. Thank you. So a key theme that's coming up is a trend toward alternative assets. Where do you see the most opportunities in that space? And I mean, first of all, I guess I would say, do you agree that there's a trend to alternatives? And if so, where?
Pete Miller: Yeah, absolutely I agree. And I think that's probably, at this point, pretty well established that there's been a very noticeable trend really going back to the financial crisis. And with rates being just super, super low for so many years. Not only insurers, but really all investors and in particular institutional investors clearly had a very strong demand, insatiable demand for returns, and hence this kind of multi-year trend towards more private market exposures and alternative investment strategies. And I do think it'll continue. One of the things that comes up a lot now. Clearly the last year or two, rates particularly in the US have backed up a lot. And that means on the one hand, public markets are offering returns that really haven't been available for such a long time. And I think one natural inclination is to assume, well, okay, so that's going to kind of reduce the interest in alternatives.
And I think that's just not the case. For one, private markets, it takes time to build up a program. There's not just the asset allocation decision, but then there's implementation, manager selection. There's so many things that go into it that you have to really be committed to it and you have to be up for a multi-year journey. And so I think that will absolutely continue even if rates stay at their current, if you want to think of it as elevated levels, and I guess specifically we still like private credit. There's been a lot of ink spilled around how much capital has piled into the space, and there's potentially some risk on the horizon. And I think that's fair. But the flip side of that is you're still getting pretty attractive all-in returns and spreads that are in large part compensation for illiquidity, not necessarily just pure default risk, especially first lane type of exposure. So I think for us, we still think you're being compensated for that risk. And now especially with the fed on pause, maybe likely to embark on an easing cycle again here in the coming quarters, let's say, that could be constructive for private credit when you think about spurring some more deal flow, some more activity. And also from the borrower's standpoint, that will naturally ease some of the pressure that may have been building up in terms of interest coverage and creditworthiness. And so for us, we still think private credit is very attractive from that standpoint.
And then I would also say for us, I mean we have a big real estate, private real estate and public real estate franchise at Invesco, but I would say specifically for our insurance clients, commercial real estate debt is something that we are talking a lot about and really focused on because understandably, I'll just paint with a broad brush, real estate has been maligned in recent years and there's very valid reasons for that. But I think with debt in particular, you've got security, you still have very attractive returns. We might be kind of at a turning point or at least nearing a turning point in the cycle. And especially for insurance companies and lifers in particular, it's a pretty capital-efficient way to get return and yield. And so I would say those two within alternatives are where we spend a lot of our focus on a lot of our time with our clients.
Stewart: I think we have a budding data business and certainly based on our proprietary market intelligence, the demand for private credit is strong. Absolutely. I would even get on my soapbox a little bit and say really financing those kinds of businesses are really a great fit for an insurance company's balance sheet. I mean, you don't have the liquidity, the risk of a run on the bank that you do in the regional banking sector. And there just seem to be a lot of very valid reasons of why this shift is taking place and looks by all indications to continue to take place going forward. So I'm with you on that one. So aside from alternatives, what other asset allocation shifts or trends have you noticed with your clients and other insurance companies over the past couple of years?
Pete Miller: I think there's been a lot of trends, not just in terms of the macro backdrop, but even things like regulatory activity, accounting changes, all of those things that we talked about earlier that make insurance investing interesting and fun, there have been so much activity in the last few years, more so than I can remember from decades prior, really, at least for my whole career. It feels like the last couple years have been exceptionally active across all these different dimensions. I would say some of the other stuff that we're talking about a lot, now more in the public market space, we talked about alternatives a little bit, but public markets, Invesco is a global firm, so we are working with our insurance clients around the world. And one of the things that's been topical recently in public markets in Europe in particular has been munis because there is still demand for safe, high-quality yields, public market yield, but something that's diversified to a degree from corporate credit, which I think is still the predominant exposure in probably every insurance portfolio.
And in particular, with Europe, I think another tailwind or another driver of that demand has been some of the regulatory changes where that's considered or treated as though it's infrastructure, which is essentially an advantage from a capital standpoint where there's some kind of enhanced relief, if you think of it that way, which makes it all the more attractive for our European insurance clients. So that's been something that's been quite topical of late. And then something that I like right now and we're encouraging clients to look at would be within EM debt, hard currency that is, so just thinking about corporate spreads still being pretty tight on a historical basis, relative basis.
And again, I think most insurers, they don't really need a lot of additional corporate bond exposure, but EM is something that arguably is still underrepresented in a lot of insurance portfolios and you do see pretty attractive spreads and absolute yields for, again, for hard currency exposure, investment grade type credit risk. I think that's something that more insurers should probably take a look at. And it aligns with our house views and tactical views from our solutions team as well. So I think that's something else that we've been talking a lot about.
Stewart: You mentioned Invesco being a global firm, and you have a global team at Invesco that works with insurance clients in North America, Europe, and Asia. What have you noticed or is there a noticeable trend that's different in the US versus non-US insurers?
Pete Miller: Yeah, there are certainly differences. And I would say at the core there are probably more similarities than differences. I mean, there are the same types of considerations no matter if you are a US insurance company, a German insurance company, a Taiwanese insurance company, everyone to a degree is trying to solve for maximizing their returns subject to regulatory capital constraints, internal risk constraints, accounting, tax, et cetera. So, understandably, that's going to drive a lot of behavior no matter what part of the world you're located in. But I think a lot of the differences in behavior stem from maybe different treatments in different jurisdictions. So you'll certainly see more appetite for structured credit in the US than you'll see in Europe because it's not, frankly, penalized as much in the US from a capital standpoint. Or just from a macro interest rate environment standpoint, you'll see more demand for US exposure simply because even after hedging in many cases, it's still more attractive for a non-US insurer to buy US bonds.
So some of those things are fairly widespread. I would say one obvious thing, which is probably clear to most folks, a clear difference, ESG is something that is just well ingrained in Europe and Asia at this point, I would say much more so than the US. And so I find it very interesting and fascinating how different the political landscape is and the sort of social appetite for ESG philosophies to make their way into investment decisions. It's pretty much fully accepted and acknowledged in most parts of the world outside the US. And here it's still very much a controversial topic. It is definitely not something that you see in every insurance portfolio. And if we were having this conversation two years ago, I probably would've predicted that the US would catch up and by 2024, the US would be more like Europe in that regard. But we're not, we're still much further behind and maybe that'll always be the case. So that's a big difference that stands out to me.
Stewart: That's super helpful. I agree with you. I was just in Europe in November and I was surprised to learn that traveling to an event like an insurance asset management event is really frowned upon. And one person told me that travel had to be approved by the CEO, that that's how seriously they take their carbon footprint, which I felt like we certainly have a different way of looking at things here. I mean, folks are still traveling and so forth. So when it comes to taking advantage of these opportunities, how do you go about benchmarking and modeling public versus private market strategies and exposures? That's a really hard question and it has a lot of facets to it, but at a takeaway level that our audience can grasp. Can you talk about the high points around how you view benchmarking in public and private?
Pete Miller: Well, you're right, it's definitely a topic that we could spend a lot of time on. So I'll try to be relatively brief. I mean, one thing you mentioned in the question, benchmarking and modeling, and I kind of in some respects separate those two. So I think of benchmarking in many cases as just measuring performance, you have an objective, how do you gauge whether you've succeeded or failed versus that objective? And so when it comes to performance, we, like many managers and many investors, really look at things as a mosaic, we'll look at many different things. I don't think there is a single right way or best way to do it. So looking at things as absolute return objectives, did you meet that yes or no? Over what timeframe are you interested in those sorts of things? And then relative, there are some private market benchmarks or indices or proxies that you can use as bogies if you want to think of it that way. But there tend to be a lot of flaws with those.
And I think the inevitable comment that we hear from portfolio managers all the time is, well, that's not representative of what we're doing or what we're buying or what we're seeing. And I think that's even that is more genuine or valid, I think in the private market space where it is very idiosyncratic. So a lot of times it'll be maybe looking at a private market index or public market index plus a spread as your performance bogey. But when it comes to modeling, that's where, particularly when we're talking about asset allocation, I think this is a topic that I love talking about. I spent a lot of my early years here at Invesco doing a lot of work in this space, trying to capture how do we model private assets alongside public assets? How do we give a true representation to our clients? How do we present things in an intellectually honest way to help them make asset allocation decisions?
And there's a lot of debate around, for example, most alternative assets are not marked, certainly not daily, sometimes not even monthly, or maybe even quarterly. So you have very infrequent valuations that can make it very difficult to measure risk or quantify risk. And arguably that might mask some underlying risk. And we just think it's important to acknowledge that. And again, from a modeling standpoint, use a combination of things, kind of a mosaic approach where you're not just basing all of your decisions on this one metric or this one framework. So we'll look at things when we're modeling, we'll look at historical realized risk and correlation versus public markets, but then we'll also look at more of a kind of a desmoothed or more of a mark to market sort of framework. We'll compare and contrast, we'll acknowledge, both have limitations, both are going to be imperfect, but it at least helps you triangulate to a more rigorous final answer. And you can kind of get a sense for directionality.
Are we underexposed or overexposed to something? I'm not going to get too wrapped up in whether the allocation to this should be 4% or 6%, but does it need to be higher or lower than it is today? I think that's really the crux of how we think about it.
Stewart: And it's interesting because there's been a ton of activity in the insurance regulatory landscape. In fact, we're, I'm actually having a call with the NAIC commissioner immediately after this podcast. We're going to have them on to talk about some of the regulatory landscape changes. But from your perspective, what have been the most impactful changes or discussions currently taking place?
Pete Miller: Well, I mentioned earlier there has been so much going on the last two to three years that honestly is mind-boggling. And I mean, you could say that just about the US but then when you look at the UK, the PRA has been making some adjustments to their Solvency II implementation and lots of stuff going on in Asia, which there are a lot of commonalities in different countries in Asia, but there are some nuanced differences too. So there's just no shortage of things to be watching out for. But I'm based in Boston. I focus my own individual time mostly on the US. And there's been so much going on here and you guys have stayed on top of that. I think you guys are a great resource. I look to InsuranceAUM for a lot of help in sort of synthesizing a lot of what's going on, but to me, the most impactful, it's hard to pick one because residual tranches has been a big topic lately in capital treatment there.
Just things like definitions of bonds, where do they appear on different schedules? The increased involvement of alternative managers owning insurance companies. Bermuda, looking at, let's say, updating their framework to kind of, let's say find the right balance between commercial viability and interests, but also policyholder protection. And one of the things that personally, it's certainly getting a lot of attention, but I'm surprised maybe not more attention, in the US, is a lot of the discussion around ratings, credit ratings, and the possibility that the NAIC may, let's say, move away a little bit from the historical approach of just simply mapping to rating agency for their designations and having a little more discretion. That could be massively consequential to how the industry operates, how resources get utilized and deployed, and then could certainly filter through to actual investment decisions.
So I'm personally most interested to see how that plays out. And I mean, certainly, it's a topic that's gotten a lot of attention and a lot of initial response, but frankly, I would've expected even more. And so it'll be interesting to see how the next several months or probably quarters play out on that topic.
Stewart: All right, so this is the last question, then we're going to get a couple of fun ones in and then we'll run out the door. So looking ahead, where are you expecting to see the greatest challenges and opportunities for general account portfolios and how, or what adjustments are you making or if you're making any to take advantage of those?
Pete Miller: So to me, that goes back to the alternatives topic. I think there's two sides to that coin. It's going to be a challenge because the last 10, 15 years have seen so much capital flow into private markets broadly. And a lot of things that were, not that long ago, very cutting edge and niche or maybe not widespread, are now very widespread and almost to the point of commoditized. And so the challenge is how do you find the next thing? How do you find the next opportunity that no one else has yet uncovered, or at least not many have yet uncovered.
And I think the opportunity there is not only identifying the investment opportunity, but then being willing and able to act quickly, to move before others do. And maybe that means pushing the envelope sometimes around, we just talked about the regulatory side, so maybe it's taking a bit of a leap of faith that, okay, here's how we think it should be treated. We're going to go for it, we're going to work with the regulators to make sure everyone understands what this is and everyone's on the same page, but we're not going to wait. We're not going to ask for permission and wait around for months or quarters or years. We're going to act on what we think is the right economic decision and then maybe adjust later.
So I think that's the opportunity, those who are nimble, maybe bold, willing to act because I'm sure, especially thinking about all the technology and innovation that’s happening, I would imagine there will be a lot of opportunities for insurance investors to harness a lot of that in ways that we haven't even really seen up until this point.
Stewart: Very cool. I've really learned a lot today and had a great conversation with you. I've got a couple of fun ones for you out the door, you can answer either or both, most of our guests answer both, no pressure. What's a great piece of advice that you've gotten in your career or what piece of advice would you give? And the second piece of that is if you could have lunch with anyone, even a table of four, alive or dead, who would it be?
Pete Miller: Well, I love both these questions and as an avid listener, I was ready for them. So I'll take a crack at both. On the advice topic, I've been really lucky. I've had a lot of great mentors and managers and colleagues over the years. But I think the number one thing that now when younger people ask me for suggestions and advice, the thing that I always come back to is, just get over yourself and don't hesitate or be afraid to ask questions. I mean, I definitely suffered really in my career from this fear of looking like the dumb guy and fear of asking a question that I should know the answer to this already. And it took me probably longer than it should have to fully internalize this notion that everybody has to learn something for the first time at some point. You didn't start your career fully formed knowing everything right out of the gates.
And now I think about it from the flip side. If somebody asks a question of me that they might think is a basic question they should know, there's no judgment at all. I'm fully understanding of where they are. So I think more people would benefit from just asking questions. Don't be nervous, don't be shy. And if nothing else, there's some self-interest there. Aside from just learning answers, it shows you're interested, it shows you to be intellectually curious. All those things are, even if you know the answer, maybe you tactically ask questions to show that you're paying attention, right? So I think that's a really helpful piece of advice that I got, and I try to use that every day now.
Stewart: That's cool. What about lunch?
Pete Miller: Yeah, the lunch one, I mean, it's not going to be original, but I have to say Abraham Lincoln is somebody that I've been obsessed with since I was a kid. One of my favorite books that I ever read was Team of Rivals, and I would love to, of course, his role in our country's history is massive, but I think he was a really funny person, a really folksy kind of sense of humor. And I would just love to hear some of the kind of inside scoops and anecdotes, and especially dealing with such heady stuff. How did he deal with these personalities? How did he get stuff done? How did he strategically cajole or entice or encourage people to come around to his way of thinking? Because it's just interesting from a historical standpoint. And then also I think there would be some really good life lessons in there. So I know it's probably not the most original answer, but that's number one far and away from me.
Stewart: That's super cool. I mean, where I recently moved from is the land of Lincoln, and so I have a friend who does paper restoration, and she was working on a battlefield letter that he had written and folded in fours and shoved in his pocket, and I was in their shop, and it was one of these things that you normally, there's a piece of glass between you and that thing. It was amazing to see it up close where you could actually just… it's incredible. I think that's such a great answer. I've learned so much today. Pete, thanks for coming on. Thanks for being the first guest back after a little time off. We've been joined today by Pete Miller, CFA, FSA, Head of Insurance Solutions, Multi-Asset Strategies with Invesco. Pete, thanks for taking the time.
Pete Miller: Thanks so much, Stewart.
Stewart: Thanks for listening. We certainly appreciate you as we approach 70,000 podcast downloads, so we're happy and appreciative of our audience. Very much so. If you have ideas for podcasts, please shoot me a note. It's stewart@insuranceaum.com. My name is Stewart Foley, and this is the InsuranceAUM.com Podcast.
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Pete Miller, Head of Insurance Solutions, returns for a conversation on regulatory changes, insurance investment trends in vs. outside the US and potential portfolio opportunities ahead.
Pete Miller, Head of Insurance Solutions, returns for a conversation on regulatory changes, insurance investment trends in vs. outside the US and potential portfolio opportunities ahead.
Rob: Welcome to Compound Insights, a podcast by CFA Society New York. I'm your host, Rob Rowan. Today, we're speaking with Pete Miller, CFA. He is head of insurance solutions for Invesco's multi asset strategies group. Before that, he was with PIMCO's financial institutions group, where he focused on general account investments and risk managed funds. Before that he worked at The Hartford. He earned his BS from the University of Nebraska.
In my prep for this podcast, I was shocked at how big Invesco’s insurance asset management practice has become. I thought it was important to share this with you all because some of you might not have been up on it in the way I was not. They currently manage in excess of $50 billion globally for 200 general account clients in fixed income, real estate and equity, private credit, including broadly syndicated loans, distressed credit, direct lending and some other stuff we're actually going to talk about today. And the global real estate platform, which we're going to speak a lot about today, is currently $90 billion. So as there is so much uncertainty following that market, that's what we were keen to talk about today.
But Pete, let's start at the top. Let's talk about the global economy. We have obviously rate uncertainty, high equity and fixed income correlation. We got a whole lot of things going on. What's affecting your portfolios now?
Pete: Hi, Rob. First of all, thanks for having me today. It's great to be with you.
You're absolutely right. There's certainly been a lot for investors and for our insurance clients to be thinking about this year. It’s been pretty interesting to see how resilient equities have been just given a lot of the macro uncertainty. I think there still are very real and valid questions around, can the Fed sort of engineer a soft landing and can they continue maybe hiking rates a little bit from here and not really disrupt equities too, too much? And so far the answer has been yes. The equity market has been very resilient. But, I think the flip side of that is we've seen a very volatile backdrop in rates, right? I mean, we saw the 10 Year Treasury get as high as 5% really just a matter of weeks ago and now we've already come back down by 75, 80 basis points in a matter of weeks.
And so, I think there are kind of two buckets that we think about for our insurance clients and what they're largely contending with. Certainly, any insurance company, the bulk of their general account portfolio is going to be focused on fixed income. So the rate environment is hugely important in that context. And for, just about two years now, all the talk seems to have been around handling rising rates. What does that do to our current stock of fixed income assets? If the pace of Fed hikes were to continue in a very rapid fashion that could be negative for general account portfolios.
But the flip side of that is, it does lead to some more interesting reinvestment opportunities and some opportunities for the marginal dollar to get invested in things that maybe were previously not as attractive as recently as a year and a half, two years ago. But now, as I said, where we stand today, rates having come back down very substantially in short order, it feels like we're kind of back to where we were maybe a couple of years ago and a low rate or maybe quasi low rate environment. So I think the short story there is when we talk to insurance clients, they're very cognizant of these cross currents. They're very mindful of what's going on. But you rarely see very material reallocations or changes for a lot of reasons. I mean, there's economic reasons, accounting reasons, income generating reasons that these portfolios tend to be fairly kind of slow to reallocate. So it's really just a matter of taking stock and kind of thinking about where to invest a marginal dollar I think as much as anything.
But the other bucket that we think about, aside from the fixed income bucket, is really whether you think of it as surplus assets or risk seeking assets, things that are really meant to generate return, meaningful return and maybe less of an income focus. Here I'm referring to things like alternatives whether that's private equity, real estate, private credit. And I think, insurance clients like many institutional clients, for the last couple of years have really been thinking about, have valuations kind of caught up to the economic reality? Are there opportunities to deploy now that weren't there maybe as recently as a year or two ago? And that's I think, where at least for us, that's where the bulk of conversations have been. And it's really just a continuation of the theme that we've seen for many years, which is this kind of very, very notable, very consistent trend towards more and more alternative assets. And it hasn't really changed. I think it's again just on the margin, where our insurance clients are allocating dollars and what they're kind of evaluating as the next opportunity has maybe changed on the margin, but it's really just a matter of being patient and kind of not overreacting too too much to the news of the day.
Rob: Right, because at the end of the day, for most of these insurance CIOs, asset allocation is the name of the game and allocations don't change. You might rebalance a little to make sure you're within those frames, but it doesn't really change that often. And if it does, your board's got to get involved. Your trustees are going to want to talk to you. There's a lot of things that have to happen to do that. So that part does make it difficult. But this also raises an interesting question, and I presume you've counseled people on this to some degree and others. How do you know when to change the asset allocation? Does a couple 100 bips matter?
Pete: Absolutely. As I said, I think the first question is really what to do with that marginal dollar. So if you have new flows coming in from organic sales, if you have principal and interest rolling off of your existing portfolio and you can maybe divert that in a slightly different direction than maybe your asset allocation called for a year ago, I think that's kind of the first step or the first place to look. But when it comes to reallocating, as I mentioned, that's of course on all of our clients’ minds. But you do tend to find a lot more constraints around just how much you can reallocate. And there's not necessarily a specific rate level or change in rates or specific market events that would trigger a massive reallocation because you have all those other things to consider as I mentioned, accounting and gains and losses and taxes and those sorts of things.
Rob: Right. And the credit quality, that little thing. I mean, this is exceptionally interesting time. I don't mind showing some of my stripes. Before I came to CFA New York, I worked at one of the larger bond rating organizations on the planet. I worked there during the decline in rates the whole time and we always talked about it as an exceptionally difficult thing to handle for some issuers, not necessarily alternative issuers, but just sort of rank and file state and local issuers. We would have some difficulties when it comes there so we never really talked about what level that would be on. One of the things that is also sort of a macro issue that is gaining a little ground here in some areas of the of the market is regulation. So how are you all thinking about the regulatory environment as it pertains to the macro?
Pete: Regulation is certainly a huge topic for insurers, and that's globally. I mean, I'm based in the US. My colleagues around the world, we all have very similar conversations with our clients globally. And although the exact rules and the exact regulations may vary a bit, the principles are largely the same. It's all about regulators wanting to make sure that policyholders are protected and that the risks that you're taking in this case in the investment portfolio, that you're properly setting aside risk capital and the greater the risk, the greater the capital requirement. That's a fairly intuitive concept that is true globally.
I could speak from my standpoint here in the US, it's been a very active couple of years. I've been doing this for a long time and I don't really remember a stretch as busy as the last call it 24 to 36 months. There's been so much going on the insurance regulatory front, specific to the investment portfolio. And in the last couple of years, we've already had changes around that ratings or designation process, going from a pretty blunt framework kind of bucketing, let's say BBBs across the board in a single bucket. Now there's recognition a BBB+ is different from a BBB- bond and those should have different capital charges assessed as well as something that we've certainly followed closely given our business mix.
You alluded at the top to our large real estate franchise. For life companies recently there was a change to kind of lower the risk based capital requirements on real estate equity. We thought that was a great move and good reflection of the risk there. And now there's continued discussion on other things, which are also very important to our client portfolios. I think one notable thing is the continued discussion around bond definitions versus structured securities specific to structured securities residuals. Should there be a higher capital charge to that kind of equity or residual tranche? And there's kind of a, I would describe it as a stopgap treatment where that's going to get a 45% charge for the next year, maybe two. And I personally think that's going to get reevaluated because again it's a bit more of a stopgap than a fully vetted, fully study change. So I think that's going to continue to be highly discussed and frankly hotly debated because it has been a very, very hotly debated topic. Got very strong opinions on both sides of that argument. And so I think that's going to continue to be top of mind in terms of regulatory discussion.
I think the other one is the very large and increasing role that we've seen private equity backed or alternative backed insurers in industry. Certainly the NAIC has expressed the desire to kind of study that more closely. And I think we're also seeing some similar dialogue in other jurisdictions outside the US. So I would imagine that's going to also continue to be a very big focus of regulators and one that will elicit a lot of opinions on both sides of that.
Rob: Yeah, it's hard to see how that wouldn't come true in part because several of private equity companies that got into residential real estate got egg on their faces in the press, which caused the policymakers to get a move on in there. So now that they're coming into this, it's obvious that it's going to happen more. There's just a lot of real estate carrier stuff in the news with Florida that makes policymakers do things. But look, the private credit landscape is exceptionally interesting right now amid many of the factors we've already talked about. What's your view of the of the private credit landscape right now and how you're advising your clients on investing in it?
Pete: Private credit has been, as we mentioned earlier, amongst other private assets, it's been a huge focus for our insurance, for all insurance clients really. I mean it's along with really, every alternative asset class. Credit naturally aligns with what balance sheet investors are investing the bulk of their assets in to begin with, so there's kind of a natural segue into private credit. But of lately a lot of the talk has been around just the huge flood of capital. It's been a very, very popular asset class in recent years. And so that does kind of lead to some questions around has there been too much inflow relative to the opportunity set? Is there enough deal activity to support that? Are the underwriting standards on these loans up to snuff? And I think the answer, the short answer at least in our view is it depends. Oftentimes they are and of course we strive to be very diligent in our underwriting. But certainly you would see others that maybe are a little more lax and a little more aggressive in terms of trying to land deals. So it absolutely makes sense to be very mindful of that and very cautious and very thoughtful about the managers you're working with, the deals you're underwriting.
There's also, we talked earlier about the real volatility we've seen in interest rates and given that this is largely a floating rate asset class, that's led to a lot of questions around can the borrowers really keep up and does it put stress on their ability to repay? Again, I think there's no obvious black or white answer It's pretty nuanced and the answer is it depends, right? I mean some borrowers are reasonably able to withstand a backup in rates. It doesn't necessarily change meaningfully across the industry the ability to repay. And we haven't really seen a lot of signs of real distress or real challenge there. Of course, there will always be some idiosyncratic situations, but so far it hasn't really been a broad based issue.
So for us, our private credit capabilities, we kind of tend to play in more of the kind of lower to middle market end of the spectrum. And so we're not necessarily competing with some of the real massive private credit shops in terms of the deals that we're underwriting. We try to be a little more targeted in the deals that we do. And so again we think that leads to some benefits i.e. the underwriting that I mentioned. We don't have to participate in certain deals. We don't have to take down deals that we don't necessarily like. And we think that's going to really help and really benefit our client base to kind of go through a full cycle. We expect that will probably manifest in the in the form of better performance over time.
Rob: You're hitting on something I think is exceptionally interesting about the way that people talk about underwriting. Because underwriting, like everything else, is cycle. And we do have some signals right now that the cycle might be a little long in the tooth. But there are people like me included, who were saying that we were long in the equity cycle for about, I don't know, maybe five years before. It's hard to tell when it happens. It's just easy to say where we are, and even that's not always that easy.
But the other thing that is going through a massive change and I think it's related to some of the things you were just talking about is real estate. And you all have a pretty wide area of expertise in this so I'd love to hear your thoughts about real estate. But where do you want to start? Debt, equity, commercial, residential? Anything. I'm ready for all.
Pete: Sure. One of the luxuries that I have in my role at Invesco is our real estate franchise, as you mentioned at the top, it's not only very large but it's absolutely global in nature and the breadth of what we can work with our clients on is almost unlimited. So we have equity strategies in just about every region across the globe and that spans more of the kind of core income producing all the way up through more value add and opportunistic opportunities or strategies where a little more of a capital appreciation play and maybe a bit of a higher return and higher risk sort of construct. And not only that, on the equity side, but we have a very strong commercial real estate debt franchise as well.
And I mean not surprisingly, I'm sure you've heard this from many others, Rob, commercial real estate in general has been, it's been a tough go the last couple of years just coming out of COVID. And tons of very valid questions around what is commercial real estate going to look like over the medium term or long term coming out of COVID? And what's the demand situation? What will leases look like going forward? And I think that's all very understandable, as I said very valid questions, and naturally that's led to maybe a bit of a pause in terms of activity and we've certainly seen that as well.
What I would say though is right now we're definitely already seeing real interest in both equity, but especially in debt. I think our insurance client base is starting to show genuine interest in kind of getting back into the market. And maybe we're kind of reaching a point at which again, valuations are maybe more reflective of reality and you're seeing particularly in the debt space, returns that are very interesting. Call it maybe high single digit returns for seniority or good seniority in the capital structure. And if you think about relative to equity that tends to be more interesting to our insurance clients right now. I think it also ties back to we talked about the regulatory landscape. We're thinking about in the debt space, lower RBC requirements, lower capital usage. And so if you can get pretty high relatively speaking, attractive returns for senior exposure, relatively lower risk as compared to equity and much lower capital charges, it's not really a surprise that that's where we're seeing the most interest right now.
I would also highlight, that's not unique to the US. I mean, we're seeing that from our global insurance client base. Global clients looking for US CRE debt exposure as well as some European CRE debt exposure. And so it makes all the sense in the world to us, and as I said, selfishly, for me and where I sit within the firm here at Invesco it's great that I have the ability to talk to our clients about all these different things because we do have kind of the full waterfront covered at Invesco, but certainly debt is kind of top of mind for our clients right now.
Rob: That's really interesting that they've reached an inflection point at least on the debt side. I wonder if they're interested in any of the sub sectors or are they going across the board to all the sub sectors of commercial? Are they interested in server farms or student housing? What are they going for?
Pete: It's a great question. It's hard to say one particular sector, but I think the one theme that has become fairly notable is just the interest or the desire for, call it, specialty sectors. And so that's kind of a catch all but the point being something that is differentiated and something that is maybe less correlated with kind of the core exposures and the typical real estate exposures that you may already have in your portfolio.
So it's not like clients are coming to us asking for a particular specialty sector. It's more of a kind of catch all like, hey, what sorts of exposures can you get for us that might be less correlated with our existing book? And frankly it can be a challenge because you want to make sure that you're kind of accessing parts of the market that are scalable and that we can really deliver. And, again, we have a large real estate franchise and so we're trying to be mindful of what are those parts of the market that are at the same time both differentiated but also scalable and ones that we think are durable. So you do have to be thoughtful about that.
Rob: Right. The durability comes from the relatively long term approach that most asset owners, particularly insurance companies, come to with these investments, right? They're forecast is at least seven years for this, right?
Pete: Right, exactly.
Rob: Yeah. And if not more. That makes it very difficult in a narrow market. Parenthetically, I would mention that our next podcast is actually going to be on senior living facilities. So we're going to drill down this in our next episode. You heard it here first about. I joked with specialty credit is basically not office.
Pete: There you go. Yeah, that's a good way to put it.
Rob: So this is where I'd like to pivot this a little bit to your process because, boy, you and your team writ large are covering a lot of different things in a lot of different places. And I think some people are wondering how your team is structured? Do you bubble ideas up, down, sideways? Like how does all that stuff work? And because you have a global team, how do you handle the information exchange on a global team basis?
Pete: That is the $1,000,000 question because where I sit, I'm part of our solutions team and the short answer to your question is there is no one way that ideas bubble up, down, sideways. It's really all of the above. And the way I think of it is myself and our solutions team, we kind of sit at the center of all of our investment teams around the firm. And we've talked a lot about private credit, private real estate, but also our fixed income franchise is very sizable. We also have a very big ETF and equity franchise. So I have the luxury of sitting kind of in between all that. And so we get ideas from all of those investment teams, all of those experts in their respective areas. If they are seeing opportunities or activity that might be new, or kind of nascent things that maybe haven't been trafficked in highly, that might be an opportunity that we can bring to our insurance clients.
Conversely, we can go to our investment colleagues and say, look as an example, here's what's happening in the regulatory context right now. Can we maybe repackage something that might deliver the same exposure for insurance clients, but just in a different wrapper or a different vehicle that makes it more capital friendly? So it can go that direction. There's really no limit to where ideas can be sourced or any good idea. We're absolutely open to discussing wherever it may come from. And the way we work with our clients, it's very similar. I mean we in one sense we as a solutions group, we're kind of an extension of our investment teams, but we're also, from our clients perspective, we're an extension of our clients teams and that's really how we kind of bill ourselves and how we kind of offer our services is we're dealing with very sophisticated clients, but our insurance clients, I mean they know what they're doing. They have their views, they have their models, they have their analytical frameworks. And many times, arguably they don't. They don't need help. But the way we frame it is if you would like help, if you'd like a second set of eyes, we're here to do that. If you need help again, packaging something or delivering something in a different wrapper, we're here to help with that.
But, I think the key is we're here to really consult with and partner with our clients as an extension of their own teams and they can kind of point us in the direction that's most helpful for them. And as an example, a newer capability that we've developed here in the last year or two is more of a kind of a multi alternative capability where for let's say our kind of smaller or mid sized insurance clients who maybe don't have the bandwidth or don't have the in house resources in terms of personnel, might be an investment team that's a couple of people, they don't necessarily have the bandwidth to assign somebody to just cover private equity or just cover private real estate and then deal with manager diligence and all the operational elements and dealing with capital calls and distributions and all that sort of stuff. So we've kind of put together a multi alternatives capability where we can deploy and by the way, it doesn't have to be Invesco content. We can utilize other managers capabilities as well. We recognize we're not going to be the best at everything at Invesco. So we can do that on behalf of our clients and really function as kind of a de facto staff member for them and just do some of that heavy lifting to kind of take some of the stress off of their plate while they're still really making a lot of the key decisions. They hold the keys right? They decide what they want to do at the end of today. But it's something that's been really helpful working with really large insurance mandate in this context with a client in the UK. And it's been really rewarding because again it gives us access to a lot of great ideas, to your earlier question, both in Invesco and even outside, and it's a really interesting avenue for us to be working with our clients.
Rob: Yeah. I mean, the sort of insurance comp, insurance book, if you will, that you just described is most of them. Most of them are not the really large firms by definition, right? So this is the exceptionally important thing. And also in the asset categories you just mentioned, there is, to dig into an old statistic word I would use, there's misfit risk or exogenous risk that clips those things and you really need somebody who does that, who lives it because it's all often painfully obvious to them.
Pete: We think so, yeah.
Rob: As we are nearing the end of the year, I know a lot of people are sort of topping up their reading lists and downloading stuff and getting ready for the time off. I wonder if there's anything in particular you've been reading watching, otherwise intellectually consuming as we all have so many options today.
Pete: Yeah, well, it's funny, outside of work, I try to not read finance all the time. I try to broaden my horizons a little bit. So I think the last book I read was Colson Whitehead’s “Crook Manifesto.” He's one of my favorite authors. And that was a continuation, if you will, of one of his prior books, which I loved. And it's very much into the New York mindset which is always interesting to me.
And honestly lately just in the last week, with the passing of Charlie Munger, as an Omaha guy myself, I keenly follow the Berkshire goings on. And obviously he's a very well known guy who was not short on funny quotes and quips and also good investment advice and content. So it's been kind of fun to go back and see a lot a lot of the writings and quotes and clips, video clips of his shareholder meeting appearances over the years. So honestly, I've been consuming a lot of that the last week or so. And as I said, he's provided a lot of fodder, which is both educational and entertaining at the same time.
Rob: Right? It's the best. As a person who's involved in sort of continuing education, that's the best. So thank you for that. And I just want to point out to everyone who's listening to the podcast here today that there’s a little bit of coincidence coming up on Wednesday. Invesco is the sponsor of our event on Wednesday, the 8th Annual Insurance Roundtable. Just before we recorded this, we had 14 seats left for this, so if you’re members out there, thinking about coming, do sign up soon because we're going to be closed soon. And the hopefully we'll see you on Wednesday.
This has been great, Pete. Thank you very much for the relatively broad touches on a lot of things, and it was fascinating to hear about how your team is structured.
Pete: Yeah. Thank you so much, Rob. Really enjoyed it.
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Pete Miller, Head of Insurance Solutions, weighs in on what’s affecting insurance portfolios right now, the private credit landscape and trends in real estate.
Pete Miller, Head of Insurance Solutions, weighs in on what’s affecting insurance portfolios right now, the private credit landscape and trends in real estate.
Stewart: Welcome to another edition of the InsuranceAUM.com podcast. I'm Stewart Foley, I'll be your host. Today's topic is private distressed credit and special situations, and we're joined today by Paul Triggiani, Managing Director and Head of Distressed Credit and Special Situations at Invesco Private Credit. Paul, thanks for taking the time to come on. We certainly appreciate it.
Paul: Yeah, great to be with you today.
Stewart: We're thrilled. This is a great asset class. We want to learn about it. I've got lots of questions for you. Before we get going too far, we always ask our guest, where did you grow up? What was your first job? Not the fancy one, and what makes insurance asset management so cool?
Paul: The third one's tough. I'll have to think about that for a second. But the first two are easy. I grew up in the suburbs of Maryland, now very developed area, and my first job was as a produce boy at the Country Counter grocery store.
Stewart: There you go. Character building.
Paul: Yeah. Now what's so great about insurance asset management, lots of money to invest. Lots of ways to think about risk. Risk is a big part of what we do in terms of thinking about our investment philosophy. We'll unpack that I suspect a bit in terms of how we think about risk and manage risk. But one of the things that we always talk about investors in the insurance asset class about and we focus on is how we think about risk and how that integrates into our philosophy. So that's what’s exciting about it to us.
Stewart: That's terrific. And I mean, I'm a fixed income geek, but not in the distressed area at all. So it would be helpful to just talk about an overview of your investment philosophy and approach when managing distressed debt. But I think before that, even, can you sketch us a definition of distressed debt?
Paul: Yeah, so let's talk about two different ways to think about this asset class because it can be a bit confusing at first, right? So thinking about buying into a company's capital structure, they have debt and equity. There may be various reasons their debt is, when issued at par, 100 cents on the dollar available to folks like us at 50, 60, 70 cents on the dollar. Some of that might be interest rate driven, some might be company performance, or it could be a mixture of both, could be refinancing issues that they're having. But we like to sort of segment it simplistically into two buckets.
There are those who trade distressed at meaning they're buying something at 40 cents and they think it's going to go to 100 and they're going to sell it. And then there are folks that do what we think of as distressed for control or special situations investing where we're accumulating a debt position, typically a majority position, and we're going to restructure the business and convert our debt ownership to equity ownership in the business. So we fall into that latter camp, which can feel a bit more like private equity in some ways. And there are some important distinctions which we can get into in terms of how we differ from that asset class. But simplistically think of it as trading versus debt for control.
Stewart: That's super helpful. What types of distressed assets do you specialize in? And the types that come to my mind are corporate bonds, loans, or distressed equity. So where are you focused?
Paul: We are focused on a pretty niche market in that our strategy targets small capitalization, lower middle market companies. So typical company for us is going to be a loan-only structure. It's not going to be big enough to have high yield bonds generally. There are some exceptions to that. There are some small high yield secured bond issuances in the Nordics, for example. You don't see them very much in the US anymore, but there are still some over in Europe and the UK. But we generally focus on smaller companies, think average EBITDA, and everybody has a different definition of small capitalization.
So we think generally companies with on the low end, $100 million of debt, a high end, maybe five, $600 million of debt. They tend to be senior secured loans and they're almost entirely private equity owned businesses. So the private equity firm would own all of the equity and they would go out and issue debt to buy this business. And when that debt becomes distressed, that's when we get interested.
Stewart: So can you talk about just the macro background of distressed investing, particularly as it relates to the growth of the loan, high yield direct lending markets over the last 10 years?
Paul: So if you think about one easy comparison to make is the size of the leveraged credit market overall, if you include loans and high yield is up anywhere depending on who's estimate you use, pre-GFC to today, 3 to 5 X. And a lot of that growth has come from private credit direct lending, which has become 1.5 to 2 trillion part of that asset class. And a lot of that growth has come from Europe where the growth and leverage credit has expanded dramatically over the last 10 years. So the market is much bigger today in terms of what we can address as distressed investors. But that in and of itself doesn't make something interesting just because it's bigger.
What's interesting is how it got bigger. There's still quite a bit of regional bank participation in these smaller loans to smaller companies in Europe. Regional banks generally sell pretty quickly when a company gets into distress, even if it's just financial distress because the capital charges they have to take if they hold assets that are non-cash pay or going to convert to equity are negative. And then there are obviously the vast majority of direct loans that have been made are going to be just fine. But there are some standalone managers and club deals that were done that don't have in-house restructuring capabilities. And those folks in particular as we live in a higher interest rate environment for a longer period of time, will run into some problems and they're going to need to sell their debt to folks like us.
What makes the next year or two so interesting from a distressed point of view is there's an old adage that distressed investors have used for years, which is that folks like us buy good companies with bad balance sheets. And the reality is that while that's a great marketing slogan for the past 25 years, it really hasn't been true. If you think about every cycle we've been through, '01-'02 was very tech, telecom, broadband-related, right? '05-'06, we had an auto cycle during the GFC, very industry-specific issues around mortgages, banks, home builders, building products, et cetera. We had an oil crisis in 2015. You could argue the last 10, 15 years have been an industry cycle in retail, as Amazon disintermediates every retailer, right? And even COVID vintage funds, '20 to '22 had certain industries that were drastically more impacted than others.
So the point we're making is that if you look back over the last 5, 6 cycles, 25 years, you've always invested during a cycle in industries that had some kind of secular issues to them. What's interesting right now is that there's no company that's immune from inflation. There's no company that isn't experiencing pretty dramatic inflation in their cost structure, not to mention 400 incremental basis points of borrowing spread that they have to endure, which equates to about 20% of EBITDA degradation.
So costs are up. We're starting to see the consumer pull back, industrial production pull back a little bit. And so what you have right now is really your pick of the litter, so to speak, rather than in the past you've had to enter certain industries that may have had some kind of secular distress. You don't have that issue right now. And it means as a distress manager, you can skew your portfolio in terms of the opportunities you look at, to really, really sound companies in sound industries. And it's the first time in this asset class that you've really been able to do that with the entirety of the opportunity set. So there's no reason to spend time on operating turnarounds or industries in transition, and that may generate higher returns, let's hope. But what's more interesting about that, particularly for your audience, I think, is that it means there's a lot less risk in this coming vintage of distress than we've seen likely in a long period of time.
Stewart:That's a really interesting assessment and helps me understand how you approach it in particular. How do you assess credit risk and determine the potential for recovery in distressed assets?
Paul: So when we look at a business, there's two initial thoughts we have. One is, and it's helpful just to think about it, what we're after is asymmetric return profiles. If investors want to find symmetric returns where you can make a lot of money but lose all your money, you can buy listed equities, you can buy private equity. There's lots of places to express that opinion. Our job as distressed investors is to find places where you have credit downside protection, but can make equity-like returns. So the first thing we're thinking about, is this a good business? Is it in a good industry? Does it generate a good return on invested capital? And is it a business ultimately we want to own? Because again, going back to your question a few moments ago. Everything we touch, we want to convert that debt to equity ownership through a consensual restructuring of the business, free up the company from a lot of leverage, reinvest in it.
So our exits are typically buying a business, de-leveraging it, reinvesting in it, growing it, and then selling it 2, 3 years later to private equity, to a strategic, maybe one of our companies gets big enough to go public. We have one that is large enough now to do that. And so it all comes back to fundamentally sound business that we can grow and sell onto someone who can take it to the next level. But it starts with thinking about risk and then thinking about the quality of the underlying business itself.
And the final point on that really is you think about how do you try to make money for investors? There's two ways. One is being extremely cheap. So buying distressed debt at a big discount to what you think the business is actually worth. That's the easy way. And then what do you do with the business once you own it, right? How do you add value?
Stewart: And it's interesting because I think that your focus on risk is music to the ears of the people who listen to our podcast. So how do you mitigate, I think this is what every CIO that I know of right now is thinking, is like if something goes bump in the night how do you mitigate downside risk? What measures can you take? And can you give me an example of one that we can talk through?
Paul: The easiest way to do that is the comment we just made, right? Buying something well inside the value of the business. So if the business is worth $200 million and you can buy it through the debt at a $100 million, you've created that investment at a 50% discount to its intrinsic value. Another way you can do it is I mentioned most of the companies we look at are small. They tend to be first lien senior secured only debt structures, or maybe there's a little bit of second lien or mezzanine, but our entry point 90% plus of the time is in senior secure debt. So top of the capital structure, least risky part of the capital structure and also the part of the capital structure that controls overstructuring. So that's a huge mitigate.
When we restructure a business, we don't convert the debt to 100% equity. So in that example I gave you of a 200 million company, we may take leverage down to $40 or $50 million through a restructuring, we'll take back that piece of debt and then own hundred percent of the common equity of the business. So we're still keeping a little bit of debt on the business that pays us a nice coupon, but we own all of the equity of the business as well.
The de-risking piece is actually the simplest from an explanation point of view. And that if you have a company that's over-levered, as $200 million of debt in our hypothetical example, is paying high cost interest on that and you snap your fingers and restructure the business and now it has $40 million of debt, you can redirect all that interest that was being paid on that over-leverage balance sheet back into growth avenues of the company. So that in and of itself, that financial de-risking we call it, which is sort of part one of our value creation, is another really simple, easy way to free up capital. And what management team doesn't want less debt on their balance sheet, more money to invest in their business, and by the way, their equity underneath a lot less debt as well.
Stewart: And I've heard this said by folks who are in the private credit space that, "Hey, these are floating rate assets and rates have reset and everything's great." And you go, "Okay, yeah, but..." That gets me to the question of, how are these small cap borrowers able to absorb the backup in rates that have happened over the last two years? Because not everybody, to your point earlier, not everybody's going to be able to deal with these substantially higher rates.
Paul: It's a great question and you might even add onto it. What about lapping another year of these rates and what does that do? So if you look at just the small cap universe that we target, on average fixed charge coverage ratios, so think of that as just simply your cashflow to coverage your interest expense, right? It's about 1.13 times right now on the cohort of 5,000 small cap issuers we look at in the private credit space. And if you look at how many are below one, it's about a third. If you proforma another year of rates where they are now in terms of base rates being north of 5%, you get to about just under half of that universe being sub one times.
So the answer to your question is many of them can't already, and a large chunk a year from now aren't going to be able to. And what I think many folks that make that comment are focused on is, there's been a bit of a myopic focus on how much more the Fed is going to hike. Is it another 25 basis point? When is it coming, when is the first cut? And until the last 2 or 3 weeks, you haven't really heard people talking about, well, the fact that it's going to be high for a lot longer at base rate, right? It's going to remain elevated for longer than folks thought. And when it reverts back, it's not going back to zero post-GFC levels, right? It's going back to, what, 3%?
So it's higher for longer, and when it does revert back it's going to be at a higher level than we've endured in a decade and a half. So it's a fundamentally different paradigm for the next 2 or 3 years in terms of thinking about how these companies are going to deal with that. Many folks will pick their interest. Many folks will find ways to extend the maturity of their facilities, but there are folks who will have maturities in '24 and '25 and they'll need to be proactive and find ways to restructure their businesses.
Stewart: That's very helpful. So what recent trends are you seeing in the distressed debt space and how have those trends influenced your decisions in distressed debt?
Paul: If you think about the simplistic view I painted of trading distressed debt and buying debt to own a company, that's generally been the MO, if you will, for the past 25 years in this asset class. The situation we just talked about, about a private equity firm owning a business that's over-levered, having maturity in '24 or '25, maybe even early 2026, these are very smart funds. They're smart individuals. They're looking at their capital structure and saying, "Huh, I may not be able in 18 months to grow into this capital structure and get a refinancing done. So maybe I should reach out to my lender group and talk about incremental liquidity, a way for a special situations transaction to come in and maybe provide rescue financing or incremental liquidity and at the same time potentially extend my maturities."
And so typically our funds or strategies would be entirely debt for control or catalyst-driven distressed credit. But what you're seeing more recently, particularly in the last 12 months, is the strategy being much more focused and evenly balanced between distress for contro, transactions and special situations transactions, rescue financings, liability management transactions, amend and extend transactions where the creditors are putting in more capital and earning good returns. So I think if you asked most folks in my chair what they expect for this next vintage is an overweight of special situations types of transactions versus distressed for control, which will be the first time we've really seen that part of the toolkit expressed in such a major way.
And private equity firms being proactive with their lender base to solve liquidity needs, is a very, very new phenomenon. That's not something that happened up until the last 12 months or so, and we think, and we're already seeing it, that that will continue to increase and become a large part of what we do in follow-on vintages for frankly the entire universe, large-cap, mid-cap, small-cap, distressed managers.
Stewart: That really helps. I mean, I'm learning and as we walk through here, I feel like I'm getting a good much better understanding of this market than I have when we started. Is the opportunity set limited to the US or are you seeing opportunities in Europe and elsewhere?
Paul: It's interesting. It's very broad based, and it really started a couple years ago in that, if you think about 2019, the end of 2019, take yourself back to pre-COVID times. And you think about how the US economy was doing then, you know, growing 2-3%. Asia Pacific, 6-7%, but Europe was on wobbly footing in 2019. You had a negative quarter in the UK and Germany, which are really the growth engines of UK and Europe.
And so Europe went into COVID, so to speak, on weaker footing. And if you look at the sort of recent economic indicators coming out of Europe over the last couple of quarters, if you were to bet and say, "What do you think is a more high likelihood of a recession UK/Europe or the US?" You would say UK/Europe right now, we're not macroeconomists, but we read the same information probably many of your listeners do, and we spend a lot of time studying these data points. And so you focus on the fact that you do have the growth engines in Europe slowing. A chance of a recession there is more likely, and it's quite possible, the US skirts one.
So the opportunity set is very broad. Our portfolio, when we look at it, our pipeline, I should say when we look at it, is pretty evenly balanced between the UK, Europe, and the US. And we expect that to continue and potentially even be overweight in the coming years, Europe and the UK, given the potential higher likelihood of a recession there.
Final point on that though is that in the end, whether these economies and individual countries have a recession or not is far less important than what your view on rates is, because we can skirt a recession globally, but if rates remain elevated at these levels for let's just say another year, which I think is very reasonable in our view, that's going to cause all of those issues you asked about a few minutes ago in terms of strains on coverage ratios and refinance ability for those that have maturities in the next 12-24 months.
Stewart: That's super helpful as well. So we've talked a little bit about downside mitigation. What are some of the features of this asset class that your insurance clients have found attractive?
Paul: So probably a few things. One is that because we're investing at the top of the capital structure in senior secured loans, they all tend to be current pay and they’re current pay through restructuring and they’re current pay once we restructure the company, because we do keep a little bit of debt on the company, we don't relever it until the company is very stable and growing and healthy again. And when we do put third party leverage on, it's at de minimis amounts. But that ability to keep getting a coupon out buys your basis down, de-risks you, gives you some of your bait back. And I think many of our insurance LPs find that very helpful.
I think the other piece of it is, senior secured debt is obviously a very protected part of the capital structure. You have a mortgage on all of the plant property equipment, IP, intellectual property, if that's applicable. You have a lot of control in the restructuring process in many jurisdictions. Take the Nordics as an interesting example, as a secured creditor, you can share pledge and force and restructure the company in 24 hours on a default.
Stewart: Wow.
Paul: So there are some jurisdictions that are incredibly... Everywhere we invest is favorable to secured creditors, but there are some that are extremely favorable. And so those things tend to resonate. I think the other thing that resonates with that client base is the fact that it is a nice hedge against other parts of the portfolio they have on because it does tend to have much more of an asymmetric skew than other parts of their portfolio, so to speak. And so all of those things sort of combined, each one in and of themselves is not a reason to invest or to be in distress. But combined, I think they make it easier, in our view, for insurers to wrap their arms around this as something that does have good risk mitigation in place if it's done correctly.
Stewart: That's great. And just on the wrap here, what are you most excited about as you've been in this business a long time, you know the market well. What are you most excited about looking forward?
Paul: I think the most exciting thing that we're seeing, and again, this is a generic statement that applies to anyone that's in the distressed business, but as an asset class, this is really the first time you're going to get to have a really wide open market to choose really high quality businesses that have nothing operationally wrong with them, that are all suffering from right side of the balance sheet issues. In other words, the over levered rates have gone up, challenges refinancing.
And when you look at the maturity wall, and we're not big fans of throwing up big maturity walls and saying, look, what's coming. When you look what's inside the maturity wall, the credit quality in terms of, there's a lot of lower rated credit that's embedded in that and a lot of challenges getting a lot of that lower credit refinanced in '24, '25, '26 in the cohort we look at, given where rates are today. And the ability for you to enter this asset class, thinking about it less from a return point of view, that this might be the greatest vintage. You hear a lot of folks talking about this is a golden age coming of distress from a return perspective. And look, we all hope that's true, but we think the better way for investors to think about is, is the reason it's a golden age potentially is you're going to take a lot less risk and your probability of making those returns with less risk is higher than it's ever been in this asset class. That's super exciting.
Stewart: That is a really compelling set of facts, and it's honestly the first that I've really been able to focus on this area. So I really appreciate the education here for both me and our audience.
On the way out the door, we have two fun questions. You can answer either or both. Lots of people take both, no pressure. The first one is, what's the best piece of advice you've ever gotten or given? And the second one is, who would you most like to have lunch with alive or dead?
Paul: Oh, the second one is such a hard question, but... I think the best piece of advice I've gotten is to be patient when you're looking at environments like this. I don't like to use other people's quotes, but I think Buffett has such a great quote on waiting for that fat pitch, and I feel like the pitcher is getting more and more tired every week here, and the pitches are getting slower and slower and fatter and fatter, and being patient and diligent and prudent in capital deployment and having a team that believes in that I think is something I learned from people I worked for over the years and continue to learn today. And I think it's a great mantra to have. There's no reason to rush in. It's a little bit like, "Do you want to be the first guy at the party or the last one thrown out to leave?" No, you just want to be right at the heat of it.
In terms of who I'd have lunch with, I'm going to give you a completely off-the-wall answer since it's a fun one. It'd be Jerry Garcia.
Stewart: Oh, very cool. My good buddy is a neighbor of mine, his name is Armand, and he is a huge Dead fan, and it's kind of halfway rubbing off on me, so what a great answer.
Paul: Yeah, I'd love to spend an hour with Jerry.
Stewart: Very cool. Well, I've learned a ton today and I really appreciate you joining us and giving us a great education on distressed credit and special situations. So thanks for taking the time, Paul.
Paul: Great. Thanks for having me. Wonderful.
Stewart: We've been joined today by Paul Triggiani, Managing Director and Head of Distressed Credit and Special Situations at Invesco Private Credit. If you like us, please rate us and review us on Apple Podcasts, Spotify, Google, Amazon, or wherever you listen to your favorite shows. My name's Stewart Foley, and this is the InsuranceAUM.com podcast.
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Invesco Private Credit’s Paul Triggiani discusses the evolving landscape of distressed debt and what’s exciting him in this space.
Invesco Private Credit’s Paul Triggiani discusses the evolving landscape of distressed debt and what’s exciting him in this space.
Stewart:
Welcome to another edition of the InsuranceAUM.com podcast. I'm Stewart Foley, I'll be your host. Welcome back. It's nice to have you. We are talking today about US commercial real estate, which is a fantastic topic and super important right now as we're seeing questions abound, particularly around office real estate. We're joined by Dan Kubiak, who's the managing director and portfolio manager at Invesco Real Estate US Income Strategy, a role he has had since 2013. Dan, welcome to the program.
Dan:
Thank you. Great to be here and looking forward to doing my first podcast ever. So hopefully that'll be entertaining for everybody.
Stewart:
We're thrilled to have you on. I'm glad that this is your first podcast. Hopefully, we'll have some fun and we'll learn some things along the way. But before we get going too far, how about your hometown, your high school mascot, and what makes insurance asset management so cool?
Dan:
I'm not sure which one of those is harder. My hometown is a small town, Santa Fe, Texas, often confused with Santa Fe, New Mexico, but it's a small town in Galveston County right by the coast, which I guess might make me a pretend expert in wind insurance and hurricane risk, although I won't act like I am one. The mascot was the Indians. And I guess this is really top of mind right now, I mean, because I guess not only is real estate top of mind, but obviously insurance has been almost as big a topic this year as real estate's been from a number of different angles. So I think hopefully this will be pretty timely.
Stewart:
That's fantastic. So let's talk about the big picture here. Lots of concern about commercial real estate valuations, what's happening in the commercial real estate market today?
Dan:
Yeah, I mean maybe to rewind just a little bit, obviously, we've had an ultra-accommodative monetary policy for quite some time, and then post-COVID it was even more accommodating. And then we had a really abrupt shift in that. So I think anytime you have a very rapid shift in the macro environment, you can see some choppiness in the markets. We saw that the global financial crisis within about a month's time period, October '08. And then we saw it literally play out last summer to fall with interest rates increasing from a widely historically low level to something that's probably just a little bit more normal.
So I think it's going to take a little time for the real estate markets to adjust to this. And I think situations where capitalization of real estate investments and funds that were not in such a risky position should be fine, especially with higher quality investments. But maybe some of the ones that were maybe put together a little bit more risk to them might encounter a little bit more volatility as they adjust to just the higher cost of capital. And that's the capitalization side. And then on the fundamental side, largely the real estate fundamental side is still relatively positive, albeit not as positive maybe as it was post-COVID where it was in a real boom mode. Albeit there are several sub-sectors that have struggled post-COVID, most notably office, which I know we'll probably get into.
Stewart:
Yeah, it's interesting. So I think that's where a lot of folks are focused. And I guess the simplest way to ask this is, are things as bad as the headlines suggest? My mind goes to, what about trophy assets - are they investible today? Can you talk a little bit about how you read the office market?
Dan:
Yeah, I think my short answer to the question on the headlines, the short answer is probably yes, unfortunately. It's not overblown, it is legitimate and it's still relatively early in that story. I think the analogy I like to make is that some of the listeners may know that the retail sector around five, six years ago went through a fairly similar situation where it was the penetration of online sales, and shifting consumer behavior made it feel like bricks-and-mortar retail was, "dying". So there was a period of time where the retail sector was somewhat uninvestable, it was viewed negatively, but then things kind of slowly shook out. People realized that there would be winners and losers and you could see that in asset level performance. And then you had other helpful attributes happen in terms of just less new supply coming online, increased consumer spending. And now retail is actually one of the better relative performers within all of the sectors of real estate. And I think office is likely to play out somewhat in the same manner where right now it's still in that initial phase of shock to the system. And it's really hard right now to tell which office assets will be the winners and losers. And I think the one thing we certainly know is that unfortunately post-COVID there will be more loser, "office buildings" and there were pre-COVID. And so I think that similar to what retail went through a few years ago, that's still shaking out.
Stewart:
And we did a podcast on CRE, I don't know, come maybe two months ago. And someone mentioned a chart that graphed basically lending tightness by banks. And that person said valuations won't find a floor until that chart reverses course and banks begin to be more accommodating themselves. Do you agree with that statement generally?
Dan:
Yeah, yeah, generally speaking, yes. I mean, real estate valuations tend to be a function of both fundamentals performance, cashflow performance of the asset, and sentiment behind both equity investors and debt investors in the space. And right now, we've seen the headlines that banks in general don't have a lot of capital to lend right now. The capital they do have to lend is somewhat expensive and has some terms and conditions that aren't ideal. So that is impacting real estate broadly, albeit in some of the more favored sectors such as the industrial or logistics sectors or the residential sectors, there is somewhat available debt capital and that's helping transactions continue to happen at a much more moderate pace. But yes, in the office sector, a number of lenders either feel like they have too much exposure there already, that's not where they want to allocate capital, valuations are uncertain. So there's really not a lot of available debt capital for that sector right now, unfortunately.
Stewart:
So I think that COVID is the catalyst for this stress in the market because of work from home. I've spoken with somebody in the last week that's 100% remote. I've spoken with folks who are hybrid, and I've spoken with some folks who are five days a week in the office in New York. What do you think is next for working from home?
Dan:
Yeah, I guess I agree with your premise that more broadly COVID served as an accelerator of a number of secular trends that were maybe already in place such as work from home or online shopping or more mobility in our society. And it really served as a great propeller of those trends that might have played out over 5 to 10 years, playing out over 2 to 3, which puts a lot of stress on the system, so to speak. Within office, there's a lot of speculation, but I think it's very clear that things are not going to go back to the way they were pre-COVID. There is going to be more flexibility built into how we use office space, the way we do it, in the manner we do it.
Office is not dead, it will not die. That was a headline with retail as well. It'll not die, it'll not go away, but it's being transformed, and it's being consolidated. And I think right now is the time to try to figure out which buildings will be the ultimate winners within this. And there's potentially some tactical investment opportunities there at some point. It's probably a little early. And frankly, which buildings are not, and I think trying to avoid and get away from them because I think even firms like ourselves that have come back to the office generally 4 to 5 days of the week, we even have additional flexibility built in, and we're probably utilizing space more efficiently. So our aggregate space demand is probably going to be flat to somewhat down. And so I think you need to take all that into account.
Stewart:
So let's shift our focus to the international markets. What are you seeing in commercial real estate in Asia and Europe today?
Dan:
Yeah, definitely, I'll start by saying I'm foremost probably much more versed on the domestic side here in the US, but I think there are a couple things really to point out across the globe. One is, generally speaking, we tend to see a little bit more growth in the Asia region than the European region, which I think is fairly intuitive to people, albeit there's still are opportunities there. But two, kind of piggybacking on the office sector conversation we've been having, we've generally been seeing a quicker return to the office and more office utilization occurring outside of the US versus inside of the US. And that's been an interesting phenomenon.
I think there's a number of reasons people might speculate on that. I guess one of which being that living quarters tend to be a little bit smaller in some of the European markets or Asian markets. So it's a little harder to consistently work from home so people actually have that desire to leave the residence and go to the office. I think maybe there's some other maybe demographic issues relative to large millennial, kind of Gen-Y population here in the US that is in that 30s to 40s seeking to move out to the suburbs, so to speak, and get a home. So the commute times are farther. There's probably a lot of reasons for that, and you could probably have a good argument about it, but I do think it's something worth noting that some of these other regions tend to have had a little different recovery.
Stewart:
That's really helpful. So Dan, when we think about real estate capital markets, what's going on there? Are there transactions getting done? Is anything getting financed? What are the current market conditions in the real estate capital markets?
Dan:
Yeah, things are getting done. There is a propensity for... Newspapers and magazines sell because they write headlines that lead you to want to buy them. So I think there is a focus on some of the negative, but there are some positives going on out there within sectors that I know we as a firm and within our strategies really like on the residential side, the logistics side, especially sectors relative to self-storage. It's absolutely moderated from the last year or two, but admittedly those were record levels. So it's a little unrealistic to think those would continue.
But it's more in those favorite sectors that are still seeing positive fundamentals that back to your earlier question that lenders have an appetite for and can help facilitate transactions relative to the debt part of the capital stack. Although, you still see a lot of capital out there to the point where a number of buyers that may be over the last year or two might have used leverage on their investments aren't using it now. They're just buying them all cash and they're waiting to finance at a later date, but they really like the asset and the basis that they're getting in on and don't want to miss that opportunity because it's probably at a much better pricing level for them relative to where it was maybe a couple years ago.
Stewart:
So as a real estate investor, how are you investing in these markets right now?
Dan:
Yeah, I think some of it goes back to what we've talked about on the sectors. And there's certain sectors that I think we have a positive forward viewpoint of both near term and long term relative to just secular changes in demand, residential relative to just demographic changes within population ages such as the millennial generation-wide demographic we talked about before. It's the largest grouping. It's at that age in life where they're consuming, they're purchasing homes, they're forming households. So the residential side we think has a lot of drivers to it. Correspondingly, logistics as well in terms of just continued transformation, supply chain system, online retail sales. Onshoring, so to speak, as we've seen operations move maybe from global locations back to domestic locations. So those are some of the sectors that we really like and that you'll see a real emphasis within our portfolios.
Stewart:
That's really helpful. And one of the things that is always a topic of conversation on a podcast is the impact of rising rates. And rates went up dramatically last year, and we've got a little bit of decline of late but still significantly higher than levels that you mentioned at the top of the show. Can you walk me through how those rising rates are impacting this market right now?
Dan:
Yeah, I think what you're seeing is the ability for strategies within this environment to differentiate themselves if they have premium income levels that can somewhat match where the cost of financing's gone. So we really like strategies that feature premium income as well as growth of income, which is a little bit of what I've been talking about on the sector side relative to sectors that have forward growth fundamentals as well as market focus. Maybe some of the markets that we all know right now that are maybe in the southern and western United States and the Sun Belt region tend to have more growth characteristics because that's really the best way in a somewhat higher rate inflationary environment to combat that within your real estate portfolio is having a premium income level in the first place and then also having an income stream that can really grow through that in a well-managed balance sheet.
So I think those are characteristics we look for in our strategies to help guide us through the near term with rates being a little bit higher for a little longer, albeit we think they will probably moderate some at some point here over the next year to two.
Stewart:
Thank you. I often say that I learn the most on these podcasts because I get to talk to subject matter experts like you and I get to ask questions that I simply don't know the answer to. And so this is one of them. So when we're talking about real estate... I mean, I'm a fixed income geek. So when we're talking about fixed income, I know what these terms mean, but it helped me understand what core, core plus, and opportunistic mean in real estate terms for the description of different strategies.
Dan:
Yeah, I'd say they're all characteristics that I think are needed within a well-balanced portfolio whether, as you mentioned within the fixed income world, they have their own terminology for it within the equity stock side of the business, they have their side of it, whether it's growth stocks, value stocks, there's a balance there. And that's really what those terms all seek to achieve is diversification within a real estate portfolio, complementary aspects where you can have a core portfolio that maybe features, like you mentioned earlier, maybe some trophy buildings with really low-income returns to them but a lot of perceived durability and quality. So maybe a little lower returning total return, but a lot of safety to that.
And then you kind of go up one step to core plus where maybe the total returns are a little higher, you're taking a little bit more risk in a smart way in terms of going maybe a broader set of markets, a broader look at sector weights that you might utilize, maybe utilizing a little more leverage but not a dramatic amount and further emphasizing those total returns and maybe premium income returns as well that fits very complimentary with your core approach.
And then lastly, opportunistic. Obviously, these are typically non-stabilized investment profiles that don't have income returns, but the potential for really strong total returns, albeit at a riskier level. So they all kind of complement each other in terms of risk level income orientation, or honestly lack thereof quality, market breadth and depth, sector weights. So that you're building something that's fairly durable that can go through cycles like what we're going through now and have some really all-weather attributes to it.
Stewart:
That's really helpful. So we've kind of gotten ourselves to this buy, sell, or hold segment, Dan, and I guess it goes something like this, what types of asset profiles do you like as a firm? What are you avoiding and why?
Dan:
Yeah, I think maybe starting with the avoiding part of it, I guess I would say clearly the office sectors we talked about, not that we don't think there will be some winners out there within the office sector, but it's fairly early innings on that right now. I think it's not overly transparent as to which ones they'll be, but at some point, they'll present themselves, but it's still a little early on that front.
I'd say the other thing that we're avoiding is, I think there still are some owners and sellers that are, even on attractive assets, maybe locked in into yesterday's valuation, so to speak, at really low cap rates or income returns that frankly, even if interest rates do settle out a little bit, still don't make sense in terms of where the true cost of capital sits. So conversely, that kind of helps me answer the other side of it in terms of what we talked about before, premium cap rates, premium income levels that can help better match where the cost of funds has gone and sectors and markets that we think have growth characteristics to them we think can really demonstrate well through both the near term and the long term.
Stewart:
Thank you. And Invesco manages a significant amount of insurance assets. What are some use cases for insurance general accounts? How are they using real estate in their portfolios?
Dan:
Yeah, I think a lot of investors, I think first and foremost, they really value the income generation that comes from it. It can serve as a little bit of an inflation hedge as we've talked about. So the income component can help balance out some more of the more volatile areas within their portfolio. It can generate income today that can go to use however they see fit, it can diversify their portfolio, again, lower their volatility within their portfolio. And I know there's been certain regulatory changes over the last year or so that have made the viewpoint of real estate within the insurance business a little bit more favorable relative to reserve requirements. So I know we've seen a number of clients that have approached this over the last year or so that now that things are a little bit more amenable to real estate and realizing some of those benefits that I talked about, we've been seeing a lot more activity from that side.
Stewart:
That's great. And so it's just kind of a little bit of a wrap question. When you look at the commercial real estate market today, what are you most excited about on a looking-forward basis?
Dan:
That's a great question because, and you've talked about it, I think there's a lot of negative headlines right now, and I think sometimes we can get lost in that and not really see the opportunity. I can tell you that a couple years ago when there was a lot of capital flowing and cap rates were around 2.5%, 3%, 4% on certain investment profiles, it was really challenging to invest in the right profiles that could get the right growth at the right cap rate. I mean, everything was really aggressively valued. And now valuations have come off that a little bit, and it's a little bit easier to buy, frankly. There's a lot of good opportunities out there. And so, frankly, I've been here at Invesco for 20 years, I've invested through a number of cycles, these are the parts of the cycle that honestly leave me the most excited because that's where the most opportunity is and the ability to really differentiate.
And that's a lot of what we're doing now is capturing opportunities that previously were just priced well beyond us. So I guess I'd say that while we've seen valuations back up a little bit, it's always really hard to precisely time the bottom of something. And to the extent, you see a portfolio or a strategy, you think really makes sense for you long term and you generally think we're getting close to an inflection point, I guess I would just advise clients not to try to time it too perfectly and really try to think more long term in terms of what they get into.
Stewart:
Great advice. It's been a pleasure to have you on, and I've got questions on the way out that you have an option you can do either or both. You ready?
Dan:
Okay.
Stewart:
Who would you most like to have lunch with alive or dead, or what's the best piece of advice you've ever gotten?
Dan:
Well, being a native Texan, I might pick Sam Houston is the person I'd like to have lunch with. This very dynamic individual, if you go back and look at his biography. And he was a contrarian on a number of items historically that I think proved him right. So I always find characters like that fascinating. And then also, I guess I'd say the best advice I got was really to look at situations where you are broadening your experience level and your responsibility levels. And it's advice I give some of the younger folks in our office all the time because if you're doing those two things and you're not necessarily getting lost on what that specific role is and then maybe how long you're in it, if you're broadening your skillset, you're getting more responsibility, you're generally going to end up in a much better position in the future. And I know that's something that's put me in the position that I am today in terms of having to know a lot about a number of topics. And so being able to have a variety of roles and experiences really put you in the best position to have all the context you need to make good decisions.
Stewart:
Very good advice. Thanks for being on. We've been joined today by Dan Kubiak, managing director, and portfolio manager at Invesco's Real Estate US Income Strategy. Dan, thanks for being on, and thanks for listening. If you like us, please rate us, review us on Apple Podcasts or wherever you get your podcast content. My name's Stewart Foley, and this is the InsuranceAUM.com podcast.
Investment Risk Warnings
Property and land can be difficult to sell, so investors may not be able to sell such investments when they want to. The value of property is generally a matter of an independent valuer’s opinion and may not be realized. The value of investments and the income from them can go down as well as up (this may partly be the result of exchange rate fluctuations in investments which have an exposure to foreign currencies) and investors may not get back the amount invested.
For strategies invested in a particular sector, you should be prepared to accept great fluctuations in the value of the portfolio than for a strategy with a broader investment mandate.
Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date.
For Institutional Investor Use Only
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
NA3259726
Post-COVID, concerns around commercial real estate have been mounting. Managing Director and Portfolio Manager Dan Kubiak joins the podcast for a deep dive on the challenges and opportunities he sees in the sector.
Post-COVID, concerns around commercial real estate have been mounting. Managing Director and Portfolio Manager Dan Kubiak joins the podcast for a deep dive on the challenges and opportunities he sees in the sector.
Stewart:
My name's Stewart Foley, I'll be your host. Today's topic is senior secured loans and we're joined by Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research at Invesco. Kevin, thanks for being on man.
Kevin:
Stewart, thanks very much for having me. It's a pleasure to be here.
Stewart:
This is a little bit of an unusual deal because my flight got canceled going to Chicago last night, I'm sitting in a hotel room in Philadelphia, and we're employing all of our technology possible to make this happen today. We tried the timestamp these things because markets are moving so quickly, and so we are recording Friday morning, April 21st. And so before we go too far, I wanted to ask you, where did you grow up? What was your first job ever? Not the fancy first one. And then what's a fun fact?
Kevin:
Okay, so I grew up in a town called Greenlawn, which is a small town on the north shore of Long Island, so about 30 miles from where I'm sitting today. My family still lives out there, so really never moved too far than go to school. Actually, I went to school in Philadelphia for grad school, so very familiar with where you are. You could have taken the train up, we could have done this in my living room.
My first job was pumping gas at the local Getty Station in Greenlawn and then moved on my next summer job after that was selling furniture at Macy's. So, like you said, not glamorous jobs, but they certainly were fun. Fun fact, I have really a strong work ethic, so much so that my first day here at Invesco 25 years ago, like you, very similar, I was coming in from New Orleans for Jazz Fest and my flight, just like yours, got diverted. And so instead of arriving home on Sunday, I arrived home on Monday, the day I was supposed to start and I didn't want to be late for my first day of work. So like you, I went to the office dressed as I was from my vacation in shorts and a T-shirt. And fortunately, I had a very understanding boss who really appreciated my effort and was willing to overlook my attire for my first day. She sent me downstairs to a Banana Republic to buy some Chinos. So, not everybody starts their first day of work dressed quite like that, but obviously it's gotten better from there.
Stewart:
It reminds me of a kid that was a student of mine that was going for an internship interview and somebody in his house that he was living with, they parked their car behind his and the battery died and they couldn't get it started and whatever. And he ran in a suit to the meeting and he was a hockey player and he was wringing wet when he got there and he's just like, he got there on time and everything, but he ran in dress shoes, right? And it's like, that shows you something, right? It's like, this guy wants it and that matters. And he got the internship and it worked out well for him.
Kevin:
Good for him. That's very admirable. I can completely understand. So...
Stewart:
Yeah, so one of the things that happens, Kevin, with me is I get a chance to learn a lot on these podcasts. So the asset class we're talking about today is senior secured loans. And so what I wanted to start level set the thing is, what exactly are we talking about with senior secured loans? And what makes them a compelling asset class today in your mind?
Kevin:
Sure. So I guess take a step back and what are senior secure loans? They are exactly what the name would suggests. They are loans made to big US and European corporations, generally Fortune 500, Fortune 1000 corporations, names you would be familiar with, Hertz, Burger King, Carnival Cruises, and they can be made for a number of purposes. Companies are making an acquisition, Burger King being acquired by a private equity sponsor or Carnival looking to finance a new ship. And what happens is they'll go to a big money center bank, a JP Morgan or a Barclays, the bank will underwrite that loan and then that bank will turn around and syndicate it to a group of investors such as Invesco. And so we'll buy a portion of that loan.
And the thing about the senior secure loans makes them so attractive is they're exactly what it says they are, they are senior, they are the senior most obligation in the company's capital structure, which means that we are first in right of repayment. That makes it very attractive. Secondly, they're secured by all the assets of the company, the property, plants, equipment. So in the case of Carnival, we're secured by the cruise ships. So if there's a default and want to keep in mind these are all below investment grade companies, if there's a default because we are secured by the assets of the company, we can accelerate, in the same way that the bank can accelerate on your mortgage if you don't make your mortgage payments and take your house, and we can accelerate, take the company and either sell it in parts or refinance, pay ourselves down first. And so therefore, if there is a default situation, senior secured loans, generally speaking, recover 80 cents on the dollar. A high yield bond, which is below us in the capital structure, generally covers about 40 cents on the dollar. So that seniority and security may provide potential upside protection.
They are also, which is very compelling in the current market, floating rate instruments. So unlike a high yield bond which has a fixed coupon, a senior secured loan floats generally over three or six-month LIBOR or so forth. So as rates go up, and that's obviously what we've seen over the last year or so, as rates go up, coupons on our loans go up almost in lockstep. So we saw a 400 basis point increase in rates last year. We've seen almost a 400 basis points increase in coupons on our portfolio. So that may potentially benefit some investors in a rising rate environment. Senior secured loans are the only asset class that actually benefits from rising rates. They have almost no duration, whereas every other fixed income asset class obviously suffers in a rising rate environment.
Stewart:
And so what about deal flow and are these rated instruments or are they not rated instruments?
Kevin:
These are all rated instruments. Again, they're generally below investment grades, so single B, double B names generally speaking. In terms of deal flow, while this is a private asset class, you as an individual can't go out and buy a loaned Carnival. It can only be acquired through institutional investors like ourselves. Even though it's a private asset class, these are not securities. It's actually a $1.4 trillion asset class here in the US, just about the same size as the high yield bond market. So while people are much more familiar with high yield bonds, loans are a very important part of corporate capital structures. And in terms of market size, the equivalent of high yield bonds. They're also very liquid instruments. We can offer daily liquidity products in the loan space. So there are loan ETFs. In fact, Invesco has the first and by far the largest loan ETF in the bank loan space. It's about a $4 or $5 billion fund today. And our institutional products can offer daily liquidity as well. So, large liquid asset class trades frequently. You can't buy it as an individual, but again, as big as the high yield bond market here in the US.
Stewart:
That's interesting. And so, not a lot of fixed income instruments did well in 2022, as you alluded to, a big increase in interest rates means a big decline in price for most of these fixed income instruments. How did senior secured loans do in 2022 and how have they performed this year?
Kevin:
Well, they performed exactly as you would expect in a rising rate environment. They outperformed every other fixed income asset class, despite the fact that we obviously saw a lot of volatility in markets in general, senior secured loans were down just 1.1% in 2022. And then you compare that to high yield bonds, which were down almost 11%, and investment grade down more than 15%. So very strong outperformance on a relative basis. And even though they had negative returns in 2022, it was marginal. And that was actually only the third year in the last 34 years that loans even had a negative return overall because that high current income that you get on our coupons right now, coupons on the asset class are running just about 9%. That buffers a lot of volatility.
You move forward to 2023 and loan performance has been even stronger. We've seen very strong demand for the asset class. Loans are up almost 4% year to date. Investors are clipping a current coupon and sort of 9%. So every quarter you're getting, let's call it two and a half percentage points of coupon. And we've seen strong price appreciation because institutional demand, particularly in the form of CLOs, has been very strong for the asset class to start the year.
Stewart:
Let's switch over just a little bit to risks. So the risks in the asset class, I was fortunate enough to be at a couple of industry events in the last couple of weeks and there was some discussion of, while these floating rate instruments, the coupon resets higher, is there a point at which the companies who are the borrowers begin to struggle to repay those higher interest rates? Can you talk a little bit about the risk in the asset class and where you see it?
Kevin:
Sure. So as you correctly identified, the number one risk to the asset class is the risk of default and the risk of loss-given default, and defaults can be caused by two different things. One, as you said, the inability for the company to be able to service its debt. And certainly in a rising rate environment, rising rates are a double-edged sword for the asset class. On the one hand, they result in much higher coupons. That's great for investors who are benefiting from higher coupons as rates go up. But as you correctly point out, companies are also faced with higher interest burdens. The good news about the asset class is that coming into this hiking cycle, companies were in very good shape in terms of both one, their leverage-their leveraged today is actually lower than it was in 2019, and two, their ability to service their interest costs.
So, coming into 2022, the average company interest coverage ratio, the number of times their earnings actually compensated for their interest costs was about four times. So the average company could service their interest costs four times over. We did an analysis that suggested that for every 100 basis points of rate increases, the average interest coverage ratio would fall by half a turn. So coming into 2022, when we saw 400 basis points of rate increases, you would expect interest coverage ratios to go from four times to two times. Companies generally don't get into trouble until their interest coverage ratio falls below one and a half times.
So, the average company could easily absorb those higher interest costs. What is even more interesting is that interest coverage ratios didn't fall by two turns. They didn't fall from four times to two times, they actually fell from four times to 3.4 times. And that is because during that same period of time, EBITDA growth from our companies was substantial. We saw even in the fourth quarter of 2022, year over year EBITDA growth was 14%. So companies had higher EBITDA to absorb higher interest costs and therefore their ability to service their interest expense was much greater than expected.
The other thing that happened is a lot of companies hedged out their interest costs, swapped the floating for fixed, and that helped them absorb higher interest costs as well. So as a result, defaults right now at the end of March are only running 1.3%. So despite very sharp hiking cycle, we only have 1.3% defaults. And while we do expect that to go higher, investors right now are being compensated for about a six and a half percent default rate in the market, where most prognosticators think defaults in 2023 would be somewhere between 3% and 4%. So, even with the higher interest burdens you mentioned, companies have very strong ability to absorb higher interest costs and defaults are going to move higher certainly, but probably only approach their long-term average of about 3%.
Stewart:
That's extremely helpful, thank you. And so, with regard to the issuer fundamentals, and it sounded like when you talk about interest coverage going from 4% to 3.4%, that that's somewhat, and I don't want to put words in your mouth here, but that sounds like a result of solid underwriting analysis on your part in terms of security selection. What can you tell me about the fundamentals of the companies that you're investing in? Are you focused on particular industries? Are you avoiding certain things? I mean what can you tell us about that?
Kevin:
Yeah. So as I said, underwriting is obviously key to this asset class and we have the largest team dedicated to just the bank loan asset class of any asset manager. And we're also on what's called the private side of the information wall, which means that we can receive information on our companies that are not available to high yield bond investors or other public investors. So we have a real informational advantage here in underwriting companies. As you said, underwriting is key here in terms of the fundamentals, leverage for companies in our portfolio is lower today than it was pre COVID. So you've seen companies lever up during pre-COVID and that leverage has come down sharply. We definitely are focused on sectors that we think are one, more resilient in the face of recession, so our base case scenario is to run interest rates up to five and a quarter percent, cut EBITDA by 10%, and look for those companies that can survive that type of scenario.
And we're really focused on a couple different areas. One, the leisure and travel space. As you know from paying from airfare recently, demand for travel, demand for hotels, even in the face of recession remains very strong and some of those companies are still trading at a discount. You look at Carnival Cruises for instance, their bookings right now are ahead of what it was pre COVID, so very strong demand for travel. We've been overweight in that space as a result.
We've also been overweight in the chemical space because as oil prices have come down, we've seen companies be able to retain pricing, have lower feed stock costs, their margins are expanding. That's very defensive in the current environment. Conversely, we've been underweight companies that have a very large labor component because as we all know, labor inflation has been very strong, labor has been very sticky. And so industries like healthcare for instance, where the government is your payer, the government is obviously not giving you big price increases, but you're facing large wage cost increases, their margins are getting squeezed. That's a very unattractive place to be.
Similarly, retail and restaurants, you think about that very large wage components there, not as much pricing power as they would like. You're getting squeezed there as well. So really looking for those industries where labor is not a big component of their cost, whether they have very strong demand or types of companies such as chemicals where if we go into a downturn, it's a relatively defensive play.
Stewart:
And so you mentioned a little bit about this a moment ago, but is there anything else that investors should be expecting from this asset class this year? And I'm going to go, maybe unrelated, but something that was brought up to me and I think is relevant here. So, given what's going on in the banking sector, it's hard to see how the banks become a bigger component of meeting the capital needs of companies. And it seems like private credit is, there was a commentary out there that said, "Oh yeah, well once the 10-year note gets back to 4%, all this demand for private credit's going to go away." And it doesn't seem like that's the case at all. It seems in fact that given what very well may be tighter regulations for some banks, that the availability of bank lending could be lower and that private credit is going to be a very important source of funding to grow the US economy. How do you feel about that statement? What do you think?
Kevin:
No, I think you're right. I think you're right on base and you sort of have to look at the private markets in two different components. There's the broadly syndicated market, which is where we play, which are the large corporates there. And in that case, you're right, the banks, while they underwrite the loans, they don't hold them on their balance sheets, they are syndicating them. So you think about Morgan Stanley for instance, brings out a large deal, or JP Morgan, they're not holding their credit and for exactly that reason, they don't want to be in the business of holding that on their balance sheets. So they turn around and syndicate it to private lenders like ourselves. And we have become an increasingly large component of the broadly syndicated market.
In fact, banks hold very little or almost none of the big corporate loans that are originated in America today. So that is definitely true. Firms like ourselves have stepped into that void to provide that financing for corporate America.
At the smaller scale, the direct lending scale, which is typically loans less than $250 million, you're completely correct there in that respect. In that case, banks aren't even involved in the process at all. There's a direct relationship between firms like ourselves that have a direct lending practice and smaller corporations. And those small companies that are small dental practice roll ups, for instance, or landscaping companies, will approach two or three small companies or lenders like ourselves directly for a loan. And that is becoming an increasingly large part of the market as well. So is that the high end? You're right, banks have been completely disintermediated. At the lower end, banks aren't even involved in the process at all. And that's a good thing because it allows credit to flow more freely. You have institutional investors like ourselves who are completely agnostic and focused solely on returns for their investors.
Stewart:
And as you know, our entire reader base and listener base is essentially insurance investors. So, whenever I speak to someone who's an expert in an asset class, I want to try to put on my CIO hat. So with that in mind, if I'm an insurance company and I like this asset class, should I be buying it in SMA form? Should I be looking at your ETF? And if I do an SMA, how much customization can I get into the mandate?
Kevin:
Yeah. I think that's the last point is key. If you have an SMA, you can customize it any way you want to. We have SMAs that range from, I only want double B assets, I only want double B and single B, I only want a minimum of 10%, 20%, 30% in any sort of asset class. You can put concentration limits on individual issuers. You can put concentration limits on industries. An SMA is completely customizable and most of our insurance clients are actually in SMAs just for that reason because it allows them to dial the risk up and down depending upon their demand and where they see the market.
An ETF is a passive strategy. Our ETF holds the 100 largest loans in the loan market because that enables it to provide daily liquidity because those 100 largest loans are also the most liquid loans in the market, but there is no ability to customize. You can have a triple C asset in the top 100, the ETF has to hold that. In an SMA, you can say, listen, I don't want any triple C assets. And so you can serve as ballast on the downside there. So SMA completely customizable. The ETF does have the advantage of daily liquidity, but most of your insurance clients, most of our insurance clients don't want daily liquidity, they want to have their money locked up fully invested. Certainly you could liquidate at any point in that time, but again, completely customizable. And that's generally speaking the route we've seen insurance investors go.
Stewart:
Yeah, it makes total sense to me, Kevin, that the customization has its advantages. I came from a small insurance company and I've always got the smaller firms in my head and it's nice though that they can still get access to the asset class in smaller bites efficiently, which is, I think a lot of insurance companies that are smaller don't necessarily have a way to measure how challenging it is to get access to some of these asset classes. So that's a great, it seems like it's a good alternative for that crowd.
Kevin:
Absolutely. And we offer both ETFs and also we offer commingled institutional funds for those insurance clients that want an actively managed strategy versus a passive strategy. Very similar in terms of their fee structure, but you have the option of the ETF passive or you have an actively managed strategy and a commingled fund for institutional investors as well.
Stewart:
That's helpful. So how do you see the current and projected interest rate environment affecting the asset class? And to bundle that together, what market technicals are affecting the asset class this year?
Kevin:
Yeah, I think the technical picture has really been the biggest driver of the asset class this year. We've seen very strong demand from CLOs. CLOs are probably 65% to 70% of demand for the asset class currently. And year to date we've seen about $33 billion of CLO issuance, which is the same pace as we saw in 2022. And 2022 was the second largest year on record in terms of CLO issuance. So very strong demand from institutional investors. At the same time, very little supply. Many banks were still stuck with deals. For instance, the Twitter deal that was stuck last year, those deals have not yet cleared the market. And so bank underwriting has been slow and so therefore, new supply issuance has been slow as well.
So you have the technical where you have very strong demand, very little supply, and as a result, prices in the secondary market have been bid steadily up because as the CLOs look to ramp up- no new issuance, have to go into the secondary market to buy, and that's bid prices up by more than 2% year to date. So, very strong technical picture in terms of the supply demand imbalance. We continue to see the new issue calendar going forward to be relatively weak. And as a result, we expect prices to continue to move up.
So that's largely a positive for the asset class. But right now, instead investors are clipping a 9% or so coupon, so that's very attractive from a current income perspective. The yield on loans today is actually higher than the yield on high yield bonds. So you're getting senior secured, top of the asset, top of the capital structure, and you're getting a better yield than high yield bonds, which historically have demanded a yield premium because they're subordinated and unsecured. So that's shaping up for a very strong technical picture for the asset class this year. And we expect that returns with the asset class will be well in excess of 10% for the year. So I think that shapes up as a very attractive relative value. JP Morgan did a study that showed even if interest rates declined by 1%, senior secure loan yields would still be double digits for the year. So you may serve to reduce downside potential of the floating rate asset class; as rates rise, coupons rise, your returns increase, but even if rates decrease, which obviously is not the base case scenario, senior secured loans are still going to offer very competitive returns for the year.
Stewart:
That's terrific. So every time I have somebody on like this, I learn a bunch, and I learned a lot about this asset class today. I've just, I really appreciate you being here. I got one, this is a new question for 2023, Kevin, this is a good one, right? So here we go. I'm going to try it out. What's the best piece of advice you've ever gotten?
Kevin:
The best piece of advice is probably don't make assumptions, ask the questions. And I think that that's key to credit analysis. You want to be curious, you want to be tenacious, but you're also going to be able to work with people. And I've been very fortunate all throughout my career to have great colleagues, great partners, wonderful teams to work with, and no one does it by themselves. And without that, I wouldn't be sitting here talking to you today. So always ask the question, never make the assumption.
Stewart:
I love it. Thank you very much. We've been joined today by Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research at Invesco. Kevin, thanks for taking the time.
Kevin:
Stewart, thanks for having me. Appreciate it.
Stewart:
Thanks for listening. If you like what you're hearing, please rate us and review us on Apple Podcast. We certainly appreciate it. My name's Stewart Foley and I've been your host, and this is the InsuranceAUM.com podcast.
Investment Risk Warnings
Many senior loans are illiquid, meaning that the investors may not be able to sell them quickly at a fair price and/or that the redemptions may be delayed due to illiquidity of the senior loans. The market for illiquid securities is more volatile than the market for liquid securities.
The market for senior loans could be disrupted in the event of an economic downturn or a substantial increase or decrease in interest rates.
Senior loans, like most other debt obligations, are subject to the risk of default.
The market for senior loans remains less developed in Europe than in the U.S. Accordingly, and despite the development of this market in Europe, the European Senior Loans secondary market is usually not considered as liquid as in the U.S. The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested.
Invesco Senior Secured Management, Inc. is an investment adviser; it provides investment advisory services to individuals and institutional clients and does not sell securities.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. Past performance is not indicative of future results. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
NA3259907
Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research, discusses the marketplace for this private asset class including differentiating features, investment benefits and risks, and his outlook for secured senior loans in 2023 and beyond.
Kevin Egan, Senior Portfolio Manager and Co-Head of Credit Research, discusses the marketplace for this private asset class including differentiating features, investment benefits and risks, and his outlook for secured senior loans in 2023 and beyond.
NA3247778
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