Invesco Insurance

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.

1. Source: Bloomberg, as of November 14, 2024.
2. Qualified Mortgage
3. Loan-to-Value
4. Source: Invesco Real Estate using data from the Giliberto-Levy High-Yield Real Estate Debt Index (G-L 2). Trailing 10-years of data, last 10 years of quarterly returns annualized 2014Q3-2024Q2, latest data available. Total Return Annualized (%): Private Real Estate Debt, 8.11.
5. Source: Invesco Real Estate using data from the following indices: Direct Lending – Cliffwater Direct Lending Index, Private Real Estate Debt – Giliberto-Levy High-Yield Real Estate Debt Index (G-L 2), High Yield – Bloomberg US Corporate High Yield Index, Senior Loans – Morningstar LSTA Leverage Loan 100 Index, Private Real Estate Equity – NCREIF Property Index, Corporate Bonds – Bloomberg U.S. Corporate Total Return Value Unhedged USD Index, CMBS – Bloomberg US CMBS Investment Grade Index, Investment Grade Bonds – Bloomberg U.S. Aggregate Total Return Index, and Treasuries – Bloomberg U.S. Treasury Total Return Unhedged Index. Trailing 10-years of data, last 10 years of quarterly returns annualized 2014Q3-2024Q2, latest data available. Sharpe Ratio: Private Real Estate Debt, 5.36, Direct Lending, 1.88; Private Real Estate Equity, 0.22; Senior Loans, 0.39; US High Yield, 0.16; CMBS, -0.31; Corporate Bonds, -0.18; Investment Grade Bonds, -0.39 and Treasuries, -0.43.

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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. 

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Stewart (00:02): Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back and thanks for joining us. We've got a great one for you today. The topic is US elections and investment implications therefrom, and we're joined by Andy Blocker, who's Global Head of Public Policy and Strategic Partnerships at Invesco. Andy, thanks for being on, man. Thanks for taking the time.

Andy (00:50): Great to be with you.

Stewart (00:51): It's great to be here. You are a veteran of podcasts, and I'm tickled to get to talk with you about this, which is I think on everyone's mind right now. But before we get going too far, where did you grow up, your hometown, and what was your first job? Not the fancy one.

Andy (01:11): Look, I get this question all the time, where am I from and it's a tough answer because it's got many parts. So the quick and dirty is, born in Little Rock, Arkansas, packed my bags when I was 2 so I could move close to the big city, New York City, but was in Jersey. So I was in Jersey, Jersey Strong for 11 years of my life. And then for high school, I moved to Maryland, a suburb right between Baltimore and DC, but a little bit closer to DC. So that's that answer.

And my first job was actually a business that I started with my buddy down the street. We lived on Bignonia Drive, so we called it Bignonia Brothers. And it was not a cutting grass situation, it was a landscaping. We did full service.

Stewart (01:58): Wow.

Andy (01:58): We not only cut your grass, we do the trimming of your bushes, and if you wanted some more stuff, we'd do it for you too.

Stewart (02:04): Wow, I love that. I was basically labor for my grandfather starting at about age 8, which was my birthday present, was a riding lawn mower, and it was a full service-

Andy (02:18): Wait, wait, wait, dude, you're living in style and you got the ride. I'm talking about legit push-pull.

Stewart (02:27): Yeah.

Andy (02:28): It was at least gas. It wasn't like the old school ones.

Stewart (02:28): Yeah, I know.

Andy (02:28): But yeah.

Stewart (02:32): We lived on 11 acres and my grandfather wanted it to look like a park all the time. So we did have a push mower, but it was mainly riders. I'll be first to tell you.

You've had some really interesting career experiences prior to Invesco, including the White House, which is I think... I've had the opportunity. I had a really good friend, my college RA, a guy named Tony Wilson, who was actually Al Gore's scheduler at one point, and he actually got us into… I got a tour with him of the White House, which is regardless of your politics, I mean you have to respect the place. I mean, it is amazing. You've seen it your whole life. I was astonished that I was there. So I'd love to know about your career prior to Invesco and how you became the global head of public policy there.

Andy (03:27): So interesting. So my first, not real, real job in high school, but my first job after college was actually at Bell Atlantic; I was a Financial Analyst in a big building, and then I got an opportunity to move over to politics. So I moved over and made a lot less money. I think my starting salary on Capitol Hill was $19,000 a year working as a congressional aide to a congressman from Texas.

And then I moved from there to a senator from Tennessee who was chair of the Budget Committee, and then I ended up at the White House. So there's all kinds of things there. And then after that I got a chance to move to the private sector, worked at American Airlines, doing a bunch of things there, and then switched over to financial services industry at the New York Stock Exchange and have been there ever since. But anyway, so there's more there. But yeah, it's been a pretty varied career here.

Stewart (04:24): So it's been a summer of political surprises, and I would say that it's been a few years worth of political surprises. You had Trump and Biden, then you have the fallout of the Biden-Trump debate. There's an assassination attempt. Harris replaces Biden, can you help... And the DNC, the convention is going on right now as at the time of this recording, which is the 21st of August. Can you help unpack some of this and talk about the impact in your mind on the election? And if you want to do a little handicapping, I'm all for it.

Andy (05:06): Yeah, Stew, you really asked the easy questions here, unpack all of that.

Stewart (05:10): Yeah.

Andy (05:11): This is historic territory. I've never seen in my 30 years of actually working in the political space, a period of 50-odd days like this.

I mean, you unpacked it. If you add it all together, we had 34 felony counts for one of the candidates, followed by a debate debacle by the other candidate, with concomitant internal party revolt. Then followed by assassination attempt, followed by one of the candidates getting out. And then after the candidate got out, we thought it was going to be chaos, and it was coalescence around Kamala Harris, and that's still going on.

So I've been saying for two years, ever since the midterm elections, going around the globe saying, "Get over it. It's going to be Trump V Biden, because they're the ones who make the decision on whether or not they're the standard-bearer for their parties. So unless there's a health incident that I can't predict, that's what's happening." And people can argue about whether the debate was a health incident, it's health related, clearly.

Stewart (06:21): Sure.

Andy (06:21): But it wasn't until one of them decided that they were going to step aside. And I think President Biden was assisted in that decision, but he made the decision. And because any other way you weren't going to... If you kicked him out, whatever situation you thought you were in before was going to get worse. You're going to have a divided party, you're going to have chaos, and you're just ensuring the other party wins.

So to get to that point where they were actually able to convince him to step aside and set the party up for at least a chance going to November, was just amazing. So even if nothing else happened between now and the end, it's already been one of the most amazing election periods that I've seen. And handicapping, I mean, really you want to...

Stewart (07:06): Okay, all right, but let me ask you this. So in what's always the case is that I've got some harebrained opinion and the guest goes, "Well, you know..." So there were people, the chatter that I heard is neither one of these two guys. When it was Trump-Biden people were like, neither one of these two guys, I don't like either one of them. And now it appears that Kamala Harris is benefiting from that, that it's almost like she's late enough to the party that there hasn't been all this focus and negativity on her for all this time. Do you think that she benefits from not being an aging older candidate?

Andy (07:54): Look, I think you've hit on it. I think going back to my talking to clients for the last two years, I was basically telling them, "Hey, go through your five stages of grief. Stop being in denial. Stop getting angry, stop negotiating. This is what it is."

Stewart (08:09): Yeah.

Andy (08:10): And I actually went through my five stages of grief, and so I was all settled, but they continued to ask me and I had to start my session with saying, "Michelle Obama is not walking through that door." I would have to start the session off. And she wasn't anyway, because she doesn't want to run for office, which is probably smart on her part.

Stewart (08:28): And she's made that clear, right? I mean, she's made that-

Andy (08:30): Oh, yeah, she's clear.

Stewart (08:30): ... Abundantly clear.

Andy (08:30): She didn't even want her husband to run.

Stewart (08:30): Right.

Andy (08:36): So my thing is, what you've hit on is that what I think does explain a lot of this energy for Kamala right now, is that... And I think Nikki Haley had it right even though she's trying to deny it now, when she said the first party to get rid of their 80-year-old candidate is going to win this election. Well, the first party who got rid of their 80-year-old candidate has increased their chances tremendously. And what I think is going on now is that they're being pretty smart about trying to channel all of that anti-energy into positive energy and saying, "Yes, she's the one you've been waiting for," doing a little voodoo spell on them or a little hypnosis.

You know what I saying? Look, I think a lot of this is real, but a lot of it's just like we want anybody, "Oh, you're there and you're 20 years younger, we like you." So I'm not trying to diminish what Kamala's bringing to the table, but I'm also saying it's capturing all of this energy and trying to bottle it in Kamala's favor. And I think Trump sees that, which is why I think he's been a little on edge.

Stewart (09:44): And so there's been a couple of things happen. So the Supreme Court made a ruling that essentially said that you can't be prosecuted criminally while you're president if you're doing anything that resembles being president. Does that decision trouble you in any way or is it, did that need to happen?

Andy (10:10): There's many ways to look at it. So on the surface, if you're just looking at it broad strokes, it could be construed as the president has immunity if he's doing an official act. And then the question becomes, what's an official act, right?

Stewart (10:25): Yeah.

Andy (10:26): What are you... So I think they're going to have to tighten that up over time 'cause what they're trying to prevent... And look, just so you understand, I mean part of the legal theory here is from the conservative side and especially John Roberts who's the Supreme Court Justice, I feel like there are many people who want to preserve the power of the presidency. They don't want to hamstring the president from not taking an action because of potential future litigation.

Okay, I understand intellectually that thought. But if you're going to do that, you need to have some guardrails around it, especially when you're talking about someone like Donald Trump. And the reason I'm focusing on him a little bit is 'cause he's kind of different from a lot of the other actors we've had out there, where others I think have had a little bit more respect for the office than him, and that is what it is. But I don't think you can ever totally account for someone like Donald Trump.

Anyway, that aside, it troubles me in the sense of it's not defined, but I think the future court cases will define what that means, and I think we'll have more comfort there. I mean, you don't want to have it so that he just does XYZ or she does XYZ, then on post-hoc say, "Oh, it was an official act."

So I think you want constraints on... You don't want the president to be seen as above the law when he's acting as president, because that can... It's almost an endless thing. But I would hope that the court, as they bring exacting specific instances, that they will be able to define that more what they mean by that, so that no one's truly above the law.

Stewart (12:12): Thank you. There's been a lot of talk about paths to victory, and I would be the first to tell you that I'm not incredibly clear on what exactly that means. I mean, I kind of know, but can you talk a little bit about what people mean when they say path to victory? And then what do you think Trump's path to victory and Harris's path to victory is?

Andy (12:40): So I think about this in two different ways. I think just on a macro messaging imagery, their path to victory, and then there's the nuts and bolts of the electoral college. So on the macro side, on the messaging side, Kamala's path to victory is kind of like the Obama path to victory, of, "Hey, even though I'm liberal, I am the candidate for all America and all are welcome. So don't worry about XYZ policy that might impact you or be not for you specifically, but I'm about hope and change or I'm about the future, not the past." The more she can stay in that realm, I think that helps her.

The opposite is true for Trump. The more he can define what that means for you in your daily life, and what it means for inflation or immigration or whatever policy you're not happy about, that helps Trump. So that's the battle. The battle is who defines who first, they use the word humanizing, which is kind of an interesting term, but just she's not the scary thing over here. She has family values, she has this. And that's the whole purpose of the Democratic Convention to say, "Hey, she's just like you, or you can relate to her." And that's a story she wants to do.

Whilst Trump is going to try to interrupt that messaging and say, "No, this is going to be bad. This is going to be bad. And don't you wish you had the economy when I was there and don't you trust me more on these issues?" So that's the macro messaging side. And the one issue I think where Kamala actually wants to delve into how it's impact your life will be abortion, 'cause she usually wins on that abortion as all Democrats have since the overturn of Roe v. Wade. So that's going to be the battle on the macro. And the question is how does that impact the Electoral College and the key swing states?

I think we've got 7 now. We really only had 6 before. Actually, we only had 5 when Biden was there, but I think we've expanded to 7. And there would be the Rust Belt, which is Michigan, Wisconsin, Pennsylvania. And then the Southwest, we have Nevada, Arizona and then the true south of Georgia, North Carolina. And I think that those messaging play differently in each, and there's different demographics and there's different... But she's definitely brought North Carolina in play, which under Biden I thought was not in play. And so the question is can Kamala hold the Rust Belt and can Trump get one of those states? Just give me one. Give me Pennsylvania.

For Kamala, I don't think you replace losing one of the Rust Belt states with one of the other states. I think that's a directional signal, if you've lost Pennsylvania, you're not making it up by getting Georgia and Nevada or getting Arizona and North Carolina. I think that's a sign that you didn't win that other macro messaging. So it's kind of like you either get the three Rust Belt states and you win by the hair of your chinny chin chin, or you win with the three Rust Belt states, plus you get two or three of the others or the other way around, where Trump gets Pennsylvania and then adds in some others. But I think if he gets Pennsylvania, I think the others... I think they've gotten together the last two elections, 2016 and 2020.

Stewart (15:59): That's super helpful.

Andy (15:59): So that's the best I can do for you. Yeah.

Stewart (16:01): I'm learning as fast as I can over here. So you mentioned abortion, I'm sort of the opinion that young women could have a significant impact on this election. I think that the abortion issue is a lightning rod and it's one that a lot of people vote on. What do you think the implications of abortion and the way that the parties come down on it, what do you think the implications are there for the election?

Andy (16:35): So ever since there was a referendum in Kansas on abortion, that pro-abortion folks won 60 plus percent, this became the issue. And whereas prior to Roe v. Wade being overturned, it was really, I believe an advantage, even though a slight advantage for conservatives and Republicans, because they could focus on late term abortion and all these things that no one should be for, right? And reverse it to, no, you've taken away my freedom, you've taken away my right to my own health. And then they stretch it out to IVF and contraception, which may or may not be in play, but it...

There's a conversation happening, so therefore it's in play, right, politically. So I think it plays a huge role. And if you're looking from an electoral standpoint, it's on the ballot in Nevada, it's on the ballot in Arizona and it's on the ballot now in Florida. So I don't think it brings Florida into play on the presidential, but it may impact the Senate race there. But this is a real issue and I think the combination of Kamala now coming to the top of the ticket and having that, A, energizes young people and young women like you said, I think that combo is really potentially powerful if they were to execute on it.

So I think you've hit on something where... Look, at the end of the day, I think both sides are going to be very motivated and it's who actually gets the job done and they actually show up.

Stewart (18:07): So could we see a party sweep and what do you think the odds and implications there are?

Andy (18:16): Prior to Biden exiting, I thought it was like a 5% chance it was a Democratic sweep, 50% chance that there was a Republican sweep and 45% chance whatever, the split government. Now that he's out, I'd say there's probably a 70% chance there's split government and maybe a 20% chance as a Republican sweep and a 10% chance as a Democrat sweep. And that's going to change. Talk to me in September.

Stewart (18:47): Sure.

Andy (18:47): Right?

Stewart (18:47): Yeah.

Andy (18:48): When I know some of this polling on some of these swing seats in the Senate and The House.

Stewart (18:52): And so what are some of the key implications Invesco is most tuned in on for your own business, and what are you hearing from your counterparts in Washington about their concerns?

Andy (19:07): Look, the number one thing probably for us for our own specific concerns, is the regulatory agenda. So what's the regulatory agenda? How extensive is it? Is it deregulatory? Is it regulatory? So in that sense, obviously theoretically a Trump administration would be more advantageous than a Harris administration. But there's a lot more populism going on in the Republican Party. So even though directionally it might be better, there might be little nits and gnats and little things going on that could be impactful.

I think it's interesting that either administration, there's going to be this US-China discussion, which I think is just for everyone as a discussion. It's like the one thing we agree on in America is that we have an unfavorable view of China. If you look at when Donald Trump came into office in 2017, I think 47% American people had a negative view of China. By the time he left office, 76% had a negative view of China, and today 83% have a negative view of China. So that's part of the reason Joe Biden did not reduce any of the tariffs on China. Yeah, he could not be seen... No one can be seen as weak on China.

That's why you had the CHIPS and Science Act pass in a midterm election year, where the party out of power doesn't want to give anything to the president in power, and yet they signed onto it. Why? We've seen as competition with China. So that's an issue. I think another issue that a lot of financial firms dealing with is ESG and so that's going to be an issue either... Whoever, it's kind of like a state federal kind of thing and so it'll be interesting either way.

And then obviously the financial services regulation is always front and center. There's a lot out there for our industry, specifically asset management, but also beyond that to insurance and banking.

Stewart (20:57): That's super helpful. I don't know how to ask the next question other than this. What do you think the investment implications are? And I mean, I think you'll agree with me here, this is me, I'll get on my soapbox for a minute. It always intrigues me when a president is willing to stand up and take credit for the economy because you know damn good and well that you're going to get the blame for it too.

But at the end of the day, it's like there's economic cycles that happen. And so I think there's entirely too much credit given to who's in the White House at a particular economic time, but people do vote their wallets. So what do you think the investment implications are of this election depending upon the outcome?

Andy (21:45): Just for the record, when I was in the White House, we were responsible for everything good that happened in the economy. Just for the record.

Stewart (21:45): I like it.

Andy (21:53): Let the record show...

Stewart (21:54): Let the record reflect, that's right.

Andy (21:55): I don't think we can take credit for the dot-com boom. I don't think we can take credit for that, but it's worth a try, right? It's worth a try.

Stewart (22:01): Absolutely.

Andy (22:02): So no, I think you make a good point, and I think if the listeners, anything else on this call, want them to listen to this. We did a study and I think other firms have done the same thing, showing presidents over the last hundred years and the impact on the market. And on a macro basis, if you just invested only when there was a Republican administration or only when there was a Democratic administration, you lost tons of money.

I mean, the returns over that time were literally a hundred times less than if you stayed fully invested the entire time, because you missed all the big updates of those periods where you weren't there.

Stewart (22:46): Yeah.

Andy (22:47): And it's cumulative. And so all I'll say is on a macro basis, you want to stay invested. The question is always where are you invested, not if, right? And sometimes it's counterintuitive. And so look, I mean we're doing that analysis right now. We're redoing our analysis. We did a paper earlier this year, Biden versus Trump, Biden 2.0 versus Trump 2.0, what does that look like and what the market implications are, and we're redoing that right now with Harris.

And the question we're really wrestling with as we're investigating is how much of Harris is Biden 2.0? How much of it is Harris 1.5? What is it, or is it a mix between the two? I'm not sure you're going to see too much variation between now and the election because he's still president. How much headroom... She could do nuance, she could be tonally different, but can she really be substantively different? I think she has to be directionally the same while he's president. I just don't know how you do it.

And that brings us something else, and I know you didn't ask this, but I think it's pretty amazing that so far Kamala Harris has been able to position herself as the change candidate when she's the sitting vice president. I'm just saying.

Stewart (24:02): Yeah, that is interesting. I mean, I'll say. So let's talk about fiscal policy for a second. How do you see the debt and the deficit impacted by the election results and what point... I saw that we're spending more on interest than we are on defense currently. Nobody seems to be of the mind to... Nobody's mentioning reducing the deficit. What's your view there?

Andy (24:33): You didn't know this, but you hit my third rail, debt and deficit. No, look, it's... Just to review the bidding. So I worked in the Clinton White House, I was part of the team that worked to negotiate with Republicans on balancing the budget in 1997.

Stewart (24:52): Was that the last time it was balanced?

Andy (24:53): Yes, that was the last time it was balanced and we had 4 years of surplus, so very proud of that moment.

Stewart (24:54): Absolutely.

Andy (24:58): Now I'll give you a couple caveats. That does not happen except for a few things. Number one, it doesn't happen unless there was a split government. If we in the Clinton White House were left to our devices, we'd find some other things to spend that money on. But we had a Republican Congress who was very bent on balancing the budget, and we took that opportunity to work with them in a way. And we were advantaged by the fact that it was dot-com boom to help make it easier to do that without as much pain in the budget.

We also had 60 plus percent of the American people saying they wanted it, because there was a concept called crowding out where all this public debt was private investment and all that. You're talking about public crowding out public, the service on the debt with these higher interest rates on the debt is, yes, larger than the defense budget. People are going to be paying attention to that in Washington. But as important, the last leg of this to be able to get there is you need the bond market to say, Hey, we're done. Until that happens, the other two don't really matter as much.

Stewart (26:08): Yeah.

Andy (26:09): They matter, and I think they're part of the ingredients, but you need all three of those, in my mind, to get... And you need to do it while the economy is going well and growing to assist you, because the American people aren't going to put up with draconian cuts. We'll put up with cuts, but this whole notion of austerity in a time of recession, it's like building on.... It's hard to do. So you need to do it when things are good. And the only time you're going to do it when things are good, is when you have a split government. Because if things are good and you have all levels of power, you're finding something to spin it on.

Stewart (26:09): Yeah.

Andy (26:46): You might spin on different things, but both parties have not shown that discipline to do it when they don't have the other party to help discipline them.

Stewart (26:54): So moving beyond the US, more than 50 countries are also holding significant elections this year. Which international elections are you following and what do you think will have the greatest impact?

Andy (27:08): So most of the major elections abroad have taken place, and we're putting out a quarterly letter this week actually, which is our election special, and it kind of goes to that. So we're following India with Modi losing full control of the parliament there. We've got Macron in France losing control of the parliament. You've got the EU election with von der Leyen being reappointed, but it's shifting a little bit to the right. You've got the UK with Labor taking over in a pretty dramatic win there.

Look, all in all, I mean they're all going in different directions, but there isn't really instability. In fact, it's creating more, I think, stability. Now it's kind of limiting people's ability to do more, which in a market's perspective, I'm glad. I don't want all this change. I want stability. I want the bid-ask spread on policy to be tighter, not larger. And even in the UK where Labor has a super majority, they're limited politically in what they can do. They can't be the Labor Party of old. They need to make sure they're making the economy work, and they've got to be careful about their spending because of their budget constraints. So they're constrained by other reasons.

And then you come to the US... Well, first of all there's Japan, sorry, with the resignation, so they'll figure that out. But I see that as more stability play as well. And sorry, you had Taiwan too. Anyway, but in the US, it's like I said, 70% I said for split government, I think. Look, we're heading towards a place where if you get that answer, you'll get some directional change and some tonal, but you're not going to disrupt things to the point where the markets are going to react too negatively, in my opinion.

Stewart (28:58): We have covered a bunch of ground today. What are a couple of key takeaways that you want to share with our audience?

Andy (29:06): Despite all the volatility either had been in the markets this year or in politics, in the US in particular, and even around the globe, we're going to be okay. This is a long-term play. There's going to be more ups and downs, especially in the US election coming the end of the year. And even the market might have some other things, but I think the biggest message I have is just stay the course and pay attention to the details.

I know in our place we advise our clients whether institutional or retail based on some of these geopolitical movements, but they're not a macro decision. They're more of a micro decision. And so work with the people who advise you. Understand that just can't predict the market, but you can place yourself in a good place to mitigate the potential risks.

Stewart (30:00): That's super helpful. I've really enjoyed talking with you today. I've learned a bunch and it's been great to get to know you. I've got a couple of fun ones for you on the way out the door. The first one is, I want to take you back to your undergraduate days when you were coming out of college. What advice would you give a 21-year-old Andy Blocker today, knowing what you know?

I've got a real emphasis on, I love to help kids that are earlier students and working professionals that are early in their career, and you have a really outstanding background, and I just love to hear your thoughts on what advice you'd want to give today?

Andy (30:42): So I think the most important thing is that some things when you're younger seem like they're the most important thing in the world and they're not, because it's kind like... I'll use a sports analogy. If it's baseball or football, you make an error or you make a mistake, whatever, you know you've got so many more plays. It's only the first quarter, right?

Stewart (31:06): Right.

Andy (31:08): And people are not going to remember what grade you got in that one course, second semester sophomore year, or if you're just starting your job, the one... No, you make the mistake. Did you lose the company a billion dollars? Okay, well, we're good. You got another chance. Just putting things in perspective, taking it seriously, but as long as you learn from it and you adjust, I think it's not the end of the world. We over index things, right? And the second thing I think is the importance of relationships.

Stewart (31:43): So true.

Andy (31:44): And in today's world on social media and all this stuff and the things we say to each other on social media, I'm like, oh... I just cringe sometime and I'm thinking, "Do you understand this is... You may feel good in the moment, but what are you doing for your long-term maintenance and relationships?" And just valuing that from the beginning because as I say, people don't care until they know how much you care. There's so many different ways of saying it, but treating other people the way you want to be treated...

It sounds like the golden rule, whatever. But Maya Angelou, I think says it better. She says, people forget what you said. They'll even forget what you did, but they'll never forget how you made them feel. So if we're just a little bit more sensitive to other people and how we're interacting with them and say, "Hey, how would I like it if someone came to me that same way?" I just think it would be a better place for the world. But just even for yourself, those relationships may come in handy 10 years, 20 years down the road, you don't expect it.

Stewart (32:42): Okay, one more. Who would you most like to have lunch with, alive or dead? You get to have three people at lunch, including you. It doesn't have to be three. It could be just one. But I always think this is an interesting question.

Andy (32:55): That is a very interesting question. So I would say I would want Abraham Lincoln, Martin Luther King Jr, and Warren Buffett.

Stewart (33:09): Wow. That would be a power lunch for sure. I've really enjoyed it. I really have. I appreciate you being on, Andy, and thanks for sharing your views and sharing your knowledge with us, and I hope you can come back again.

Andy (33:22): Thank you so much.

Stewart (33:23): It's been a pleasure. We've been joined by Andy Blocker, who's Global Head of Public Policy and Strategic Partnerships at Invesco. Thanks for listening. If you have ideas for podcasts, please shoot me a note. It's stewart@insuranceAUM.com. Please rate us, like us and review us on Apple Podcast, Spotify or wherever you're listening to your favorite shows. My name is Stewart Foley, and this is the InsuranceAUM.com podcast.

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Stewart (00:02): Welcome to another edition of the insuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. We have got a very popular topic for you today. It is real estate, which was one of the top five topics as voted on by the registrants of our recent symposium. And we're joined today by Bert Crouch, Head of North America at Invesco Real Estate. Bert, man, thanks for coming on. Thanks for taking the time and I'm waiting for a really good education on real estate today, so thanks for being on.

Bert (00:54): Yeah, Stewart, thanks for having us. It's always great to be a guest and team up with you and your podcast.

Stewart (01:00): The idea for us to do podcasts, Invesco was at the very forefront of that way back in March of 2020, when we first started, and we just crossed over something on the order of 75,000 downloads. So, it's great to have you on, and this is, I think, the ninth podcast that Invesco has done with us and we appreciate the partnership and look forward to the education today. So good stuff.

Bert (01:26): And congrats on all the success. That's fantastic.

Stewart (01:28): It's fun. I will tell you that as I said, everyone, it's your job to be professor for a day here. But I want to start this off the way we always do, which is where did you grow up, your hometown? And what was your first job, not the fancy one?

Bert (01:47): Yeah, so I'm actually a Dallasite, born and bred, before it was cool. I was reading in the Journal earlier this week that's being deemed the new Wall Street of the South. I'm not sure we're quite there yet, but it has come a long, long way. I lived in San Francisco a little bit in my professional career and in New York as well, but I've been in Dallas really since I had my first of three children. And then, on the work front, it was a little illegal back in the day, but I started at 14 years old working at Subway as a sandwich artiste, so a little young for the labor laws, but I snuck in there and I was promoted to assistant GM my first summer there. So, I was going into high school and I got to open the store. I loved it because I graduated to the register by the end of the summer, so baby steps, but fun to get a first legit paycheck.

Stewart (02:37): I can completely relate to that, because I started at McDonald's, and I'm 6'2" and I had on 30-inch inseam pants, so I had about 6 inches of white socks showing, and I was on the quarter pound grill at McDonald's. And then you move over to the regular meat grill, and then you ultimately move up to the front, in the counter, if you can be nice to the customers and get the money right. And then if you're fast, they put you in the drive-through, so I can relate to that progression. I never got close to management at McDonald's, but I can definitely relate.

So your career, you joined Invesco Real Estate in 2009, which is a minute or two ago. Give us the background on Invesco Real Estate, a snapshot of all what you do, and also, if you can, give us a little bit of history on the evolution since you joined there.

Bert (03:42): Yeah, so we're actually really excited about celebrating our 40th anniversary this year. So, we were established in the mid-80’s, really before the institutionalization, Stewart, for commercial real estate investment management. So it was wild times back then. And when you fast-forward to today, we've got 21 offices, 16 countries, so 5 here domestically, 8 and 8 in EMEA and APAC respectively. Our firm has grown in large part organically, to almost $90 billion of assets under management,¹ and domestically the US is our flagship, with just under $50 billion of AUM.²

So, you're right. I joined in the middle of the global financial crisis. Again, going back to my earlier comment, whether it was mid-80’s and creeping up on what was going to be SNL, or when I joined, which was really in the depths of the post-Lehman debacle, that was the global financial crisis I was hired into... And it's really a good segue, unintentionally, into what I think in part we're going to discuss today, which is all things real estate credit. The capital markets were completely dislocated, we were obviously in a recession. And my job was to come in, we were raising a new vehicle to buy distressed commercial real estate, and that's what we did. In 2010, 2011 and 2012 my job was marrying up our real estate just on the ground, bottom-up sticks and bricks expertise, with all things capital structure.

So that was loan modifications, extensions, workouts, foreclosures, deed in lieu, and then what ultimately became our credit business of today. We've since 2011 done $19 billion of originations. We figured out that as a non-bank lender we could be much more flexible and fill a much needed void in the market in floating rate bridge loans. And so, we started doing that for various clients, and then ultimately ramped it into what it is today. So, my role evolved through that, I was the portfolio manager for the opportunistic strategies, for our credit strategies, and then ultimately when the head of North America retired at the end of 2019, you'll love this, Stewart, you know how much God loves you when your first day as Head of North America's January 1st, 2020. I had no idea what was ahead of me there, so it's been a trial by fire since.

Stewart (05:52): Wow. So you mentioned this term ‘deed in lieu’, and I don't know what that means, so could you unpack that? Just that one term please for us? Because we have a lot of people listening to the podcast like it's education for them, and so I think it's a good time for us to unpack that if you can.

Bert (06:10): Well, the great thing about the insurance industry and the investment experts that run it, in large part your audience, they're very well-versed in all things commercial mortgages, and that's all that is. It's a term related to that. So, if a loan is underperforming, or non-performing, so it's not paying its debt service, or it's matured and hasn't paid off on time, it would be in default. And when a loan's in default, there are a handful of options. You can get paid down, modify that loan, extend that loan, or you can exercise what are called your remedies, and that's your legal recourse against that borrower to, at a minimum, take back the property. And there's two ways to do that.

You could either foreclose, that would be, there's two ways to do that, judicial and non-judicial, that's state-specific foreclosure laws. The other way to go about that would be to do what's called take a deed in lieu, and what I didn't say, which was in brackets, deed in lieu of foreclosure. So, that would be basically an amicable situation, which is in large part happening today with office properties, where the owner of the office property is saying, "Look, I'm way underwater, man. There's no path here forward, and I'm not going to make you go through the time, effort, or expense to legally foreclose. I'm just going to give you the keys, if you will, back. And I will do with a deed, I'm going to hand you the deed of trust of that property in lieu of foreclosure."

Stewart (07:24): Thank you. That's super helpful. So, we had a panel at our symposium on real estate, and it appears that it's office and everything else. So can you give us an idea of where we are today with transactions, activity and valuations? Is price discovery still going on? Are the media headlines representative of what is actually going on in the markets’ real-time?

Bert (07:52): Yeah, a lot to unpack there. I'll try to take them in order, and just stop me and delve further where helpful or insightful, but transaction volume first question. Before the pandemic, so what I would call a normalized run rate of domestic transaction volume, defined as buying and sellings, arms length, institutional transactions, that was running about $500 billion. And the monetary, policy-fueled excess liquidity environment of 2021, 2022, that jumped all the way up to $700. And if you look at the run rate now, so what I'd call post capital markets dislocation, we're somewhere in the $300 billion-ish run rate. And I'm using rough numbers, just to give your audience context. So, if we were up, call it, 40% at the peak, we're now down about 60% from that, and about 40% from the run rate.

Stewart (08:43): Is that per year, and is it purchases? This is transactions of real estate top line.

Bert (08:53): That's right. The gross sale price, if you will, of an institutional quality asset. We're not getting into an owner user, or a smaller sub, call it $50 million or sub-$25 million asset. Everything above that would be included.

Stewart (09:07): And so, if I've got that right though, you're talking about from pre-pandemic to today, we're down about 40%. Is that right? From $500, we went up to $700, and back down to $300?

Bert (09:22): You got it.

Stewart (09:23): All the way around. Okay. All right, good.

Bert (09:24): Rough numbers, and again, we're just trying to provide context. There's a lot of nuance in that, breaking down property types, breaking down regions. Obviously, if I were to break down the Sun Belt that is very popular right now, or single family rental, or industrial, that would fare infinitely better than, let's say, something like Northwest US office. So, you would see dramatically different deltas in those percentages, probably wider than we've ever seen before, given how in favor or out of favor certain asset classes are. But the rough directional numbers that you gave are spot on.

And the only thing that I was going to add, just for your audience, because everyone likes to equate this back to, okay, but in the last downturn, in the last dislocation, how does this compare? And if you inflation adjust the $300 billion-ish run rate today, relative to the tech wreck, so 2001, or the global financial crisis in 2009, we're at a 2 or 3 times respectively, multiple of that. So, my simple takeaway, or punchline there, is while transaction volume is way off, it's still materially higher than it has been in previous downturns.

Stewart (10:31): That's helpful, really helpful.

Bert (10:33): So, we can talk valuations. You want to hit that next?

Stewart (10:36): Absolutely, yeah.

Bert (10:37): So, let's just keep it super simple. So two ways to look at valuations. One is spot valuations, which I would call transactional, or what we would call in real estate ‘comp-driven’. So where you've got a comparable sale, what does that look like? And then appraisal based. And the latter is much more heavily scrutinized in the press, getting to your third question, are the sensationalist headlines right?

And the fundamental question is, do real estate investment fiduciary, do we have valuations right? And it's a tough question to answer. But let's start with the former. If you look at Green Street, or Real Capital Analytics, those are two popular indices, those have recently bottomed out peak to trough, so peak was March of 2022, so first quarter of 2022, that was... Sorry, peak valuation to trough, which was really in the last month or two, that's down about 22%.

And what's happened of late that is important from a psychological standpoint is we saw the first uptick in valuations in each of those indexes. So, from March to April, we saw the RCA go up about 10 basis points, Green Street from April to May, about 70 basis. So, it's really important to feel like we've hit the bottom and now we might be bouncing off of it from a valuation standpoint. So, where I can buy an asset in the market today, there is a FOMO aspect of that, a fear of missing out, should I be leaning in today? Which I can get to later, to the extent we get into convictions.

On the other side of it, on the appraisal side, it just lags a little bit, because appraisals are based on comps, and comps are less available today than what they had been in the past, given the transaction volumes. So, they're focused on discounted cashflow models and other areas that are just harder to pinpoint and slimmer to move. And so those are down now approaching, they were down about 3% last quarter, so about a quarter lag to the spot indices, and are now down about 20%. The expectation is there's still some more room to run there, but it feels, Stewart, like we're getting close, and that is very important to most from an investment standpoint.

Stewart (12:41): Yeah. That makes total sense. And it's interesting that interest rates have had a big impact on real estate markets, but can you focus on what do the fundamentals look like across the different sectors?

Bert (12:58): Yeah, happy to. And I think there's a way to break this down categorically, three ways. One is the outperformers today. What are those asset classes and why? Ironically, and this might surprise your audience, retail is cover off the ball at the moment. 20 year low in vacancy, historically it runs about 9% vacant today at 6.5%, because the better part of the last decade when e-commerce really hit, we were over retail per capita here, especially relative to Europe, there was a rightsize of retailers footprints, the number of stores that they had, and the rent that they were paying. And that's played out. There has been no new development and that rightsizing has happened, and e-commerce has recognized the omnichannel is important. It's important to have that brick and mortar store in addition to that last mile delivery. So, we've seen retail really flourish.

Single family rental has held in incredibly well. Affordability has never been worse on buying, so people want to rent, and we're under supplied, so you see sub-4% vacancy there. Medical office, demographics, the US baby boomers are getting old, they need that care and they get it in the MOB, the medical office sector. So, those have had fairly inelastic demand, and or they're seeing tightening vacancy.

On the other end of the barbell, office. I don't need to tell you, other than to say your earlier question, are the headlines right? Look, office is talked about a lot, and in large part it's not that far off base. You've got five and a half billion square feet of inventory, 15% of that is best in class, the rest is somewhere in the middle to obsolete. We're seeing vacancy approaching 20%, and expenses rising, and the cost of tenant improvements rising as well. So, that's the other end of the spectrum.

And then everything else is somewhere in the middle. And in the middle I would use apartments as a good case in point. So, when you think about multifamily, right now, it's benefiting from the affordability point, the under-supply of housing in this country that I mentioned, but there was a lot of it that was launched for new development in 2021 and 2022. All of that's delivering now, there's an oversupply, and rents have come off. And there's this interim period where insurance expenses are up, labor expenses are up, taxes are up, debt service is up, and rents have plateaued or slightly downed. So, there is some stress in the system for apartments. That said, most expect with the new supply tailing off significantly, and the fundamental trends, my points about affordability and housing shortage playing out in late 2025 through 2026 and beyond, going really, really well. And when you put all that together, to end that comment, Stewart, and you compare it to the listed real assets market, so publicly traded real estate investment trusts, you can see that.

So the best-in-class assets, most in-demand: data centers, they're trading at a 10% premium to NAV, and they're trading at a five three cap rate. That's the best fundamentals we've seen. AI has just taken that to the moon and back. When you look at things like multi, apartments, that's trading at a slight discounted net asset value, but a cap rate... And a capitalization rate, for your audience, I think most people know this, it's just the inverse of a price to earnings ratio. So, just flip it. Public reach are trading at an average in the lowest sixes, and apartments are trading in the mid to high-fives, and that's wide of where they're trading in the private sector, going to your question about price discovery. So, you see a lot of trends that are consistent fundamentals to valuations, and there's no better place to look than the public markets first, and the private market second.

Stewart (16:25): So, speaking of sectors, it didn't seem like it was that long ago that there were four or five main property sectors, but that's expanded significantly, and you've touched on several in your comments so far. Can you walk us through that evolution and what specialty... You mentioned data centers, I've heard that kind of consistently, that that's an area of just straight up growth. And is there a way that you think an asset owner should be thinking about incorporating these alternative sectors into an existing real estate program?

Bert (17:01): Yeah, it was amazing seeing what the pandemic did to pull demand forward for what you called specialty sectors, or what others would call non-traditional. We were already moving, Stewart, in that direction, meaning adding more and more of the non-traditional sectors to our portfolios, given the capital flows as a result of the tailwinds and the fundamentals. But gosh, COVID just took that to a completely ‘nother level. So to put some context around it, 10 years ago for private institutional real estate, there were four major sectors, and this is somewhat obvious, but industrial, retail, multifamily and office. That was 97% of the index. Fast-forward to today, that's fallen to 86%. Or let me flip it to the inverse. Non-traditionals have gone from 3% to 14%. Now it sounds like a huge jump, because it is. But when you think about it relative to listed real assets, again, public reads, that's well over 50%, approaching 60%.

So, what we are seeing and experiencing real-time is not only, like I said, the fundamentals materially improving in non-traditionals, but in two of the majors. So, office was second, retail was first, there was an outflow of capital to those sectors institutionally, a focus on downsizing those relative to their overall portfolios. So, it's fundamentals and non-traditionals being good, but it's also needing to reallocate dollars away from sectors where they feel like the fundamentals are weakening and the capital demand is significantly lessening.

So, as we look forward, NPI, this is the major index that governs institutional real estate, it's NCRIEF, which is basically the fiduciary's index for our world; it recently expanded from having those four majors plus hotels, to having eight majors, and then under that 30 plus different sub-property types. So, I'll wrap this up and just say now not only do we want to invest in these sectors, do we have to invest in these sectors, given the deprioritization of office and to a lesser extent retail, but the third piece is we can now track it.

So, we are judged on performance. My primary objective when I wake up in the morning and go to bed at night is outperforming for our clients, whatever those KPIs are, whatever those key performance indicators are derived by them. And I can now track the alpha I generate, because NPI has expanded that index. So, when I'm looking at self storage, I'm looking at medical office, data center, senior living, student housing, I can go in there and dissect. I have now invested X percent in this, Y percent in that, and I'm overweight the index, and I'm generating a resulting alpha. That is super important to driving flows, which drives performance.

Stewart (19:37): That's super helpful. Let me ask you a little bit about insurers’ holdings. So, insurers, particularly life and annuity carriers, hold a significant amount of commercial mortgage loans, something on the order of $700 billion. Can you give us an update on the state of the lending markets, and the opportunity for non-bank lenders like Invesco, in insurance companies? And just a little editorializing here, but it seems like it's particularly well-suited, given the nature of a lot of insurance companies’ liability structures.

Bert (20:15): Yeah, I think that's right. So the dislocation, and this is a really nuanced time, at least in my 25-year career I've never seen... And what I mean by that is what normally would happen in a dislocation is you have a recession that drives it, and so the Fed would immediately, through monetary stimulus and then the government to a lesser extent through fiscal stimulus, would try to drive demand forward to take us out of a recession. And a big part of doing that would be to increase the money supply and drop interest rates. So, cost to capital lower, amount of money and the related velocity higher. And the irony here is we had a pandemic that drove that stimulus, that drove inflation, and then that was combated by trying to pull monetary policy in tighter rates higher, and that drove a dislocation in the broader capital markets, which drove spreads wider.

What's the punchline there? Why does your audience care? Because I've never in my career seen spreads wide. So, by spreads I mean when I'm originating a new loan, the spread at which I'm originating that over, and the majority of loans that I do are floating rate bridge loans, the majority from an asset liability matching standpoint of your audience is largely fixed, but neither here nor there. The spread is wider and the base rates are wider, whether it's the 10-year treasury, which has fallen significantly of late, or in my world, SOFR, which is the replacement for LIBOR, the secured overnight financing rate, either way you've got wide base rates and wide spreads. So, it's a best of both worlds environment. Answer your question earlier, where are the capital markets for commercial real estate? People don't realize how big of a market it is. It's $5.7 trillion.³

So, when you think about equities and fixed income, you think about $8 to $13 trillion, depending on how you look at domestically, or total real estate values domestically or internationally, the commercial mortgage market is massive. And when you break that down further, to keep it super simple, half of it is held by banks, and the residual is life companies, commercial mortgage backed securities, so it's just tranched in securitized loans, and then non-bank lenders. When you think about non-bank lenders in our market share, 10 years ago we were probably less than 5%, in 2022 we had risen to 15%. I'd argue today we're at least 25%. At most, whether you're a money center bank, and definitely on the regional banks as defined by asset size of a $100 billion to $250, they are overweight commercial mortgages.

And whether it's the OCC, the Office of the Comptroller of the Currency, the FDIC you know, or just Wall Street, if you're publicly traded, you want to decrease that. So, at most we see bank lenders wanting to keep their exposure to real estate flat, that's best case. Most want to take it down, because they're dealing with stress in their portfolio and/or they're getting flagged from their credit officer, their regulator or their public investors. That's created a real opportunity for us. It's honestly the best I've seen in my career.

Stewart (23:04): That whole logic flow makes good sense to me. It just does, all the way around. So, can you talk a little bit, and it was super helpful too, to get the comparison of the size of this market versus stocks and bonds. It's a comparison I've never heard before, and I think it helps me get it straight in my own head too, so how in your mind does real estate credit compare to other credit slash fixed income alternatives?

Bert (23:36): The short answer is ‘well’, but let me break that down real quick. So when you think about free money today, so money market is going to be in the low fives. You're going to have BBB corporates probably in the mid-fives and up. Spreads have come way in there, and then seeing treasuries come down into the low fours is driving that tighter and tighter by the day. You're going to have high yield, if you will, in the eight-ish percent total return range. And then BBB commercial mortgage backed securities, probably, depending on how you look at loss adjusting those yields, high single digits to 10%. And REIT unsecureds, that's going to be in the mid-fives. So, that's a good lay of the land. You're going to have free money at fives, the widest it's going to be 10%, but I'd say most in that 5.5% to 8% range.

And so then you think, "Okay, so what are we doing to drive value, and how does it fit into a portfolio?" The average we've done, Invesco Real Estate, my group's done about a billion of loans so far this year, and it's a backup the truck from our perspective, because we're creating a solution for our best borrowers, they're in desperate need of financing. We look at credit in a credit over yield mantra, and that should be very consistent with how your audience looks at it. We don't believe in stretching for yielding credit. There's no upside. You have got to stem volatility and minimize losses in every way possible. And so, when we do that we're making 65% as is loan to value loans today, arms length values, meaning most of those have the valuations are down anywhere from 10% to 25%, and then we're lending at a 35% discount, or cushion to that. Three year floating rate at SOFR, which is mid-fives right now, percent, 300 over.

So, that's an unlevered eight and a half. And then what we're able to do is use warehouse financing on top of that, to the extent that that strategy makes sense for a particular client or strategy, and generate a low double-digits cash on cash floating rate. So, why is that attractive?

Well, one, it's inflation-adjusted by definition because it's SOFR based.

Two, we feel like from a NAV perspective, net asset value, your equity, there's minimal volatility because it's a floating rate instrument, and we're at a 35% discount to today's values.

Third, when you put those two things together, the Sharpe ratio is very high, minimal volatility, nominal loss is consistently high return, so it fits very well risk adjusted.

And then fourth, when you think about efficient frontier, and you're stepping back and looking at it and say, "All right, well, but I already have alts in my portfolio, I have real estate equity." The correlation is 0.11 to real estate equity. You say, "I have direct lending, private credit in my portfolio." That's the highest correlation of 0.21. The rest are basically 0.0 or 0.1. So, very limited correlation to other asset classes, so it fits pretty well. And most are underallocated to the asset class. So we love the cash on cash, we love the optionality. Let's say the market improves markedly, and these loans start to pay off, well you would just cycle that capital if you wanted into real estate equity. Or another more total return asset class, but if inflation stays sticky, you stick with it. Or what we would typically recommend is you do a complimentary strategy with a little bit of both.

Stewart (26:48): Interesting. So, given your global real estate footprint, how do the real estate markets overseas, Europe, UK, Asia, compare to the US market, and are there important nuances, or cyclical factors to consider there?

Bert (27:08): Yeah. So again, it's a big question, I'll try to answer it as to the point as I can. So, when you think about just overall size, the US is the biggest by far, that's no surprise to your audience. But it's actually more overweight than even logic would dictate it. Call it, of the overall global value of real estate, and again, that number is $13 plus trillion, the US is 45%-ish of that. If you look at transaction volume, we're over 50% on a normalized basis.

So, more than our fair share of value and transaction volume, and that's really a result of a number of things. The US markets are more sophisticated structurally, capital markets, and accordingly, if you look at fundamentals and the various options, in the US, meaning the asset classes, we've already touched on that, it's a deeper bench and a more stable currency. So, you see a lot of that international capital wants to be invested domestically, strong fundamentals, more inelastic economy and a deeper bench of options. Not to, again, mention the US dollar exposure, we have benefited from that for the better part of 50 plus years in real estate.

Your question on the cyclicality of it and asset classes, it's funny, when we think about apartments in the US, that is a fairly new asset class, globally. It's accepted in Germany, it's ramping in the UK, in Denmark, but in large part otherwise it's still fairly new. When you get into things like manufactured housing, medical office and even data centers, these are areas that are burgeoning, whereas in the US it's fairly deep. And the same is true for the capital markets. Securitization is not nearly as structured and sophisticated outside of the US, nor is, again, your audience, whether it's life company lending, or non-bank lending, neither has the depth and breadth of capabilities that we do here. So, what does that mean?

US, I told you banks are 50%, in Europe, it's usually, depending on the market, 75% to 90%. And I'd say the same thing is generally true in Asia-Pac.

Stewart (29:11): That's super helpful. So, risk is top of mind for insurers when it comes to real estate. You could say that that's the case for any asset class for that matter. In your opinion, what are the biggest risks in the private real estate market right now, and how are you managing them?

Bert (29:30): Yeah, look, and I hate to state the obvious side of the gate, but the biggest risk out there is always the one you can't see, per the Black Swan Theory. So you and I, whatever I tell you here will be wrong, whether it's 6, 9, 12 months from now, something will surprise us. But that aside, I would tell you where I struggle the most is hearing colleagues in the industry, in our peer set, say they're hoping for a soft or no landing scenario. And I would argue the opposite. I think it's one of the bigger risks. If inflation stays semi-sticky, the economy remains... In this I'm talking domestically, remains generally strong. So starting with employment, if you think about the Fed, Federal Reserve's dual mandate, inflation and employment, if inflation's semi-sticky and concerning, the last thing that the Fed chair wants is inflation to pop up again after he cuts rates.

So, you would see rates stay high, the curves stay flat, and that's going to be really tough on real estate and the related fundamentals. It's going to keep lenders on the sidelines, it's going to make leverage and financing not accretive, the vast majority of investors domestically are levered buyers, and it's going to keep that uncertainty high and valuations challenged. So, I would tell you that the real estate market needs one of two things, either demand to take off, or more likely there to be a larger... And again, it doesn't have to be a significant recession, but something that drives rates, not back to 0% or 1% where they've been for the better part of a decade and a half, but to a more normalized range. If you look at the forward curve for the Fed Funds Rate, that would be in the high 2% range.

If we could just get back there, and the market feel comfortable with inflation and growth, nothing outsized on either front, that would be really good for real estate, because you would see that sentiment change. I told you valuations have largely bottomed out. The stock market just hit a new all time high earlier today, so denominator effect is strong. Meaning with the equity market up, that's where the majority of investors' wealth is. They are underweight real estate, so they want to allocate, and if they can do that with leverage that is accretive, that would drive real estate values.

Stewart (31:39): Very cool. So, looking ahead, investors seem to be coming back to the market in certain strategies. Where are you seeing the most interest? And how do you see these trends evolving over the next couple of months?

Bert (31:54): Yeah, our top idea, top conviction, as I said earlier, is real estate credit. It's best of both worlds environment right now, it's where we're seeing the most interest. Because you don't have to be right to be right. And all I mean by that is you don't have to predict the bottom in values, you don't have to predict whether we're going to be in a recession tomorrow or never, you don't have to predict inflation, whether it goes up, down or the Fed's forward curve, because you benefit in any of those scenarios. So, if inflation adjusts, it's all current income, and it's insulated from capital loss and NAV volatility, net asset value volatility. So, that's our top idea right now, we're leaning in hard, given that there's 26% less active lenders, so we can pick the collateral quality, the institutional borrowers are there, and the structure is right.

So, that's number one. Number two I would tell you is we, from a core plus standpoint, a lot of people want to lean into deep distress and opportunistic, and we like that strategy, but it's harder to scale, it's inherently more volatile, and we just haven't seen the level of stress distress, at least in property sectors and regions that we're leaning into from a fundamental standpoint.

But on the core plus side, there's a dearth of capital there right now and we think that risk is mis-priced. If you look back to 2001 or 2009, if you leaned in right about the time where values troughed, which again is plus or minus now, we could argue whether that's 3, 6, 9 months, we don't have to be right, we're long-term investors and convicted in the space. If you did that in 2001, 2009, you generated respectively a 15% and 14% five-year, unlevered return. So, that's an area that if you're like us and you have a portfolio of, let's call it 335 properties, a 100 different markets in 140 million square feet, you're using data, strategic analytics to understand those fundamentals where you want to invest, and you're able to lean in when others are leaning out, I would tell you that's attractive. So, we were saying right now, number one conviction, lean in floating rate, core plus credit, with a tight second being core plus equity. Pick your spots, and be ready to lean in further as the market continues to improve.

Stewart (34:01): I have gotten a great education today. I really appreciate it, Bert. I've got a couple of fun ones for you out the door, if you're willing. One is, you've been doing this for a minute, what advice would you give a 25-year-old Bert Crouch about the real estate market, the investment market, the asset management business, or whatever? There's other people, there's young people who listen to these podcasts, and I love the opportunity to give them some great advice, so what can you share with them?

Bert (34:34): Yeah, I'd say two things. Embrace the cycle and embrace the change. So, cycles are coming now more consistently and more quickly than ever. So if you look back, 2001 to 2009, you've got 8 years. 2009 to the pandemic, you've got 11. Suddenly you've got the pandemic, then you've got monetary stim... I've never seen a whipsaw 2020 to 2021, and then the dislocation that we're feeling now that feels like it's gone on even longer than the 18 to 24 months, depending on how you define it, that it's happened and we don't know when it's going to end.

So, I would tell you, when I sit down with younger investment professionals, that's the first... When I say, "Gosh, I'm anxious about where we are and where we're going." I try to flip it and say, "Use this as an opportunity to really learn and embrace that." Because the lessons learned, as an organization, not just myself, we keep track of that very, very closely, it's the old history doesn't repeat itself, it rhymes, so do mistakes. And the one thing that you can never do in my profession, as a fiduciary driven daily by out-performance, is make the same mistake twice.

And so, even though these cycles are happening more volatilely, more quickly, at the end of the day, there's inherent messages and lessons that you can take out them. So, as the industry's evolving and change is happening, embrace that and learn from it.

Stewart (35:55): I love it. All right, so here's the second one. We got a lunch table of up to four people, including you. So you can bring three people, you can have just one. Who would you most like to have lunch with, alive or dead?

Bert (36:10): Oh yeah. So, I got to expand it to four, because I've actually thought about this more than I'm willing to admit.

Stewart (36:15): All right, this is good. I'm happy about it.

Bert (36:19): My dad and I debate this all the time. I love it. And I've got my kids involved.

Stewart (36:23): Oh, that's great. Oh, great.

Bert (36:25): It's great. I love the, "And deceased." Because that just really opens it wide up. But I would say John Lennon, Margaret Thatcher, Abe Lincoln, and Willie Mays.

Stewart (36:35): Wow, you have thought this through.

Bert (36:38): Yes, I have. Again, I'm constantly subbing people in and out-

Stewart (36:43): Of course.

Bert (36:44): ... and thinking about Willie Mays is a sub in, I've learned more about him in the last 48 hours and, man, to say that what he accomplished in life and in his career is just wild. It's so impressive on so many levels. And you try to take personal and politics out of it to an extent, and just look at what they were trying to drive, whether it's, again, Margaret Thatcher, Abe Lincoln, or John Lennon, there's a lot that you can disagree with, but when you think about what fundamentally drove them and you think about sitting around a table and that... I always try to think about the interplay between them.

Stewart (37:17): Oh yeah.

Bert (37:18): Times, regions, background. It would be fascinating. Fly on the wall, I can't imagine what you'd learn over dinner and a cocktail.

Stewart (37:24): Yeah, I think showing Abe Lincoln your smartphone would be amazing. You go, "Hey, Google Abe Lincoln, check this out."

Bert (37:25): Fair enough.

Stewart (37:25): Right?

Bert (37:33): Fair enough.

Stewart (37:34): It's very cool. So, we've been joined today by Bert Crouch, who's the Head of North America at Invesco Real Estate. Bert, thanks for taking the time. I've gotten a great education and it's been great to get to know you.

Bert (37:44): Hey, thanks so much, Stewart. Really enjoyed it.

Stewart (37:47): 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, Google Play, Amazon, wherever you listen to your favorite shows. My name's Stewart Foley, see you again next time. Thank you for listening.

1    As of December 31, 2023.

2    As of December 31, 2023.

3    As of December 31, 2023.

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.

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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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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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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.

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.

Alternative investment products, including private debt, may involve a higher degree of risk, may engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, may not be required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual portfolios, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. There is often no secondary market for private equity interests, and none is expected to develop. There may be restrictions on transferring interests in such investments.

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. 

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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. 

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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. 

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