pi LSTA Supp · 2019-05-06 · Bra m S ith Executive Director Loan Syndications and Trading...

Visit www.pionline.com/lsta for exclusive featured content, white papers and web seminar

advertising supplement

For More Information on the LSTAPlease Call: 212.880.3000 Or visit us at: www.LSTA.org

The Loan Syndicat ions and Trading Assoc iat ion promotes a fa ir, order ly, e f f i c ient and growing corporate loan market and provides leadership in advancing and balancing the interests o f a l l market part ic ipants .

Since 1995 , The LSTA has been the l ead ing advocate o f the sen ior secured l oan asset c lass

13pi0197.pdf RunDate: 05/27/13 pi supp 8 x 10.875 Color: 4/C

Credit SuisseOne Madison AvenueNew York, NY 10010Contact: Paul RothVice President –Senior Product SpecialistTel: [email protected]

Symphony Asset Management555 California StreetSan Francisco, CA 94104Contact: Lindsay GruhlManager of Client ServiceTel: [email protected]

R.V. Kuhns & Associates, Inc.1211 SW 5th Avenue, Suite 900Portland, OR 97204Contact: Seth CothrunAssociate DirectorTel: [email protected]

Strategic Investment Solutions, Inc.333 Bush Street, Suite 2000San Francisco, CA, 94104Contact: Ping ZhuSenior Investment AnalystTel: [email protected]

Neuberger Berman190 South LaSalle Street, 23 FloorChicago, IL 60603Contact: Stephen CaseyCo-Portfolio Manager, LoansTel: [email protected]

Callan Associates Inc.101 California Street, Suite 3500San Francisco, CA 94111Contact: Kelly Cliff, CFA, CAIASenior Vice President andCIO, Public MarketsTel: 415-274-3086www.callan.com

3advertising supplement www.pionline.com/lsta

This special advertising supplement is not created, writtenor produced by the editors of Pensions & Investments anddoes not represent the views or opinions of the publication

or its parent company, Crain Communications Inc.

The Loan Syndications andTrading Association - LSTA366 Madison Avenue, 15th FloorNew York, NY 10017Contact: Alicia SansoneExecutive Vice PresidentTel: [email protected]

SPONSOR DIRECTORY CONTENTS

SPONSORS

Why Loans,Why Now?

Unfixing FixedIncome

Adding Loan Fundsto a Retirement Plan

4

9

12

www.pionline.com/lsta advertising supplement4

Senior secured loans (also bank loans,leveraged loans, and floating-rate loans)have become their own asset class, offeringtremendous benefits in a retirement plan.Yields are currently 2 or 3 times as high astraditional fixed-income core components(see chart 1, below), like Treasury and in-vestment-grade bonds. Loans also have vir-tually no duration risk, with rates that arereset every 3 months at a spread aboveLIBOR. Plus, as secured assets, bank loansare much safer with a significantly higher re-covery than bonds which are unsecured oreven subordinated, in the event of default.

In short, investors in senior secured loansare well compensated by assuming lowercredit risk while taking effectively zero interestrate risk. In an environment with low economicgrowth and a sluggish domestic recovery, anincreasing number of investors feel that a pre-dictable 6% yield, plus the floating-rate protec-tion from inflation in a defined-contribution ordefined-benefit plan is pretty attractive.

The Wallflower No MoreSenior secured loans have long been

viewed as diversification instruments, but agrowing number of investors have takennote of their performance and other bene-fits to invest in them as standalone assets.Indeed, loans have performed better thanor on par with equities over most of the past15 years. (see chart 2, page 5) Equities relyon highly volatile capital appreciation aswell as dividends for their total return.Loans, by contrast, depend on a couponyield, which self-adjusts, and the fixed re-payment of principal.

Showing positive returns every year ex-cept 2008, loans stand in stark contrast toother fixed-rate investments, which fre-quently have negative total returns in periodsof rising rates. The seniority, security, pre-payment terms, and floating-rate featureshave all contributed to the asset class’s his-toric stability. (see chart 3, page 6)

WhyLOANS?WhyNOW?

It’s an easy, 2-part question with an easy, 2-part answer: Bond yields are at a low, while loans are above their historicaverage. And interest rates, while currently low, will one day rise—why live with the risk of loss? And there’s more...

Moderator: Bram SmithExecutive Director, Loan Syndications and Trading Association

Part icipants: Stephen CaseyCo-Portfolio Manager, LoansNeuberger Berman

Kelly Cl i f fCIOCallan Associates

Amy HsiangLead Fixed Income Consultant,Manager ResearchR.V. Kuhn & Associates

John G. PoppManaging Director, Global Head and CIOCredit Investments Group, Credit Suisse

Gunther SteinCEO and CIOSymphony Asset Management

Ping ZhuLead Fixed Income AnalystStrategic Investment Solutions

CHART 1: Loans vs. Common Fixed Income Investments

Sources: LSTA and Barclays


A Brief Stroll Through theLoan Market

Emerging as its own institutional assetclass, the senior secured loan market todayis large and liquid with hundreds of partici-pants. In 2012, it saw $550 billion of out-standing institutional loans and more than$396 billion of trading volume across 2,300separate loans.

There are more than 200 separate sen-ior secured loan funds, with each managertypically overseeing multiple loan investmentvehicles. Dozens of retail mutual funds investspecifically in loans and offer daily liquidity.The hundreds of other investment vehicles in-clude pooled institutional funds, separatelymanaged accounts, closed-end funds, andCLOs. (see chart 4, page 8)

Six portfolio managers and pension fundconsultants discuss how loans can augmentdefined-benefit and defined-contributionplans as well as other issues in today’s ro-bust senior secured loan market.

Bram Smith: Loans have great attributes:senior, secured, floating rate, low default,and high recovery rates. Which are importantto portfolio managers, especially in compar-ison to other investments?

John Popp: The characteristics that makeloans attractive have always been there, butthey resonate particularly strongly now be-cause people are still anxious, despite thepositive momentum that fixed-income mar-kets have experienced. As new investorsenter the loan market, they’re seeing theseattributes play different roles in their portfo-lios. Loans diversify—they are covered, ver-sus bonds, should interest rates move

up—and they address duration risk in a fixed-income portfolio. I don’t think the institu-tions look at loans as an inflation hedge,per se, but as a way to protect the real valueof their portfolios against a backup in gov-ernment bonds. Conversely, if things don’tdo well and default activity spikes, why notbe senior secured and get the benefits of aloan if there is a slowdown in the economy?Be it rate or credit related, loans here canreduce an overall risk profile. And whenpeople look at what they’re getting paid tobe in loans versus other asset classes on arelative-value basis, I think they find it com-pelling. People are probably getting morenervous about the idiosyncratic risk andtight spreads at the lower end of the in-vestment grade corporate spectrum. Loansget around that.

Gunther Stein: When you think about theloan asset class and how it’s performed overtime with default recovery at roughly 70cents on the dollar, the value proposition iseasy to understand. Senior secured loansare collateralized by real assets, which pro-vides protection to lenders in the event of adefault. Furthermore, there’s a lot of dura-tion risk in corporates, especially in invest-ment grade. With loans, you’re effectivelybuying a duration-free asset, and there aren’tmany of those available right now, institu-tionally or even for retail investors.

Stephen Casey: I would add one thing aboutvolatility. When we hit periods of turbulence,loans have reacted with much less volatilitythan high yield or equities. A lot of the in-vestors we talk to like that characteristic.And, of course, because they are senior se-cured, if we’re going into a default cycle, thelack of volatility is because of the security.

continued on page 6

* Time-weighted returns Sources: S&P/LSTA Index, Merril Lynch

Bram SmithExecutive DirectorLoan Syndications

and Trading Association

Stephen CaseyCo-Portfolio Manager,

LoansNeuberger Berman

CHART 2: S&P/LSTA Leveraged Loan IndexAnnual Returns vs. Other Asset Classes

Kelly Cl if fCIO

Callan Associates

Senior Secured Loans:• Strong Risk Adjusted Returns• Low Volatility• Protection from Rising Interest Rates

AvgAnnual S&P/LSTA ML High 10YRReturn* Index S&P 500 ML High Yield Grade Corp TreasuriesYear End2012

1 yr 9.67% 16.00% 15.58% 10.37% 4.17%

3 yr 7.03% 10.94% 11.60% 9.03% 9.48%

5 yr 5.68% 1.10% 10.01% 7.66% 7.30%

10 yr 5.72% 6.80% 10.41% 6.28% 5.54%

15 yr 5.14% 4.28% 7.01% 6.61% 6.11%

Kelly Cliff: There has definitely been a thirstfor the credit markets, and we’ve seen asurge in demand for loans. The perception atthe moment is that the duration impact onthe high-yield bond market is elevated, giventhe strong yield compression versus whatwe’ve seen in the past. So given that loansare currently on par with high yield, from anoption-adjusted-spread basis, it’s pretty com-pelling to go into an asset class that con-tractually has less duration risk and also hasthe additional credit protection of specificpledged collateral.

Amy Hsiang: We believe one of the reasonsbank loans are drawing an increased amountof attention is due to their lesser sensitivity tochanges in credit fundamentals than highyield bonds as they are typically senior in-struments, secured by a debtor’s assets andrank first in priority of payment in the capitalstructure. Moreover, we’ve found that in re-cent years, the yield discount of loans to high-yield bonds has narrowed significantly. Forexample, recently, the leveraged loan indexyields about 45 basis points less than thehigh-yield index, and historically that averagehas been about 160 basis points. Becauseof this narrowing of yield, investors are seeingthe attractiveness of loans even more.

Ping Zhu: Relatively speaking, today’s dis-count margin for loans is comparable to thespread of similarly rated high-yield bonds,and loan investors typically get higherrecovery in a default, which makes loans moreattractive. Unlike TIPS (Treasury inflation-pro-tected securities) investors, who need to acceptnegative real yield in exchange for perceivedinflation protection, loan investors are stillearning decent current income in today’syield-starved environment, while being pro-tected if an ensuing rise in interest rates ex-ceeds loans’ LIBOR floors.

Smith: The loan market is currently very liq-uid. Is this different from the liquidity you seein the other markets?

Popp: This relates to the non-investment-grade credit markets. The liquidity is largelydriven by the investor base. Dealer invento-ries across all asset classes are materiallydown post-financial crisis. So I think the liq-uidity is the result of the confluence of theFed injecting liquidity into the system and anincreasing number of people entering themarkets looking for yield. Particularly withloans, we’re seeing an increased institution-alization of the market and a reduction of fi-nancial leverage. There’s real cash cominginto the market, and the demand for theproduct is driving the liquidity.

Stein: Also, I think there are 3 things goingon with the loan asset class. The size of

the institutional loan market has grown toapproximately $580 billion from about $20billion 15 years ago, so there’s the magni-tude. Second, banks used to have separateloan-origination and high-yield productgroups, but now they’ve combined them intoa single leveraged-finance group. Thischange provides a degree of flexibility onthe origination side, in terms of how banksare providing financing, and it providesthem with the flexibility to optimize an effi-cient capital structure tailored specificallyto their clients. The change is also in re-sponse to investors, and the ability to movefrom one asset class to another based onrelative value. Third, the types of investorsin loans were very limited even five yearsago. Now some component of loans will bein any high-yield or other mutual fund. We’reseeing a broadening of the investor base aswell as a broadening of how banks are usingtheir capital to provide financing.

Zhu: The investor base is definitely broaden-ing. Not only do we see strong institutionalflows into dedicated loan mandates, but wealso increasingly see traditional high-yieldmanagers making tactical allocations intobank loans these days, which has helped toincrease demand. On the retail side, inflowsinto loan mutual funds and ETFs have alreadyreached $15 billion during the first quarter thisyear versus only $12 billion for the entire year2012. Lastly, new CLO issuance has beenfairly strong recently, outpacing the pay-downfrom older vintage year CLOs.

Smith: What are LIBOR floors, and are in-vestors losing anything by buying into a loanasset with this feature?

Casey: I like to think of LIBOR floors as thefirst 50 to 75 basis points of interest rate in-creases advanced to you up front. As we’ve


continued from page 5

CHART 3: S&P/LSTA Leveraged Loan Index Returns

continued on page 8

Source: LSTA

©2013 Neuberger Berman LLC. All rights reserved.

75 98 7.2

110+ 20+

Years’ experience managing assets including three decades of dedicated fixed income institutional solutions

Billion dollars in fixed income assets under management

Billion dollars in Bank Loan assets under management across CLO’s, 40’s Act and Separate Accounts

Fixed income investment and research professionals

Years average experience across the fixed income senior investors

We are investors. It’s our business model, our singular focus. To that end, we offer one of the industry’s largest proprietary credit teams supporting a wide platform from investment grade through a suite of non-investment grade strategies. For more than three decades, we have been investing in fixed income markets at home and globally to help our clients participate across multiple credit, duration and sector strategies. Our bank loan team adheres to a disciplined credit process seeking to provide downside protection and upside participation.

We invite you to take a closer look. Please call Joe Lynch at 312.325.2256 or Steve Casey at 312.325.2257.



mentioned, loans are offering very good rel-ative value versus high-yield bonds, and thathas to do with the LIBOR floor feature. Thecurrent average is about 110 basis points,which means that you will not see incomefrom your loan portfolio go up for the first 75basis points if rates rise, but conversely, youstill clip a very nice coupon for the next cou-ple of years until they do.

Stein: The banks put in the LIBOR floors orig-inally to entice high-yield and other yield-seeking investors with attractive overalleconomics. However, the LIBOR floor com-ponent is becoming less relevant due to theoverall state of the credit market and the sig-nificant increase in demand for the assetclass, as evidenced by the continued tight-ening of overall compensation levels, includ-ing yield.

Smith:We’re seeing a return to covenant-liteloans. What are the issues for investors?

Popp: Covenants provide economic consid-eration when a company is not hitting itsnumbers. Companies have to come back tothe table if they bump up or fail a mainte-nance test and pay you for that. Butcovenants don’t pay me back, and they don’tinherently make an issue a better credit.There is data that shows that in the event of adefault, covenanted loans performed worseon a recovery basis than the covenant-liteloans. You can’t just universally say that everycovenant-lite loan is fine; we have to under-stand what not having those covenants actu-ally means in the context of a given credit. It’snot the covenants that are paying us back atthe end of the day, it’s the overall credit.

Stein: Our strategy is always to buy the bettercompany and with that, the better business.Covenants are preferable, but when you havea bad company, you eventually blow throughthe covenants. You are then faced with ap-proaching the lender group to alleviate thosecovenants. If it continues to get worse, it getsmuch worse. Going through the financial cri-sis, some of the banks handling the big lever-aged loans that did have covenants were insome cases not acting rationally in terms ofworking things out. And in some instances,things ended up pretty badly, so you could-n’t get any recovery at all. Many of the com-panies that are covenant-lite have historicallybeen the bigger companies, and arguably,the better companies. Once again, you wantto invest in the better companies versus thebad ones, even if the bad ones havecovenants.

Cliff: In their infancy, loans were issued withmore investor-friendly covenants, and the

market was positioned to be meaningfully dif-ferent from the high-yield bond market. Thehigh-yield market was the first to get this neg-ative connotation of cycling through covenant-lite, then covenant-heavy, and back tocovenant-lite. With the growth of the loan mar-ket, covenants have become more akin tohigh-yield bonds. So now, the paramount con-cern for investors in the broad high-yield mar-ket is issuer creditworthiness. If you have anissuer bound by a covenant-heavy loan intoday’s covenant-lite market, they can refi-nance into covenant-lite. Does that make it aweaker asset because of the re-fi? I would sug-gest not. I have also seen research on defaultrates by BB, B, and all of them together since2008 for covenant-heavy and covenant-lite,and actually, the covenant-lite segment faredmuch better. (see chart 5, page 10)

Stein: You’re seeing now with all these newCLO issues that many of them have limits onhow much they can allocate to covenant-liteloans, and it’s pretty restrictive. What is themarket perception of all this noise aboutcovenant-lite? Is it just noise? Can investorssee through it? Do they understand thatwe’re talking about maintenance covenantsand not incurrence covenants?

Hsiang: Most of the questions we hear fromour clients are how loans differ from high-yield bonds. We believe that even with therise in covenant-lite loans bank loans in gen-eral still have more comprehensive and re-strictive covenant packages than those forhigh-yield bonds. As such, for clients wary ofdefault risk, exposure to loans may makemore sense than high-yield bonds. ~


CHART 4: Market Share of Different Investor Types

Source: S&P LCD

UnfixingFIXEDIncome


Smith: Let’s discuss loan performance. Year-to-date, the loan market is up about 2.3%and the S&P LSTA index is the highest it’sbeen since July 2007. Do we see much moreappreciation than that based on liquidity andwhere we are in the cycle?

Casey: The loan asset class is probably a 5 to6% return asset class right now, in terms ofthe coupon, for the foreseeable future. In-come from a portfolio of loans will start to in-crease when rates go up and we breakthrough the LIBOR floors.

Popp: Liquidity is going to drive a little bitmore out of the market, but this is not a cap-ital appreciation asset.

Cliff: There’s been a lovefest with the creditmarkets. I don’t know how much farther itcan go, but prospective income from loans isquite attractive when compared to alterna-tive income sources. Once again, the favor-able contractual nature of loans is that ifrates start to go up, income will go up, too.

Stein: There’s probably limited upside froma capital appreciation perspective, but thereis very limited downside; and the floor ispretty solid. To clip a little bit of yield with noduration risk is pretty powerful for portfoliosright now.

Smith: Are mutual funds a big driver and thereason why we’ve seen so much interestfrom individuals in retail funds today?

Stein: It’s not just mutual funds; it’s also on theinstitutional side. All of us are in conversations

with institutions that are looking to lower ex-posure to high-yield or investment-grade cor-porates and move into loans. So it’s not justretail, it’s everywhere. The retail part is prob-ably the more dramatic piece, but the insti-tutionalization of the loan asset class isthere. I would argue that loans are the thirdasset class. You have equities, you havebonds, and now you have loans; and thatwasn’t the case 3 years ago.

Casey: Loans offer excellent relative value forpeople who seek income on both the retailand institutional side. And while you are in-creasing credit risk over an investment-gradeor Treasury portfolio, you significantly reduceinterest-rate risk. And I think we would allagree that interest rate risk is probably thebigger risk for the next 2 or 3 years thancredit risk.

Cliff: Another reason for the individual in-vestor to get in on loans is the democratiza-tion of access to the loan market. Nowthere’s a great availability of relatively inex-pensive pooled vehicles that individual in-vestors can get into for a diversifiedexposure. This wasn’t available until rela-tively recently and takes loans to the fore-front as a mainstream, viable asset classwhen you increase access like that. Thelaunch of a bank-loan ETF a few years agolargely surprised the institutional communityas the evolution of the loan market from asmall niche market to a mainstream assetclass.

Smith: How would you compare the value ofloans versus high yield and high grades in

continued on page 10

Amy HsiangLead Fixed Income Consultant,

Manager ResearchR.V. Kuhn & Associates

John G. PoppManaging Director,

Global Head and CIOCredit Investments Group,

Credit Suisse

terms of price points and demand in themarket?

Stein: The best value right now across all 3 isgoing to be in loans, obviously, because of theduration component. There is value in highyield, but you’ve got to be selective. When itcomes to investment grade, you’ve got to becareful. Japan’s recent monetary policy is in-teresting, and it could create another hugebid for U.S. credit assets. For the next 3 to 6months, we expect Treasurys to trade in aband between 1.7% and 2.1%. So it’s aboutpicking and choosing—trading around a littlebit and being opportunistic.

Casey: Over the next 12 to 24 months I don’tsee much downside in any of them, particu-larly loans and high yield. Where you’re mostexposed to credit risk, we have a very benigndefault outlook. If you ask, which of these 3asset classes is going to have bad news first,it’s probably going to be investment grade,and it’s going to be caused by rising rates. Ithink that will occur before we see defaultsand credit losses.

Hsiang: In the last year, we’ve seen more de-mand for bank loans and high yield—almostnone in investment-grade credits—as in-vestors reach for more yield and limit dura-tion risk in their fixed-income portfolio. Welike both instruments, but we’re probablymore skewed toward loans.

Stein: If we do start to see a dramatic movein rates where rates move wider, we will seethe technical backdrop in high yield getworse, and we will start to see outflows. Thereare a lot of BB- and high-quality B-rated bondsin the high-yield universe that yield 4.5%, soif we see rates back up by 50 basis points,those bonds are not going to be 4.5% anymore.

Zhu: More fixed-income managers that we fol-low are now favoring the bank loan assetclass over high-yield bonds. Of course, mar-kets are very fluid, and the relative attrac-tiveness between loans and bonds alsovaries on an individual security level. As forinvestment-grade bonds, we are concernedabout duration risk in that asset class. In ad-dition, coupons for high-grade bonds are low,so they do not provide much of a cushionagainst price declines if interest rates rise.

Cliff: Loans appear relatively attractive whencompared to high-yield bonds. As I stated be-fore, the heightened level of interest rate riskin the high-yield market is the primary rea-son. That risk is absent in the loan market.Currently, the high-yield bond market is

exhibiting negative convexity as a result ofcurrent prices, posting a premium versustheir future call price schedules. The high-grade market has a different risk/reward,making it difficult to compare. However, theamount of high-grade credit locked up in li-ability immunizing structures may providesupport for this market in a rate rising envi-ronment.

Smith: The press has been carrying storiesof late about the loan market reverting tothe bad old days of ’06 and ’07, with tightspreads, covenant-lite, and higher leverage.What’s your response to that?

Popp: We’re not in any way close to the badold days, and the bad old days really weren’tthat bad. I mean we’re still above our his-toric average on discount margins for theloan asset class. We have seen somespread compression, but we’re still wellcompensated for the risk. It’s case-by-case,but overall companies have done a phe-nomenal job navigating through the finan-cial crisis, improving their balance sheets,and building cash. I don’t think we haveseen the type of excess, nor will we, that wesaw the last time around.

There are some structural elementsthat have changed, too: The underwritingbanks can’t make the amount of commit-ments they could pre-crisis, but they alsohave more latitude than they had. We don’thave the market value-based financing driv-ing demand, we have real cash; and thereis more discipline inherent in that. Alongwith covenant-lite, the reporting makes forsome interesting reading, but I do not see

us following the same path in terms of a ma-terial uptick in overleveraged deals with aweak technical underpinning from exces-sive market value-based funding.

Casey: When we look at some of the dealsthat were done in ’07, some were 10, 11, 12times total leverage. We are nowhere nearthat. We’re seeing deals maybe around 6times total leverage, and senior securedleverage in the 4 to 4.5 range. To compareit to pre-crisis levels is ridiculous, and thereis nothing to back it up; but it makes goodheadlines. As for the covenant-lite refinanc-ings, most of the companies in our universeare pretty well battle tested, having made itthrough a recession. If some of them are re-financing covenant-lite, we’re comfortablecollectively that they deserve that structureafter their performance through the crisis.

Stein: When we look at the performance ofthe asset class back to ’08 and before, it’sbeen consistent over time. You got your 70cents on the dollar for recovery when thingswent awry. Being at the top of the capitalstructure has really worked over time.

Cliff: I don’t know why they single out loanswhen they mention tight spreads andcovenant-lite. What I mean is, that’s every-where, and I don’t know why they single outone segment of the credit market. Few areexpecting interest rates to rise soon, butgiven the possibility, it appears to be a saferapproach to identify creditworthy loan is-suers in a covenant-lite market than to ac-cept the large interest-rate risk in the bondmarket. ~


CHART 5: Covenant-Lite vs. Covenant-Heavy Monthly


Source: S&P LCD

Covenant-Lite

Covenant-Heavy

With over $23 billion in related credit strategies under management and a 15-year track record in the loan asset class, Credit Suisse Asset Management’s Credit Investments Group has navigated through multiple credit cycles. For further information, please contact Paul Roth at 212-538-5808.

Our clients leverage the power of our global franchise.Credit Suisse Asset Management is a leading provider of Senior Secured Bank Loans.

credit-suisse.com



AddingLoan Funds to a

Retirement PlanSmith: When did you start seeing an in-crease in loan funds becoming part of a pub-lic pension plan, a defined-contribution plan,or a defined-benefit plan?

Hsiang: We saw interest pick up in 2010, butit really peaked last year as more and moreof our clients started to ask about addingbank loans, either in a standalone mandateor as part of their high-yield or core-plus port-folios. Part of our discussion involved spend-ing some time educating the investment staffand boards on the attractiveness and risk-and-return profile of this type of investment.

Cliff: We saw defined-benefit plans adoptbank loans in the early 2000s. It dried up alittle in the middle of the decade, and it’spicked up dramatically in the last 2 to 3years. It’s been a pretty steady area for us.As for the defined-contribution market, welike to utilize loans in multi-asset-class port-folios designed for DC participants. Thesecan include target-date maturity funds, risk-based funds, and real-return strategies. Forinstance, we have a lot of inflation protec-tion assets in our target-date maturityfunds, but there is a real duration risk thatwe mitigate with bank loans. Bank loansalso add some other attractive diversifica-tion benefits.

Zhu: Each client is different. In some cases,our analysis has led us to recommend bankloans as an opportunistic asset class or aspart of a high-yield allocation. In other cases,we believe that bank loans can make senseas a standalone allocation, depending onwhat else is in a client’s overall portfolio. Westudy the benefits of including loans in eachclient’s portfolio. In addition, we conduct var-ious stress tests and scenario analyses to

make sure that clients are informed of addedrisk exposures from a proposed portfoliochange.

Smith: Loans are now considered to be amainstream asset class along with equitiesand fixed income. How was that achieved?

Stein: The focus is on the relative value be-tween other asset classes and the value ofloans post-crisis. Plus you’re at the top of thecapital structure, and you are compensatedwith attractive yields. And now, when was thelast time we saw rates this low? And then thenext question is, when are rates going to goup? You can still do okay here.

Casey: We discussed education. I think loanmanagers have been doing a lot of educatingfor a long time. If our clients hear the samething from enough people, they’re much morecomfortable with loans as an asset class andincluding them in a fixed-income portfolio. Theasset class makes a lot of sense.

Smith:With spread compression a way of lifein fixed income, how does an investment inthe loanmarket help ameliorate this problem?

Casey: We have had spread compression, butwhen you look at what loans are paying rela-tive to other fixed-income alternatives, in-vestors are being fairly compensated. Mostimportantly, we expect the default rate to below over the next couple of years, so the creditrisk usually associated with this asset class isgreatly reduced.

Popp: It’s a question of absolute return andrelative return compared to those otherasset classes. Loans provide a defensivecomponent when rates move the other way.

Gunther SteinCEO and CIO,

Symphony Asset Management

Ping ZhuLead Fixed Income Analyst,

Strategic Investment Solutions


continued on page 14

You’re getting fairly compensated today, andyou’re in a pretty good place from a total-re-turn perspective relative to the other assetclasses in the fixed-income market. The rela-tive value of loans has improved becausespread compression in high yield and otherfixed-income asset classes has been evenmore pronounced.

Zhu: Continued spread compression has cer-tainly been frustrating, but when investors con-sider the relative value of loans versus otherassets, it doesn’t really look that bad. It’s alsoworth noting that loan markets have manymoving parts, so continued spread compres-sion is likely to have impact on new CLO is-suance, affecting the supply-demand dynamicsand even creating short-term dislocations.

Cliff: Spread compression is one of the pri-mary reasons that loans are currently attrac-tive within a fixed-income context. Fixedcoupon-paying bonds of comparable creditrisk are exhibiting similar levels of option-ad-justed spread to loans but with much greaterduration risk. As yields continue to hover nearall-time lows, loans are still compensating youwith reasonable levels of income. They alsoprovide you with the prospect of increased in-come when yields revert to longer-term aver-age levels. Fixed coupon-paying bonds do nothave the benefit of resetting coupons tonewly prevailing rates.

Smith:What are the ways that pension fundscan invest in the loan market—CLO, separateaccount, commingled? What is some of thethinking pension funds go through?

Hsiang: Some pension funds are just not asfamiliar with this type of investment, so weprovide education specifically on the reasonswhy loans are a good investment in today’smarket environment, given the risk of risinginterest rates. We’ve gotten some questionson the operational side as well, which is dif-ferent from investing in a mutual fund. Thereseems to be a preference for a mutual fundor a commingled vehicle over separate ac-counts to avoid custodial issues.

Stein: Pension funds want to think about liq-uidity. So investing through a CLO is going tobe less liquid. We do both separate accountsand commingled accounts. Pension funds inparticular want to own the assets themselvesinstead of through intermediaries. Right now,loans offer a lot of downside protection, andthey’re a relatively low-volatility asset class thatwe feel pretty good about. CLOs are unique be-cause they’re non-mark-to-market vehiclesthat you can do a lot with over time with someof the tools that you have to utilize in thatframework. It’s really about what the investoris looking for.

Popp: I think there’s intrinsic value in actuallycontrolling the assets. I think that by andlarge most of the pension funds of any scalethat we’re dealing with want to look at havingseparate accounts. When we’re talking aboutloans, the CLO market comes up as a com-ponent of the loan market for pension funds,but someone considering loans doesn’t usu-ally look at CLOs as an alternative. They likethe very explicit exposure to a diversified port-folio, which comes out of a mindset that’smore familiar with high yield. There are struc-tured-product groups that will consider CLOs,but in the more traditional credit space withinfixed income, it doesn’t seem to be a debatethat we’ve come across. Usually it’s thesmaller municipalities and more modestoverseas insurance companies investing $15or $25 million that either don’t have the scaleor don’t want to deal with the administrativeaspects of a separate account that go into acommingled product.

Cliff: Given a client’s specific circumstances,we want to thoroughly consider the diversi-fication, liquidity, and operational chal-lenges of a loan mandate. Unless theconsidered investment is sizable enough toovercome these, we typically will look topooled funds to implement. All else equal,if you can pool your assets with other pen-sion assets that are stickier and have lessdaily cash flows, you might not disturb theactive management of the underlying vehi-cle. If you factor in a quarter to half a pointdifference in bid-offer spreads on loans, fre-quent investor cash flows can be detrimen-tal to the fund. Pooled funds that onlyprovide periodic liquidity with advance no-tice also seemingly have an advantage toadapting to the issuance calendar andmaintaining diversification.

Casey: We offer pension clients access toloans across multiple strategies dependingon their risk/return requirements/tolerance.For example, we could manage an unlever-aged portfolio of loans that had a return tar-get in the mid-single digits. We could alsoadd moderate leverage to the same portfo-lio of loans through a TRS to achieve highsingle-digit returns or even use CLO tech-nology to generate returns in the 13 to 15%range. At the end of the day, it comes downto the client’s need for liquidity, with CLOsobviously requiring a longer holding period.

Smith: If there was one takeaway for ourreaders, what would that be?

Casey: The asset class makes a lot of sense.It really sits in a sweet spot now between in-vestment grade and high yield, insofar asyou’re protecting against both interest raterisk relative to investment grade, and then

“The asset classmakes a lot

of sense.It really sits

in a sweet spotnow between

investment gradeand high yield.”

credit risk relative to high yield.

Cliff: At the moment, bank loans are a robustasset class, with lots of activity, lots of is-suance, and lots of interest from a broadarray of buyer types. I think all these thingsbode well for it having a meaningful exposurewithin a fixed-income structure. Given currentlow rates and the potential for interest rateincreases, loans seem like a very attractiveway to minimize duration risk within a fixed-in-come structure while still earning an attrac-tive yield. They also have the potential toperform well in an environment of rising realinterest rates and subdued inflation. Inflationhedging instruments like TIPS would likely notfare well in such an environment.

Hsiang: Looking forward, regardless of whichtype of market condition, bank loans helpmute interest-rate risk while providing a rela-tively attractive yield. With fixed-income portfo-lios concentrated in low-yielding instruments,loans look more and more attractive, espe-cially as the expectation of rising interestrates becomes more and more certain. How-ever it is important to keep in mind that bankloans are still a non-investment-grade instru-ment with inherent credit risk. In addition toevaluating the attractiveness/drawbacks ofthese instruments, investors will also need tomake sure the manager they consider is wellversed in investing in them.

Popp: At the moment, loans almost positionthemselves as an all-weather asset class. Thebig change, pre- and post-financial crisis, isthe institutionalization of the asset class. Rightnow it’s got a tactical element. The absolutereturn, a very attractive relative return, and theminimization of the duration risk in fixed-in-come portfolios are quite compelling. As wemove forward, we’ll see that it has a perma-nent place in the portfolios of investors. So it’sa great diversifier. It always has been. The loanasset class has continued to mature, and it’sfinally reaching that stage where it’s broadlyadopted, understood, and accepted for thebenefits that it can bring to portfolios.

Stein: I continue to think that this is really athird asset class. There’s no duration risk,and you’re at the top of the capital structure.Basically, you’re a lender, and you’re allowinginvestors, retail or institutional, to tap into thelending market. That’s really what we are. Asactive managers, we can take advantage ofwhatever volatility is created out there. I don’tthink there’s going to be a lot in the shortterm, but if there is some, as active managerswe can go ahead and take advantage of itand be confident that we’re going to get parback. With that said, it’s the low-duration riskversus other asset classes that continues tobe really compelling. ~



Senior secured loans can enhance a diversified fixed-income portfolio orbe used for their own benefits. Here’s what some of the terms mean in aloan context:

Covenants: Senior secured loans have financial maintenance covenants to pro-tect lenders if issuers are not performing as projected. If a borrower violates itsmaintenance covenants, senior lenders can intervene, which typically involvesincreasing interest payments for the higher risk, accelerating repayment, andotherwise improving lenders’ terms. This is a critically important distinction ofsenior secured loans versus other asset classes, particularly high-yield bonds,which typically have only so-called incurrence covenants that prevent the incur-rence of additional debt if certain financial thresholds are not being met. Thereis no requirement to maintain any specified level of performance other thanmaking scheduled principal and interest payments for bonds.

Floating Rate: Senior secured loans are floating-rate instruments, with theircoupons being determined as a spread over LIBOR.

LIBOR Floor: LIBOR floors provide a minimum coupon for investors if LIBOR isbelow a certain level and allow yields to increase, or float, if LIBOR exceedsthe floor level. LIBOR floors are present in nearly 80% of currently outstandingloans. Historically, when LIBOR moved up, the interest rate that loans paidalso went up. The reverse was also true, and coupon levels would go down asLIBOR went down. The introduction of LIBOR floors increases loans’ overallcoupon levels to appeal to a broader base of investors while retaining theirfloating rate upside.

Liquidity: The large number of participants and growing size of the loanmarket has created unprecedented liquidity, which has held up well, notablyduring periods of market stress.

Prepayable: Senior secured loans are typically prepayable at their par value.Despite having stated maturities of 5 to 7 years, their average life is usuallyabout 2 to 3 years, depending on conditions in the financial markets.

Secured: Senior loans are secured by the issuing company’s assets, and in adistressed situation, lenders have the first claim. If a company performs well,this collateral provides extra insurance that is never used. If a companydefaults, senior lenders can expect to be paid back about 70 cents on thedollar as a result of their secured position. High-yield and investment-gradebonds are typically unsecured and, consequently, have had lower recoveriesin a default.

Senior secured: In the hierarchy of creditors, loans have first right ofrepayment. They are repaid before any other creditors and beforeshareholders.

Loan terms defined

For more information on how we can provide broad credit solutions to your portfolio, contact Anne Popkin at 415-676-4000 or [email protected].

www.symphonyasset.com

Symphony Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.

Experts Across the Capital Structure

Symphony Asset Management is a leading boutique investment firm specializing in leveraged finance.

Access to an Industry Leader

For more than 15 years, Symphony has distinguished itself as a manager of long-only senior loans, structured products, and alternative strategies throughout various market cycles.

Expertise in Corporate Credit

Symphony’s robust credit platform looks across the entire capital structure to identify the most favorable risk-adjusted opportunities.

Institutional Infrastructure

Symphony supports its investment results with an institutional infrastructure focused on excellence in client service and independent risk management.

WHY INVEST WITH SYMPHONY?

Research Driven Dynamic Portfolio Management Performance Excellence


11pi0031.pdf RunDate:02/07/11 LSTA Suppl Page:16 Color: 4/C

pi06LSTA_p.qxp 1/28/11 10:46 AM

pi LSTA Supp · 2019-05-06 · Bra m S ith Executive Director Loan Syndications and Trading...

Documents

Transcript of pi LSTA Supp · 2019-05-06 · Bra m S ith Executive Director Loan Syndications and Trading...