BCM Conversations_6377_Multi Credit

Babson Capital Conversations
March 2014
Michael Freno,
Managing Director
Michael Freno serves as
head of the U.S. High Yield
Investments Group. He is
also the chair of the U.S.
High Yield Investment
Committee, a member
of the Global High Yield
Committee and a lead
portfolio manager for various global loan
strategies. Michael has over 14 years of industry
experience. He holds a B.A. from Furman
University and an M.B.A. from the Wake Forest
Babcock School of Business.
Zak Summerscale,
Managing Director
Zak Summerscale runs
the European Loan and
High Yield Bond team
and chairs both the
Babson Capital European
High Yield Investment
Committee and the Global
High Yield Committee. He
also has direct portfolio
management responsibility for several of the
firm’s strategies. Zak joined Babson Capital
in March 2001 and holds a B.A. (Honors) in
economics from Durham University.
GLOBAL HIGH YIELD
MULTI-CREDIT INVESTING
There has been a focus recently from both institutional and retail investors
on sourcing investment opportunities across the high yield universei through
multi-credit strategies. How does Babson Capital define high yield multi-credit
investing?
Zak: At Babson Capital, we think of high yield multi-credit investing as a
holistic approach to high yield markets. The goal of these strategies is to help
our clients gain access to the full spectrum of the global corporate credit high
yield universe—including high yield bondsii, floating-rate loansiii, distressed
debtiv, and structured creditv —with a specific focus on allocating funds to
those asset classes that offer the most value at a particular point in time. The
idea is that professional asset management firms with deep experience across
the high yield spectrum, such as Babson Capital, will make asset allocation
decisions for investors, which can be beneficial in terms of efficiency and in
helping investors to uncover the most compelling relative value opportunities
across asset classes.
Mike: High yield multi-credit strategies are intended to be “one-stop shops”
for investors seeking exposure to the high yield investment universe. They
are typically constructed with a core investment in high yield bonds and
floating-rate loans, supplemented by opportunistic investments in areas
such as distressed debt and structured credit. The core of the portfolio is
intended to provide investors with income and capital appreciation similar
to that produced by single-asset portfolios made up solely of high yield
bonds or loans. The difference with a multi-credit strategy is that allocations
to bonds and loans can be shifted higher or lower depending on the market
environment, and the portfolio management team can look to add additional
yieldvi or seek capital appreciation opportunistically in asset classes like
distressed debt and structured credit.
What are some advantages of investing in a high yield multi-credit strategy as
opposed to a single-asset strategy, and can you describe the asset allocation
decision-making process at Babson Capital?
Mike: In order to capitalize on investment opportunities in the high yield
market as they arise, it’s important that investors have the flexibility to
move quickly. In the real world, however, investors often face constraints; a
pension fund may require board approval for asset allocation shifts, or an
individual investor simply may not have the time, knowledge, or resources
to continuously monitor conditions in these complex financial markets.
This is where high yield multi-credit funds can provide investors with a real
advantage. By putting the day-to-day asset allocation decisions into the hands
of a portfolio management team that focuses exclusively on the high yield
market, investors can remove a layer of decision-making and benefit from
the experience of this dedicated team.
Zak: At Babson Capital, we view high yield multi-credit investing as a
“through-the-cycle” strategy. This means that our clients can invest in one
fund with the confidence that our portfolio management team will monitor
BCC6377_14/398_2014/068
For Investment Professionals Only
both top-down macroeconomic factors, as well as bottom-up issuer-specific credit dynamics, and adjust
allocations accordingly as conditions change. For example, floating-rate loans, which are debt instruments
that pay investors a spread over a reference rate such as LIBORvii, have historically performed better than
high yield bonds in rising interest rate environments, due in part to their floating-rate nature. In a scenario
where our investment team expects rates to rise, a reallocation from bonds into loans therefore may be
appropriate. Our portfolio management process is structured to allow this type of tactical decision to be
made and executed in an efficient manner, allowing investors to potentially capitalize on these changing
conditions.
Are there diversification benefits that come from investing in a global high yield multi-credit strategy as
opposed to single-asset strategies?
Mike: By their very nature of including several asset classes across multiple geographies, global multi-credit
strategies can offer investors enhanced portfolio diversificationviii. High yield asset classes, especially floatingrate loans, have historically exhibited low correlationsix with broad benchmark bond indices like the Barclays
U.S. Aggregatex and Global Aggregatexi. An allocation to a high yield multi-credit strategy, especially one that
seeks investment opportunities across international borders, can therefore help investors to diversify their
broader fixed income exposure. The addition of asset classes like floating-rate loans can also help investors
to manage the duration—or interest rate sensitivity—of their fixed income holdings. (See our paper from
January 2014 “Investment Opportunities in Global Loans” for a more detailed discussion on loans).
Zak: Each asset class can benefit the overall portfolio uniquely. As Mike mentioned, the addition of floatingrate loans may help lower the duration of the portfolio. High yield bonds offer income in the form of coupons,
and distressed debt and structured credit vehicles such as collateralized loan obligations (CLOsxii) can add
both to the income and capital appreciation of the overall portfolio. This level of diversification, across
both asset class and geography, should result in portfolios that are better-positioned to absorb shocks that
could impact a single asset class. By constructing portfolios in this way, portfolio managers seek to reduce
the volatility of returns and enhance risk-adjusted return measures such as the Sharpe ratioxiii, while at the
same time seeking the best relative value opportunities across high yield asset classes globally.
Can you give an example of a relative value opportunity and how a global high yield multi-credit portfolio
management team might be able to capitalize on it?
Zak: The flexibility inherent in a multi-credit strategy allows portfolio managers the ability to seek out crossasset relative value opportunities, which are often driven by technical factors, rather than fundamentals.
A good example would be the opportunity that we identified in mid-2013; following the Fed’s initial
communications around tapering its asset purchases, high yield bonds experienced significant outflows,
while loans continued to see inflows. While the market’s interest rate expectations certainly changed at
this time, this technical factor—fund flows—played a large role in opening up a relative value opportunity
in high yield bonds, which our portfolio management team was able to capitalize on by increasing the
portfolio’s allocation to bonds. In addition to looking across asset classes, our global platform allows us to
look across geographies, where again, technical factors like supply/demand dynamics can lead to credit
market inefficiencies, such as bonds from the same issuer trading at different yields depending on the
country where they trade. Our investment team constantly looks to capitalize on these types of opportunities.
Mike: One place that credit market inefficiencies can be seen is in the value of structured credit vehicles
relative to the underlying asset classes from which they are constructed. For example, our investment team
has found that certain CLO tranches offer more value than the underlying bank loans from which they
are derived. The underlying credit risk may be modestly different but by looking across asset classes, in
this case from loans to CLOs, we are able to identify the most attractive way to invest for our clients. Over
the last twelve months, our portfolio management team has increased portfolio allocations to CLOs, as
the illiquidity premium—or the incremental yield that investors receive by investing in a less liquid asset
class—has widened, offering investors the chance to earn additional income at what our team deems to be
a reasonable amount of risk. As we uncover opportunities across asset classes, the flexibility provided by a
global multi-credit strategy allows for unique, potentially return-enhancing investments.
2
For Investment Professionals Only
Babson Capital Management LLC
What are some risks to investing in high yield multi-credit strategies?
Mike: It’s important to remember that high yield bonds and loans are issued by below-investment grade
companies, so they may be more likely to default on their obligations than their investment grade
counterparts. In addition to this inherent defaultxiv and credit riskxv, assets in the portfolio may lose value
depending on movements in interest rates, or other market-related factors. Our investment process is
designed to allow portfolio managers the ability to constantly monitor these risks and adjust the portfolio
accordingly based on their expertise.
Zak: It is worth noting that liquidityxvi risk is present in a number of these asset classes including CLOs and
distressed debt. Additionally, given the nature of an active portfolio management process, there is the risk
that asset allocation decisions can be detrimental to portfolio returns.
What are some advantages that Babson Capital has when it comes to global high yield multi-credit strategies?
Mike: The breadth and depth of our Global High Yield Investments Group really stands out. We have
approximately 80 dedicated investment professionals, who exclusively cover the global high yield universe.
Because of our large team, we are able to develop in-house research on every credit that comes to market,
enabling us to narrow down a universe of 3000 global credit opportunities, to approximately 150 best ideas.
Each potential investment must then be approved by an investment committee composed of our firm’s
most senior professionals. Our team “lives and breathes” the high yield markets every day, and, as such, we
feel that we are in a strong position to spot new trends or changing market conditions in a timely manner.
Zak: We have a significant presence in both Europe and the U.S. and are set up to operate as one global
team. We feel that this truly differentiates Babson Capital from other asset management firms. Our analysts,
portfolio managers, and traders look for value across the global high yield spectrum and are incredibly
focused on sharing ideas across the platform. This global perspective forms the backbone of our team-based
asset allocation decision-making process; a premium service that we offer to our clients, and one that we
think is difficult to replicate. Looking forward, we continue to see attractive opportunities within high yield
markets and believe that investing in this space though a global multi-credit strategy may deliver strong
risk-adjusted returns over the long term.
i
ii iii iv v
vi vii viii ix x
xi xii xiii xiv xv The high yield universe refers to sub-investment grade assets such as high yield bonds, floating-rate loans, distressed debt, and structured credit
vehicles such as CLOs. These assets are rated lower than investment grade by ratings agencies such as S&P, Moody’s and Fitch. They typically
offer higher yields than higher-rated debt instruments but are likely to have a greater risk of default.
High yield bonds, also known as sub-investment grade bonds, typically offer higher yields than higher-rated bonds but are likely to have a
greater risk of default.
Loans are high yield debt instruments that typically pay investors a floating-rate spread over a reference rate such as LIBOR.
Distressed debt is corporate debt that is currently in default, under bankruptcy protection, or nearing such a condition.
Structured credit vehicles are synthetic instruments derived from other underlying securities. They are used as mechanisms to transfer risk by
pooling assets together and then separating them into tranches based on relative risk/return profiles.
Yield refers to the income return bond investors receive in the form of coupons, as a percentage of the bond’s par value.
LIBOR (London Interbank Offered Rate) is a widely used reference for short-term interest rates.
Diversification refers to the concept that investors may be able to reduce risk by investing in a portfolio of varying assets.
Correlation is a measure of how two or more assets change in price relative to one another.
The Barclays Capital U.S. Aggregate Index is a broad-based U.S. benchmark that measures the securitized, corporate, agency, government and
Treasury bond markets. IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
The Barclays Capital Global Aggregate Index is a broad-based Global benchmark that measures the securitized, corporate, agency, government
and Treasury bond markets. IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
A Collateralized Loan Obligation (CLO) is a structured credit vehicle that issues debt and equity as its capital and purchases bank loans as its
predominant asset class.
Sharpe ratio refers to the average return in excess of the risk-free rate divided by the standard deviation of return; a measure of the average excess
return earned per unit of standard deviation of return.
Default risk is the risk that an issuer will fail to satisfy its payment obligations.
Credit risk is the risk of loss associated with an issuer being perceived by the market as less likely to satisfy its payment obligations. It is closely
related to default risk.
xvi Liquidity refers to the ease with which assets can be bought and sold without materially impacting price.
Babson Capital Conversations March 2014
For Investment Professionals Only
3
IMPORTANT INFORMATION
Babson Capital Management LLC, Babson Capital Securities LLC, Babson Capital Europe Ltd, Babson
Capital Australia Pty Ltd, Wood Creek Capital Management, LLC, Babson Capital Cornerstone Asia Ltd. and
Cornerstone Real Estate Advisers LLC, each are aﬃliated financial service companies (each, individually, an
“Aﬃliate”), together known as “Babson Capital” and members of the MassMutual Financial Group*. Each
Aﬃliate may act as introducer or distributor of the products and services of the others and may be paid a
fee for doing so.
CONTACT
ADDRESSEE ONLY:
U.S.
This document is issued to investment professionals and institutional investors only. It is intended for the
addressee’s confidential use only and should not be passed to or relied upon by any other person, including
private or retail investors. This document may not be reproduced or circulated without prior permission.
Jeff Stammen
Managing Director
+1.917.542.8308
[email protected]
NO OFFER:
The document is for informational purposes only and is not an offer or solicitation for the purchase or sale
of any financial instrument in any jurisdiction. The material herein was prepared without any consideration
of the investment objectives, financial situation or particular needs of anyone who may receive it. This
document is not, and must not be treated as, investment advice, investment recommendations, or investment
research.
Unless otherwise mentioned, the views contained in this document are those of the Aﬃliate producing it.
These views are made in good faith in relation to the facts known at the time of preparation and are subject
to change without notice. Parts of this presentation may be based on information received from sources
we believe to be reliable. Although every effort is taken to ensure that the information contained in this
document is accurate, Babson Capital makes no representation or warranty, express or implied, regarding
the accuracy, completeness or adequacy of the information.
Any forecasts in this publication are based upon the Aﬃliate’s opinion of the market at the date of
preparation and are subject to change without notice, dependent upon many factors. Any prediction,
projection or forecast is not necessarily indicative of the future or likely performance. Past performance
is not a guarantee of future results or a reliable indication of future performance. The investment results,
portfolio compositions and examples set forth in this document are provided for illustrative purposes only
and may not be indicative of the future investment results, future portfolio composition or investments. The
composition, size of, and risks associated with an investment may differ substantially from the examples set
forth in this document. No representation is made that an investment will be profitable or will not incur
losses. Where appropriate, changes in the currency exchange rates may affect the value of your investment.
In making an investment decision, prospective investors must rely on their own examination of the merits
and risks involved and before making any investment decision, it is recommended that prospective investors
seek independent investment, legal, tax, accounting or other professional advice as appropriate.
OTHER RESTRICTIONS:
The distribution of this document is restricted by law. No action has been or will be taken by Babson Capital
to permit the possession or distribution of the document in any jurisdiction, where action for that purpose
may be required. Accordingly, the document may not be used in any jurisdiction except under circumstances
that will result in compliance with all applicable laws and regulations.
Any service, security, investment, fund or product outlined in this document may not be generally available
or be suitable for a prospective investor or available in their jurisdiction. It is the responsibility of the
prospective investor to ensure that any service, security, investment, fund or product outlined in this
document is accordant with any jurisdiction specific guidelines/regulations before any approach is made
regarding that service, security, investment, fund or product.
INFORMATION:
Babson Capital Management LLC is a registered investment adviser with the Securities and Exchange
Commission under the Investment Advisers Act 1940, as amended. Babson Capital Management LLC
is registered as a Commodity Trading Advisor (CTA) and Commodity Pool Operator (CPO) with the
Commodity Futures Trading Commission under the Commodity Exchange Act, as amended.
Babson Capital Securities LLC is a registered limited purpose broker-dealer with the Financial Industry
Regulatory Authority, Inc.
Babson Capital Europe Limited is authorised and regulated by the Financial Conduct Authority in the United
Kingdom (Ref No. 194662) and is a Company registered in England and Wales (No. 03005774) whose
registered address is 61 Aldwych, London, WC2B 4AE.
Babson Capital Australia Pty Ltd (ACN 140 045 656), is authorized to offer financial services in Australia
under its Australian Financial Services License (No: 342787) issued by the Australian Securities and
Investments Commission.
Babson Capital Cornerstone Asia Limited is licensed with the Securities and Futures Commission of Hong
Kong to carry on regulated activities Type 1 (dealing in securities), Type 4 (advising on securities) and Type
9 (asset management) in Hong Kong in accordance with the requirements set out in the Securities and
Futures Ordinance (Cap 571).
Wood Creek Capital Management, LLC is a registered investment adviser with the SEC specializing in
investments in real assets.
Cornerstone Real Estate Advisers LLC is a registered investment adviser with the SEC specializing in real
estate related investments.
Copyright
Copyright in this document is owned by Babson Capital. Information in this document may be used for
your own personal use, but may not be altered, reproduced or distributed without Babson Capital’s consent
*MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company
(MassMutual) and its aﬃliated companies and sales representatives.
BCC6377_14/398_2014/068
For Investment Professionals Only
SALES
Europe
Andrew Godson
Managing Director
Head of Distribution
+44.0.20 3206 4574
[email protected]
Australia
Sue-Ellen O’Keeffe
Managing Director
+61.3.9620.1800
[email protected]
Jon Millin
Managing Director
+61.2.8272.5004
[email protected]
Asia
Giselle Lee
Managing Director
+852.3515.8025
[email protected]
CONSULTANTS
U.S.
David Acampora
Managing Director
+1.917.542.8375
[email protected]
Europe
Neil Godfrey
Managing Director
+44.0.20 3206 4576
[email protected]
Australia
Sue-Ellen O’Keeffe
Managing Director
+61.3.9620.1800
[email protected]
Jon Millin
Managing Director
+61.2.8272.5004
[email protected]
Asia
Giselle Lee
Managing Director
+852.3515.8025
[email protected]