Episode 65

John Fekete on below-investment grade private credit in the current market environment

John Fekete, Managing Director, Head of Capital Markets at Crescent Capital, discusses his outlook for investors in high yield fixed income.

Steve Peacher: Hi everybody. This is Steve Peacher at SLC Management, new episode of “Three in Five,” and John Fekete, who is the head of capital markets business at Crescent Capital is with me today, John, thank you for taking a few minutes.

John Fekete: Happy to be here, Steve.

Steve Peacher: And of course, we want to talk about below-investing grade credit, you know, and it's been an interesting few months and in all the markets, and I think we've seen that in the high yield and leveraged loan market. So, you know, high yield spreads have widened year to date, though they bounced a bit, and I guess I'm wondering about your outlook. How far do you? Where do you think spreads are going? Do you think currently the market’s pricing in a recession? What do you think is being priced into today's spreads, where are we going?

John Fekete: Well, that's the biggest question right now, Steve, that fixed income investors, I think, are facing. Are we at the bottom, or is there more pain ahead? So just to kind of set up where we are, the major high yield index is down about eleven percent year to date. That's through the beginning of this month. So, if the year ended today, that would be the second worst year on record ever for high yield. So, it's been pretty significant sell-off and there's really been no place for investors to hide, as you probably know, even investment grade debt which usually holds in even better, that's done even worse. It's down about fourteen percent and all that sell off we're seeing is due to the fed changing policy and hiking rates. So, let's assume we're going to go into a recession. Not every recession is the end of the world. We took a look at U.S. recessions we had in the early 1990’s and early 2000’s, and both of those recessions lasted less than nine months and were followed by periods of strong growth. So, it's not the end of the world. One thing to note in previous tightening cycles, what we observed that credit markets generally front end load the hawkishness. So, what that means is that you generally see weakness leading into it and at the beginning of the hiking cycle, and then you have a strong market recovery once investors kind of anticipate the hikes, and they're underway. So, what does that mean in terms of where we are in the valuation? High yield spreads are about five hundred over. That's a really important level by historical standards because Barclay’s research has done some analysis, and they found when high yields at a spread of five hundred over or wider the return in the following twelve months, twelve months forward, was over nine percent. So that's an equity-like turn and suggests that it might be the right time for investors to allocate capital to high yield.

Steve Peacher: So, you know, obviously in the high yield market now investors can choose between high yield bonds or leveraged loans often, and leveraged loans can be attractive in a rising interest rate cycle, but that may be factored in evaluation. So how do you think about the relative value between yield bonds today and leveraged loans, bank loans, given where we are in terms of the interest rate cycle and the Fed moves?

John Fekete: It's a really good question, because loans and bonds have performed very differently this year. Usually, they move not quite in lockstep, but they move pretty much in sync, and this year bank loans have substantially outperformed fixed coupon bonds. And bank loans typically outperform when rates rise. As you mentioned, it could be a great way to make a fixed income portfolio less sensitive to interest rates. The benefit they have in a portfolio is they shorten the duration, and the coupons actually rise as short-term interest rates rise, so clients can benefit by expanding their investment guidelines and permitting managers like Crescent flexibility to purchase both loans and bonds. The loan market used to be kind of a small market, and today it's grown really significantly. It's as large as the U.S. high yield bond market. So, we think investors radar should be bank loan strategies because they can be very helpful these days.

Steve Peacher: And you know, within the high yield market managers have different styles, and you know, how do you think about the different styles, and I know that at Crescent Capital you have a style that you guys have employed over the years. And what is that? And how has that changed, if at all, over time?

John Fekete: That's true. There are different styles that high yield managers have. They're not all the same. Some managers are always defensive, meaning they only buy the safest, highest rated bonds in the universe, and that can be beneficial in some markets. But it can also detract in environments like today when interest rates are rapidly rising. Other managers are more aggressive. They load their portfolios with low rated credits. In fact, I recently competed for a mandate, and my competitor had over forty percent of their portfolio invested in CCC rated bonds and loans. And remember, CCC is like one or two steps away from bankruptcy. So, I would definitely say that was the most aggressive manager I've ever seen. At Crescent we prefer what we call a core style, meaning we can be more defensive or more aggressive based on the risks that we see in the market and how well we feel we're being compensated for the risks. So, in that regard we use our size to our advantage. We're a mid-size manager. We can be nimble. We can look to exploit market inefficiencies. The larger, more retail-oriented managers in high yield, they're often too big to be nimble, so they can’t do what we're doing.

Steve Peacher: Well, thanks for that. It's a fascinating time, I think, in the markets in general, but especially in the below investment grade credit market. So that was a good summary of where we are today. I want to ask you I like to end of course with a question personal question. I've been lucky enough to get a ride with you in your in your cool electric car, so I would. What I wanted to ask you about was how have you liked having an electric vehicle, and have you, has that created any stress points for you as you've driven around and found that, the I don't know if there's a gas gauge but your electric meter is getting to the low end and you've got to refuel?

John Fekete: Yeah, I have to say it's really cool, Steve. This is the first time we've ever had one, and I thought I was a combustion engine guy. I would never, you would have to pull the car away from me, but I really like the electric car. You know the fact that it's clean is great, but also the acceleration, if you're a car person, the acceleration is unreal. It's so fast, and which is helpful here in L.A. when you need to cut in and out on the freeway. So, I like it. It is a little stressful in that the range is kind of limiting, about two hundred- and fifty-miles range, so you can't go terribly far. You will start to get worried that you might run out of power, but around town it's great, and if you're lucky enough to have a charger where you live, then you just plug it in and you go to sleep and you wake up and you're ready to go.

Steve Peacher: Okay, good. I feel better. I'm getting an electric car this fall. So, now I feel good about that choice. So well, John, thank you very much for taking the time, and thanks everybody for listening to this episode of “Three in Five.”

 

 

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