Credit Investing in a Post-Pandemic World with Chris Hentemann, Managing Partner & Chief Investment Officer, 400 Capital. Jeffrey Sherman, Deputy Chief Investment Officer, DoubleLine. Dave Trucano, Managing Director, BlackRock. Sreeni Prabhu, Managing Partner, Co-Chief Executive Officer & Group Chief Investment Officer, Angel Oak Capital Advisors.
Moderated by Mei-li Da Silva Vint, Chief Compliance Officer, Brevet Capital.
SPEAKERS
Chris Hentemann
Managing Partner & Chief Investment Officer
400 Capital
Jeffrey Sherman
Deputy Chief Investment Officer
DoubleLine
David Trucano
Managing Director
BlackRock
Sreeni Prabhu
Managing Partner, Co-Chief Executive Officer & Group Chief Investment Officer
Angel Oak Capital
MODERATOR
Mei-li Da Silva Vint
Chief Compliance Officer
Brevet Capital Management
TIMESTAMPS
EPISODE TRANSCRIPT
Mei-li Da Silva Vint: (00:07)
Good morning, everyone, and welcome to SALT day two. Thank you for joining us so early. My name is Mei-li Da Silva Vint, and I'm the Chief Compliance Officer of Brevet Capital. We are an alternative credit fund based right here in New York City and we partner with governments globally to bring complex initiatives to fruition by conquering inefficiencies.
Mei-li Da Silva Vint: (00:26)
I'm thrilled to be moderating today's panel on Credit Investing Post-Pandemic World. Today, we're going to take you through some macro themes with a credit lens, walk you through the evolution of credit through the pandemic, and then I'll let our panelists take us where they want to go. We're lucky enough to have panelists from a variety of areas in the credit ecosystem.
Mei-li Da Silva Vint: (00:49)
And so, with that, I'll let each of the panelists introduce themselves with a brief background, where they sit in the credit space in their firm and how big each of their firms are. So, Chris, why don't you kick us off and we'll go down the line.
Chris Hentemann: (01:00)
Thank you, Chris Hentemann. I'm the Founder and CIO of 400 Capital. We're an alternative credit manager, primarily focusing on structured credit. We're based in New York City and we have an investment team in London. We manage both total return and absolute return strategies and hedge fund private credit separately management portfolios, primarily focusing on pension endowment foundation, family offices, and high net worth individuals.
Mei-li Da Silva Vint: (01:30)
Jeffrey?
Jeffrey Sherman: (01:30)
I'm Jeffrey Sherman. I'm the Deputy Chief Investment Officer at DoubleLine Capital. We're an investment management firm headquartered in Los Angeles. We run the gamut of fixed income equity strategies. We run up and down the cap structure. We run mutual funds, ETFs, hedge funds, separate accounts. If you have money, we'll invest it for you.
Dave Trucano: (01:52)
Great, David Trucano. I work at BlackRock. I won't go too much into the background of the firm. I'm sure people are familiar with it. But, within the four walls of BlackRock, I manage your opportunities to credit business. Think about that as investing across hedge fund and drawdown private equity stock credit strategies, targeting the lower end of the credit curve, stress distress securities.
Sreeni Prabhu: (02:14)
Sreeni Prabhu, Co-Founder and CIO of Angel Oak Capital. We're based in Atlanta. Again, fixed income manager. We manage sleeves of corporate credit, but primarily structured credit. We manage across mutual funds, hedge funds, private credit strategies. We have a public REIT about 20 plus billion in assets under management.
Mei-li Da Silva Vint: (02:34)
Great, thank you. It's a pleasure to have all of you here today.
Sreeni Prabhu: (02:37)
Thank you.
Mei-li Da Silva Vint: (02:38)
So, I think we'll start with the 50,000 foot view and what's going on from a macro perspective in the world right now. You have the Fed signaling that they're going to start tapering their asset purchasing program that they started at the beginning of the pandemic, you have inflation, you have geopolitical risks, you have supply chain disruption. And of course, you have the Delta variant coming into play.
Mei-li Da Silva Vint: (02:58)
Jeffrey, I think it'd be super helpful if you could distill some of these themes and the impact they have had, and the impact you think they will have in the credit space.
Jeffrey Sherman: (03:06)
That's it. Okay.
Mei-li Da Silva Vint: (03:08)
Loaded question.
Jeffrey Sherman: (03:09)
Yeah. So, I mean, look, inflation's on everyone's mind, this is unprecedented policy, it seems like that's all we talk about anymore, is unprecedented. And you have the Fed buying $120 billion a month, and people are freaked out that they're going to slow down their purchase pace. But, their purchase pace is still aggressive. I mean, during the peak in the crisis, they were buying 80 billion a month.
Jeffrey Sherman: (03:30)
So, the Fed is not going to be a minor player for a long time from now. So, the focus is on inflation, of course, but inflation, is it transitory? Is it not? We were joking backstage that, it's your time horizon that matters there. And it doesn't look transitory in some cases. And some cases, it does.
Jeffrey Sherman: (03:49)
If you talk about autos, used cars, airline tickets, hotels, except in New York City, you're seeing that those are calming down. But the big difference here is we haven't seen the wage component kick through and you haven't seen the rent and owner's equivalent rent side of the equation. So, that's what's a concern for us.
Jeffrey Sherman: (04:07)
However, I don't think we go to this hyperinflation, stagflation. I think those words are abused today. I think people are... I'm talking about a slowing growth. Yeah, when you have a 10% nominal GDP, you're probably going to slow a little bit at some point, unless your name is China.
Jeffrey Sherman: (04:22)
So, ultimately, I think, people are concerned that this is going to fall off a cliff, but we're in a very strong credit environment. It's really tough to invest in liquid credit today because everybody's crowded into it because the Feds push people there. So, when you think about it, it's been selective. The beta trade is not good today, because it's got a lot of risk.
Jeffrey Sherman: (04:42)
So, corporate America is in great shape from a debt standpoint, because they don't have maturity walls. They have a big debt burden. The servicing costs are low. It's not a problem right now. It could be in the future. So, what does it mean? It means you want to own it, but the problem with it is, if you're in the vanilla stuff, it's got a lot of duration. It's got a lot of interest rate risk. And so, you have a lot of challenges.
Jeffrey Sherman: (05:02)
So, what do you do? You don't have to buy it. You can buy things. I mean, you're talking structure credit, we talked about securitized products. And so, Sreeni, they do a lot there, too. So, what we find is that there's still ways to play credit, you just have to do it very selective, you got to buy stories, it's idiosyncratic risk at this point. But, don't be deterred by all the members of the Fed.
Jeffrey Sherman: (05:22)
At the end of the day, one person matters, his name is Jay. And until he's out of that seat, he's all that matters, and he's not tapering in the next month or two, he's going to signal it. And guess what? They're not hiking rates anytime in the future, or anytime in the near future. So, you got time by your arms, enjoy your floating rate mortgages and in Jay we trust.
Mei-li Da Silva Vint: (05:44)
Thank you, Jeffrey, for those insights and distilling all those trends for us. So, next, I want to bring it down to the more of a street level view and talk about the journey of credit specifically throughout the pandemic. I think it'd be helpful for each of you to discuss some of the changes in themes or focuses you saw from 2020 to 2021, and how that may have played out in your portfolio. So, if you look back 18 months ago to today, how does that look differently? So, Sreeni, maybe you can kick us off?
Sreeni Prabhu: (06:09)
Yeah, that's great. Thank you. So, pandemic was interesting. I wouldn't say our strategy has changed as much. But, the pandemic allowed us to realign in terms of at that point, there was an abundance of what I would not call distressed assets, but illiquidity that created a flow of assets where everybody had to take a step back and manage their portfolios and manage the liquidity.
Sreeni Prabhu: (06:31)
And, specifically, for Angel Oak, we had a major theme going into the crisis of originating, and owning nonqualified mortgages. We thought there was a better risk return opportunity in there. And we took a pause coming out of it as forbearances went up, and we had to redefine where unemployment was going to be, and what was going to happen to the homeowners and home borrowers coming out of it as we've seen, and as we talked back there, that there's been, as you've seen, the mortgage credit has secured a much better than people would have thought.
Sreeni Prabhu: (07:02)
And so, we are now redefining and reinitiating, our non-qm strategy. So, the shift has been. We are more and more into illiquid as we discussed. Liquid strategies are extremely competitive, creating and owning your own assets is what we focus on, on a non-qm side. And those are the ones we offer in our private credit strategies, that's been the major team that we have at Angel Oak.
Mei-li Da Silva Vint: (07:29)
If, maybe, you can go into what you've seen.
Dave Trucano: (07:31)
Great. So, and we always compared 2020 to kind of where we are in 2021, to walking down a flight of stairs, and then very quickly running back up. So, I think, if you looked at the balance of 2020, we obviously as the market started to sell off, we were long risk and [inaudible 00:07:46] as the market started to sell off, we got longer risk, because you can start to see the support that was going to come in from third parties.
Dave Trucano: (07:52)
So, our investment approach is typically down at the bottom end of the credit curve. But, what we really started out doing is deploying capital into the top end. So, think about investment grade dislocation, think about as you start to walk down. The opportunity set is the Fed started to step in and obviously, provide stimulus.
Dave Trucano: (08:09)
It started with investment grade and moved to businesses that frankly normally wouldn't spread at a level that would attract us. Think about the real estate market, think about some high quality corporates. And then, we stepped down the risk curve. And we typically have a focus on defaults. We have a focus on companies trying to avoid insolvency. That was a common theme last year. And we obviously played it in a way that I didn't think we expected to coming into 2020.
Dave Trucano: (08:36)
A lot of bankruptcy risks that ultimately converted into equity or post reorg securities. That's something we continue to hold today. And I think the recovery has been a big beneficiary for our portfolio. So, there's a lot of corollaries to the credit cycle. We didn't really have the restructuring period or staged within the traditional credit cycle that we normally would expect.
Dave Trucano: (08:59)
We think that's coming some time out, 18 to 24 months, just get any amount of leverage in the system. But, from our strategy, the created credit markets providing less interesting opportunities other than what we call events, and we'll talk about that as we go through the panel.
Dave Trucano: (09:12)
We also have an illiquid strategy where we've actively deployed capital as companies. I've really been trying to solve the problem of uncertain demand recovery. So, really, we bifurcate how we invest across liquid and illiquid market opportunities with the structure of our vehicles.
Mei-li Da Silva Vint: (09:29)
Great. Jeffrey?
Jeffrey Sherman: (09:29)
Yeah, and I mean, same thing here. I mean, you start at top of the cap stocks and crisis and you play that recovery, then you start rotating down. And the problem now you have is that, spread is almost nonexistent in most things. So, where you have to go is what's nontraditional, whether you're doing direct lending, you're doing loan origination yourself, or you're just buying securities that people hate. That's where the opportunities are.
Jeffrey Sherman: (09:53)
And so, we're big fans of the commercial real estate market, still. I think the death of office space is over exaggerated. Multifamily is obviously very strong, we've seen industrial be strong there. And so, idiosyncratic ideas there are pretty attractive. The mortgage markets still great...
Dave Trucano: (10:10)
Yup.
Jeffrey Sherman: (10:10)
Yeah, as you talked about. And so, if you're focused on these type of assets that are just real assets, the good news about them is they tend to be short life, a couple years in terms of a wall. And, therefore, duration is low, and they have a lot more spread than traditional corporate credit.
Jeffrey Sherman: (10:25)
So, that's why, I say, you can still play the recovery and credit at this point. It's just a completely nontraditional type of credit markets. But, when I say nontraditional, it's like, these markets have been around 30, 40 years. It just, most people don't know them, because they don't trade in an ETF and the likes.
Mei-li Da Silva Vint: (10:42)
Chris?
Chris Hentemann: (10:42)
I mean, thinking a lot of good ideas. I mean, I go a lot of the same things they said. I mean, I think the script is actually, well-known. You move from obviously, a very technically oriented, opportunistic environments is something that's much more fundamental today, and moving from the top to the bottom.
Chris Hentemann: (11:01)
The challenge, I think was mentioned is that the liquidity in the system so unprecedented, it really is squeezing out a lot of return. I mean, you can't be in the liquid generic, in our opinion, claiming all the products anymore. You have to be much more creative with your ideas. We have to do a lot more in depth research, and take really well-educated, frankly, bets or positions on things that you actually can develop high convictions around.
Chris Hentemann: (11:30)
I'd echo what Jeff said, is like, things that we think in this environment are more interesting, and trying to solve problems around bank and financial institution balance sheets, as they come back to the risk sharing markets. After COVID, a lot of that closes up right away, you get this technical environment. Everybody goes into a cave, things slowly reopen. And then, we're getting back to an environment where Rick sharing is coming back.
Chris Hentemann: (11:51)
And I think one of the things that we see that most people see, just look at the GSEs Fannie Mae has been closed from the risk transfer markets since COVID. And likely, they're going to be back in the market later this year, probably in early 2022. They're the biggest risk sharing participant in the market.
Chris Hentemann: (12:06)
But, we're seeing it in Europe, a lot of the European banks are starting to come back out which reassuring transactions and we're trying to be first at the door trying to solve those problems, trying to actually find some marginal, incremental, alpha return, that hasn't been squeezed out yet.
Chris Hentemann: (12:21)
So, it's trying to find, unique ideas sticking to the same scripts and trying to understand the way markets are evolving, currently. Fundamentally, I think, I'll the same thing, Jeff mentioned is that, we're looking at commercial real estate. It's kind of, we took advantage of a lot of the technical situations that emerged in March, in April, in May and June, they don't last very long. There's far too many sophisticated investors that can actually take advantage of those who try to exploit them while you can.
Chris Hentemann: (12:53)
And you look for the opportunities that actually going to take longer to emerge, evolve. We felt that commercial real estate some early, it's a long process. These are very long duration assets. Tenants are very long leases. They're longer commitments. So, the credit cycles are just longer. So, it's going to take a much longer period of time to actually see the recovery play out.
Chris Hentemann: (13:17)
Some of that that's actually, correcting as we speak. And then, there's going to be sub-sectors that are just harder. Some parts of office are a little bit more challenging. It's hard to predict the timing of recovery. Hospitality is the same. Retails got structural issues on top of fundamental issues that came up on the backside of COVID.
Chris Hentemann: (13:33)
So, there's a lot of complexity in that market. There's a need for capital. Clearly, capital has been destroyed in that sector. So, we look at that. It's actually, one of the fundamental places that we're focusing on now. That's interesting, and still has a lot of opportunity.
Mei-li Da Silva Vint: (13:53)
Great. So, it sounds like everyone had to be pretty nimble. And I think that's true across our personal and professional lives. Dave, I think it would be helpful if you can speak specifically about the flexibility of credit as an instrument and how that played out through the pandemic.
Dave Trucano: (14:07)
Sure. Again, maybe, just setting the frame. So, we're a corporate credit shop. We focus on companies across not just private markets, but also traded markets. And so, I think when we look at what happened during 2020, the flexibility of mandates, it's absolutely critical. And, frankly, a lot of what we saw coming over the private market where companies that couldn't access the public markets.
Dave Trucano: (14:29)
So, having that vehicle or having the kind of the two legs, if you will, to that stool is absolutely, critically, important. So, if we go back into kind of the depths of March and April of last year, the number of companies that, frankly, were investment grade that add issue at effectively sub-investment grade levels was significant, and the amount of collateral they historically, never used to pledge, that all of a sudden became available for stepping down the credit spectrum when they went to the issue market.
Dave Trucano: (14:57)
And so, we actively participated in that end up going to the credit opportunity when you think about the classic Carnival Cruise when they came to the market and issued with $35 billion of unencumbered collateral, you can assign whatever value you want to it, but that's historically something they never had to pledge in order to actually raise capital.
Dave Trucano: (15:14)
So, I think that's, one of the benefits of the credit market is, last year really demonstrated the power of credit to help companies through a pretty uncertain time. And I think, where we are, at least sitting here today, a lot of that benefit is continuing to be harvested. And so, when we think about a lot of how we invest, the flexibility of credit markets, what we focus on events.
Dave Trucano: (15:39)
And so, the credit market opening and closing creates volatility, we invest into that. A lot of what I would say is, financial technology that's been created into and out of the crisis is something we're continuing to harvest today. And we've an active participant in sponsoring SPAC managers, which is something that a lot of people talk in credit, it's got a lot of attributes to historical credit, investing, and we've been an active participant sponsoring backs that are now looking to buy stress, distressed assets, as they look to deploy capital into the public market.
Dave Trucano: (16:10)
So, I think there's a technology there, that is really kind of, I think, evolving. We'll see whether or not that's an institutionalized product or not, that's a question that I think is open. But, when we look at the interplay between credit, and the flexibility of credit to allow companies to finance themselves, we think the trend is going to continue to moving from liquid traded markets to liquid non-traded markets, as companies have problems.
Dave Trucano: (16:35)
And we've seen that evolution in our business. We have our private strategy. We have a capital solution approach. The number of companies that historically would have issued in syndicated markets, just are not looking for private solutions. They want to partner with companies that can help them finance themselves over time and not be subject to the market windows, opening and closing. And I think that 2020 demonstrated the benefit of having that ability to pivot across not just traded, but private for companies as much as frankly, financing sources.
Dave Trucano: (17:04)
So, I think that's an evolution that's obviously, the long tail as Jeff referenced. It's been developing over years. But, I think, it's only going to accelerate as companies obviously, have to figure out ways to creatively finance their businesses, given uncertain demand environment can pop up pretty quickly.
Mei-li Da Silva Vint: (17:20)
Right. So, I purvey we're a little bit different. We're a little bit market agnostic some of the things you guys have described because we structure and originate our own loans directly to our borrowers and partner with governments. But, I think, one of the tools that we all have in our Arsenals are the use of different types of vehicles to deploy our capital.
Mei-li Da Silva Vint: (17:35)
And Sreeni, you and I were talking before about some of the ideas and how you deployed capital through different vehicles, pre-pandemic and during the pandemic. So, can you speak a little bit of how you use vehicles to deploy capital throughout the pandemic? And why?
Sreeni Prabhu: (17:49)
Yup. So, as the teams have been... Liquid markets continue to be tight, the Fed in play reduces the amount of assets and really creates a need to do originate source, illiquid assets. And so, that needs the change liquidity spectrum of the vehicles that you deploy.
Sreeni Prabhu: (18:08)
So, one of the themes that we did at Angel, we launched a long-term private strategies with institutional investors to invest over a long period of time, where we can take advantage of some of the nuances of the non-qm mortgage market. And in pre-COVID, one of the vehicles that we looked at was to launch a public REIT, which obviously, up to COVID, there was no such thing as launching a public REIT. We had to wait for the rich to come back. But, we eventually officially launched REIT like a couple of months ago.
Sreeni Prabhu: (18:40)
And, again, we have to deploy and that's our way of facing public markets to execute our illiquid strategies. But, I think, as Angel Oak has evolved, and I think everybody on this table can say that is, the investors also are learning the thought about extending the term of the capital in terms of how we deploy. And that allows everybody at this table to take advantage of the opportunities.
Sreeni Prabhu: (19:07)
We're doing it to the mortgage market, especially non-qualified mortgage market. And, obviously, commercial real estate is something that we are also involved in. So, a lot of our strategies are now focused on deploying long-term capital, including the public REIT.
Mei-li Da Silva Vint: (19:23)
So, COVID, and the pandemic changed how we do a lot of things in life. For the whole panel, did the pandemic impact how you evaluate things, even from an operational or underwriting perspective? And did it make you think of credit as a tool differently on a go forward basis? And Jeffrey, maybe, we'll start with you.
Jeffrey Sherman: (19:43)
Yeah, there was more uncertainty in the equation. I mean, I think we all became epidemiologist. We all become macro experts all of a sudden overnight. And so, I think what you had to do is just plug a lot more uncertainty into the variables. And a perfect example, was something like the CLO market, where you have this corporate... America was borrowing heavily. You had this big engine there. And people were pricing these securities to where they were going to have unprecedent defaults, and they still were money good. And these things were trading at 50 cents of the dollar.
Jeffrey Sherman: (20:14)
So, there was some really good opportunities in that area where you can essentially take the default vectors, sorry to speak, bond jargon. But, you can stress the portfolio, you can say that's going to be two times worse the crisis, recoveries are going to be half what they were in the past. And these are money, good securities.
Jeffrey Sherman: (20:30)
So, investors scratch their head while you're buying them as they go down. That's what all of our clients do. But, you're saying these are money good through these very stressful areas. And so, there still are ways just to stress that. Sending with the residential mortgage market, how did you figure it out, when the president tells you that you don't have to pay your mortgage?
Jeffrey Sherman: (20:49)
And, by the way, don't pay your car bill, don't pay your student loan. That's like 90% of our securitized markets right there. So, we're just like, "Okay, thanks. Thanks for buying ETFs and telling people don't pay our securities back." So, you had to really just throw a lot of the traditional analysis out. And, look, we use hurricane recoveries as a way to model the mortgage market because if people cure and come back from moratorium, what does it look like?
Jeffrey Sherman: (21:13)
So, I think, really just saying, how can we stress this? How can we stress the cash flows? And what's going to happen? Because we didn't know what would happen. But, the one thing we know is, we know the cash flows. We don't know if we're going to get them or not. But, how sensitive to them are we? And so, that was really the way to really just get down and analyze securities that point in time.
Jeffrey Sherman: (21:32)
And like I said, we don't have any epidemiologists on staff. We've never seen a pandemic, none of us are over 100. So, we didn't know how to react. But, we said, "Okay, what are parallels out here?" And we thought, if some of these kind of geological events were very similar. We took the airline industry and said, "Look at what happened 9/11?" We just had the anniversary there.
Jeffrey Sherman: (21:52)
But, if you think about it, like what happened for airline travel to recover? And right on pace for that right now. Yeah, there's been some curtailment there the last month or so. But, it won't recover until business travel comes back. So, you have to really think teams the lens and not say, "Okay, this is a typical recession," because there was nothing typical about it.
Mei-li Da Silva Vint: (22:11)
Chris?
Chris Hentemann: (22:12)
I mean, I'd add to that. I mean, I think there's really, I would bifurcated into two different ways of doing the analysis. There's the crisis model, which I think applies. If you're around long enough, and do this for 30 years, you can mark all the... I think I was called rings in the tree, where you had a fire. You can see them, and you know how that model applies.
Chris Hentemann: (22:34)
And then, this was a little different, because we never seen a pandemic. And then, the next thing is, we're going to get aliens that invade from space, and we're all going to say, "How does this model work?" And it's going to be different. And you see, you have to think in the context of something will show up that we haven't necessarily planned for, and I think that's what COVID did. And it had the... That's the model we have to recalibrate, and you have to think about it differently.
Chris Hentemann: (22:54)
And I would say, we have the same... A lot of the same exposures and to consumer, and in ways that we had to think differently. And so, when you look at like default curves, you can't apply universally a default curve, you have to think about, what is COVID impact? You have to think about the hospitality industry. You have to think about the people that are in the service industry.
Chris Hentemann: (23:16)
So, there's a stratification of consumers that you got to think about in terms of who are going to be affected with regards to the employment picture, because it didn't universally hit everybody the same way. And so, those models all had to be changed. And so, and then, that actually does a couple of things. It actually highlights risks, but it also highlights opportunities.
Chris Hentemann: (23:37)
I think the other thing, too, which, to a large degree, we've been a beneficiary, because all of us have been active since the great financial crisis is, you have to think about regulation. You have to think about policy initiatives. And so, one of the things you got out of the great financial crisis is that, the government has tools that they aggressively will use.
Chris Hentemann: (23:58)
And so, yes, some of them, we thought the same thing like, "Oh, my gosh, we're just going to tell everybody as a holiday, don't pay your debts back, how's this going to work out? Probably, not so great. And then, you look at and you say, but there's certain backstops and some of the some of the structures and some of the sub sectors that were quite frankly, really helpful. I mean, Fannie Freddie being a conservative ship, I would say it was helpful that they were in conservatorship.
Chris Hentemann: (24:22)
The way the securities and the risks and the policy was deployed in that subset of the mortgage market was really different than the private market. The private markets, quite frankly, are free almost to do whatever they wanted. They can interpret the CARES Act, however, they wanted. So, we were thinking how are they going to interpret that? Let's get on the phone. Let's talk to lenders. Let's talk to servicers. Sreeni, you probably could speak to this, ad nauseum.
Chris Hentemann: (24:43)
But, it was a different world and mortgage credit than it was in the government sponsored. The government sponsored had a lot of the tools in the toolbox when the great financial crisis. So, just completely two different opportunities sets that behave differently, presented different ways that we could actually, look at the opportunity.
Chris Hentemann: (25:03)
So, if you've got the standard, crisis model, then you you've got to apply new models to this particular environment. And like, I joke, I mean, we kind of think out of our imagination, what's the next one going to be? We're going to get tech from space, or, frankly, I think, cybersecurity is something we think about.
Chris Hentemann: (25:20)
I think, that's something that's emerging that we have to pay attention to, and how can that change the financial infrastructure, and how do you prepare for things like that? Then, we will just present a brand new set of analysis that we're going to have to deploy as well. So, but, again, risks and opportunities always.
Mei-li Da Silva Vint: (25:41)
So, Sreeni, maybe you can piggyback and dive into what Chris was alluding to in terms of the mortgage market?
Sreeni Prabhu: (25:45)
Yeah. So, when we go back to... We learn a lot of lessons, but when you go back to that event, as you said, the first step was the liquidity side of it. I think, we can all agree that nobody... There was no standard deviation move that we wrote up COVID in that. And so, I am... But, in all our strategies, when we show the scenario analysis, that was not the scenario analysis that we ever had in any of our presentation.
Sreeni Prabhu: (26:11)
So, we learned that and I think what we what you saw was the first step was if you have proper liquidity makers and proper structures, you survive to get to the next point when the Fed came in playing, and the market became more liquid. But, the next step was, I can speak from our perspective is now, you have mortgages in a nongovernment mortgage that we are underwritten with 75% loan to value.
Sreeni Prabhu: (26:35)
People putting money down 700 plus micro score, and you're seeing now 30% of loans and forbearances. And the first step was, we had to call people that like, you just don't get a forbearance, but we had to forbear anyway. And so, now, you have to go to the servicing as we talked about, as Chris talked about. And we got tremendous...
Sreeni Prabhu: (26:54)
The one thing that we don't realize in adding, you know, everybody on this panel, but it's residential, or commercial mortgages, or any consumer assets. The amount of data that we have today is significantly greater. It used to be a lot in corporate credit, but not in consumer credit. And, the amount of data that we capture on each of our mortgage borrowers is tremendous. And that allows us to really, think about how we service these assets, how we talk to the servicer.
Sreeni Prabhu: (27:20)
And as we look back now, I mean, 30% forbearance has led to pretty much no defaults in the system, which tells you the strength of the consumer, the strength of the housing market, but also learning lessons in terms of the fact that if you underwrite something properly, how does that work out? So, it was a great lesson for us in terms of understanding the behavior of the borrowers.
Sreeni Prabhu: (27:43)
And a lot of our borrowers, actually, small business owners, which also talks about the small balance commercial and that market... They're pretty well, you'd have thought there were certain sectors that struggled in that, but generally, it's the small balance commercial did pretty well coming out of it. So...
Mei-li Da Silva Vint: (28:01)
Great. So, we're seeing a lot of spikes, and potential new variants, how are you positioning your portfolios for potential shutdowns? Or are you not? Dave, maybe, you can start off since you are event driven.
Dave Trucano: (28:12)
Yeah, I think, as an event orientation, really allows us to focus on just discrete outcomes. And I think it's just about pricing risk to that outcome occurring. So, I think when we look at least how we invest, it tends to be over a shorter period of time, at least at this point in time in the cycle.
Dave Trucano: (28:30)
So, you're really pricing companies' access to capital, that's a function of capital markets being open or close to certain companies. I think that the amount of corporate activity is significant. So, we tend to think that that volatility is an area of the trade credit market, you can drive up performance if you have that event orientation.
Dave Trucano: (28:47)
So, I think, at least in the market, we're not forecasting a shutdown to occur as we go into the winter months. And that's how we're positioned, but we tend to focus to discrete events, and then we price abd return we're looking for. And I think, that's just naturally at the stage of the cycle, how we can generate returns. I mean, if you look across corporate credit, I mean, for all intents and purposes, there is no convexity.
Dave Trucano: (29:11)
So, you're effectively buying a yield to two a call. You're buying a yield to maturity, and I think there were at historical lows from convexity default, experience is going to be back at 07 levels. And I think, the reality is, that's the environment we're operating in.
Dave Trucano: (29:25)
So, the only way to generate excess return, we believe across traded credit is through that event orientation. And, I think, away from that, in our private market, investing strategies, we looked at the potential for shutdown where we're invested, we're effectively the sole lender. So, from our viewpoint, we can obviously provide companies with additional liquidity to the extent that justified.
Dave Trucano: (29:50)
We sit on 14 boards of the 25 companies we have in that portfolio and the express purpose of doing that not as a voting member, but as an observer is to save the company's got a problem, how can we help solve it? Can we do it with liquidity? Can we do with covenant? Do we have to do it by actually, sitting down and restructuring debts because the company just can't service those liabilities?
Dave Trucano: (30:09)
And I think that's really the area from our perspective where you're more focused on a potential shutdown, how it's going to affect those companies. And, by sitting in the boardroom, and also, frankly, being the largely the sole lender to those companies, they're going to be a pretty advantageous position, if that were to occur to make sure that they're going to take incremental rescue to get paid for it.
Mei-li Da Silva Vint: (30:31)
Right. So, I just want to spend a minute on investor mindset and appetite. And maybe, Chris, you can start off by telling us if you notice any shift in terms of mindset, or appetite from your investors as a result of the pandemic, and what are you hearing from them now?
Chris Hentemann: (30:48)
I think from our investors, clearly, I mean, I'm going to hold back real quiet, red hot, but it seems like everybody wants to basically find a private credit opportunity. I think people have learned that liquidity premiums are very difficult to capture if you don't have patient capital.
Chris Hentemann: (31:06)
So, from our experience, we've seen just so much more demand for more patient capital type strategies, solutions. And so, that, if you want to roll that into the private credit, because most of the structures that feed into that market are of that nature. So, we definitely see a lot of that.
Chris Hentemann: (31:26)
The other thing, too, is I think that there is definitely a focus, a sensitivity to liquidity, how are you positioned around liquidity? How do you manage your liabilities? I mean, that was the Achilles heel. If you've mismanaged it, you probably wouldn't be sitting here today. It's just, you can see it, you get these events, and they wash out strategies that are probably pushed a little bit too far in the margin with regards to liability management.
Chris Hentemann: (31:50)
So, liability management's a big focus on that. I would say, the structure of funds, that private credit team is also on the right hand side of the balance sheet, it happens to do with your capital, as your capital patient. And so, those are real assets or real advantages, their focal points, I think of investors that we see today, because they see the dark side of it, when you go through an event, like March and April.
Chris Hentemann: (32:16)
And they also see the pleasant side of it, if you're well-positioned to get through it, in May and June and July last year, you can take advantage of it. So, there's definitely a focus on the right hand side of the balance sheet, structure capital. Is it well-positioned and is it appropriately aligned with the opportunity set that the manager can execute in?
Mei-li Da Silva Vint: (32:37)
Right. So, can each of you take a moment and describe what you see as the major risks heading into 2022? Jeffrey, maybe you can start?
Jeffrey Sherman: (32:47)
The inflation? Pretty simple. Everybody talks about it. It's detrimental to the bond business. A lot of people have never seen inflation that work in a fixed income trading desks. So, I think that's one of the bigger risks you see out there. I think, we've seen the liquidity, the amount of credit being supplied to the markets. It's not 2022 issue. I think, you said 18, 24 months. I think that's the earliest we'll see kind of credit events, if we see them at this point in the cycle.
Jeffrey Sherman: (33:15)
But, we're still in the boom here. And so, it's strange that, if you'd asked me six months ago, and this will show you how good I'm not at predicting things, I've just said, you get a five handle inflation grant, tenure is going to get smoked. And here it is rallying because of technical effects, liquidity supply, treasury general account drawdown. I mean, you can go into the multitude of factors.
Jeffrey Sherman: (33:36)
So, I think that there's just a lot of complacency out there where people are waiting for the next thing. And, I mean, what is the tenure trade like a 10 basis point range for the last like two months? I mean, you talk about boring. And what's happening is, inflation keeps printing with five handles. So, it's a very strange environment from that perspective. And, something's got to give. And I really think the catalyst is when the global economy reopens.
Jeffrey Sherman: (34:01)
You're starting to see the European economy start to try to reopen. Your previous question was on, "What happens if we shut down?" We're not going to. The American spirit is not going to allow it, and people just aren't going to do it. So, the bullheadedness, the stubbornness, it work, sometimes.
Jeffrey Sherman: (34:16)
And so, I would say that, as you think about it, it's what happens with this power of labor. And we haven't seen this in many decades. And I think labor starting to get power, whether it's demanding a hybrid work environment, demanding better pay, not going back to that job that doesn't pay you a living wage. And these are things we all have to deal with.
Jeffrey Sherman: (34:35)
And so, we see it in hiring trends. I mean, we're still closed in our office, it's voluntary. And, we get about, 7% of the population show up on the first day as voluntary, and now it's down to 1%. So, there's no bid for it right now. And so, I think what you have to do is think about those dynamics, and there is inflation in the system and I think we have to live with it. But, I think we go to like a three handle and I think that's the new level.
Jeffrey Sherman: (34:59)
What we've seen in the last 50 years, there's a great piece out by Deutsche Bank, they probably report yesterday talking about what's happened since the invention of the fiat currency. And, this has been the lowest inflationary environment that we've seen in the last like 12, 13 years. But, that's not the norm.
Jeffrey Sherman: (35:15)
And so, I think that's the thing we all got to think about because who's excited about buying a 130 for tenure today? Are you guys all running out? That's what you're here to hear about, how great that trade is? No, you're investing in crypto, your vices stuff that has one minute returns that are what we're going to get in the bond market in those areas, right? Yeah.
Jeffrey Sherman: (35:33)
So, and at the end of the day, you have purchasing power risk. People forget about that. So, I think inflation, it should be on a discussion, it should be on your mind. And you got to figure out a way to protect parts of your portfolio against it. But, don't look to the bond market to do it right now. Unless, it's deep down in credit, things like that, that have high cash flow, because it's not going to save you.
Mei-li Da Silva Vint: (35:52)
Dave?
Dave Trucano: (35:53)
Yeah, I mean, I was joking. I mean, looking forward into 2022, maybe the biggest risk is we all come back to the office, and we look at each other, and we start interacting with ways we have in the past. And we've been out of the office for really the last 18 months, and we've had our best two year performance over the course of the nine years. We've been running the fund inside of BlackRock.
Dave Trucano: (36:11)
And so, I think we've adapted to a new normal. I guess, and that's kind of the joke we make around the office. Maybe, we should all not see each other over the computer, because we'll continue to outperform. But, I think, in Jeff's comments are right. I mean, there isn't a company we talked to that isn't talking about inflation in their business.
Dave Trucano: (36:27)
You can look at what's going on in the commodity complex. You can look at what's happening with transportation costs. You can see the power the employee is gaining. You can try to go hire somebody and try to offer what you thought was the homework [inaudible 00:36:40] wage. And the reality is, it's really hard to find people.
Dave Trucano: (36:42)
So, that's not coming through the numbers right now. But, the reality is, I think that is the biggest risk going into 2022. And there isn't a company we talked to that isn't talking about that as the biggest concern they have in their business, finding people, input costs, and actually having pricing power so that they can raise the cost what they sell their products for.
Dave Trucano: (37:00)
And so, I think if you look at the bond market, you look at the high yield market, and I think 85% of the high yield markets trading, the negative real rates of return. I mean, it's just not sustainable, and something's got to adjust.
Jeffrey Sherman: (37:12)
Globally.
Dave Trucano: (37:13)
That's globally. That's right. So, I don't know, we're not macro investors. We tend to focus on the micro that would create volatility, if that ultimately rears its head and investor sentiment ships. I think that's actually good for our business, but it won't feel good.
Mei-li Da Silva Vint: (37:27)
Great. So, unfortunately, we have to pivot because time has flown. So, I think there are two last important things I would like to talk about, and one is the biggest learning over the past 12 months, or 18 months and biggest opportunities that we're seeing. And so, for us, it purvey our biggest learning was relationships are important. And that's our employees, but when across the spectrum to our investors, borrowers, government, partner, service providers, et cetera.
Mei-li Da Silva Vint: (37:52)
And then, in terms of opportunity set, what we're saying is obviously, people getting back out there. And so, revitalization of society and what the government's doing to help that in terms of infrastructure and economic development.
Mei-li Da Silva Vint: (38:04)
So, each of you could take that, and one, give us your biggest learning over that past 18 months. And what you're seeing is the biggest opportunity for the next six to 12 months. And Sreeni, we'll start with you again.
Sreeni Prabhu: (38:15)
Yeah, the past 18 months taught us a lot about where the markets are. And obviously, the markets became more liquid over a period of time. As you said, we went up in credit from a strategy perspective, and then as the market calibrated back, we went down in credit in terms of more focus on residential credit, over the next 18 months, and even where the government is, and even we have shutdowns and so forth.
Sreeni Prabhu: (38:42)
I feel, we feel that the consumer credit mortgage credit will continue to do better. We feel there's a lot of population in the US that does not have access to mortgage credit, and these are self-employed borrowers. Big economy borrowers, there's a lot more of those that are entering the system that are going to need mortgage credit. And so, that presents a tremendous opportunity to get some returns for investors.
Mei-li Da Silva Vint: (39:09)
Dave?
Dave Trucano: (39:10)
Yeah, I think the biggest thing that we've realized is how easily people are adapting to different environments and I think it's very simple. I think that you've demonstrated. You can actually work, I think people are mobile. So, I think, the reality is that's the new norm, but we have to adapt to it.
Dave Trucano: (39:26)
From my perspective, I think that's going to be how we're going to have to operate our business go forward even as we move back to office. And I think as it relates to the opportunity set, from my perspective, as long as there's corporate activity and as long as companies continue to access the credit markets and pivoting across public and private, there's going to be lots of opportunities and credit. I mean, I don't accept the fact that people would always look back and say there's nothing to do in credit.
Dave Trucano: (39:50)
I would agree with the fact that beta is no longer cheap. It isn't active management and credit, I think, is the way you outperform and I'm as biased, but that's my general view. So, I think, if you fast forward 18 months, I think, actively managed credit strategies are going to outperform beta strategies, which is obviously a hell of a lot of people have decided to shift their capital.
Dave Trucano: (40:13)
And I think the last point I'd make is, I'm always surprised and we talked to our investors about this, how many people try to time credit? You don't really hear that in equities. You don't hear it, a lot of other strategies, they get to mistake, you have to be able to catch points in time and you have to be able to be deployed over time in order to do so.
Dave Trucano: (40:29)
So, that's one of the biggest things that I've learned from the last 18 months talking to our investors, how often people try to time markets. And, ultimately, miss out on... It's the outperformance across credit.
Mei-li Da Silva Vint: (40:40)
So, unfortunately, we're out of time, but I'd like to thank the panelists. I think we're all a little bit more intelligent, at least from the credit perspective. And thank you to the audience. Enjoy the rest of the conference. Thank you.