Commonfund OCIO Point of View

Welcome to Commonfund Point of View. I'm Julia Mord, Chief Investment Officer of Commonfund OCIO. In this podcast, we'll be giving you our latest views and insights on capital markets and investing in fifteen minutes or less. Today, I'm joined by my esteemed colleague, Vincent Kravec, Managing Director and Head of Fixed Income and Credit at Commonfund OCIO. Thank you for joining us, Vin. Thanks for having me. Private credit has been making headlines in the popular financial press for the last several years. First, it was the decade of private credit. Then questions about a bubble, when the decade of private credit was only halfway mark. And now four zero one k retirement capital is potentially entering the picture. So is this the best of times, the worst of times, or somewhere in between? I would definitely say it's somewhere in between. I think if you're focused on senior sponsor backed private credit floating rate, there's definitely a little bit more of a volatility in the market these days. You know, we see that in the BDC space. We see that with headlines around things like software exposure on BDCs. But if you approach private credit as a multi strat, as we have for all these many years, it's, an opportunity. It creates opportunities in the asset based space and in the opportunistic segments of the portfolio for us to lean into these periods of uncertainty and add value for our investors. You brought up BDCs. What are some of the risks associated with them? Can you provide some examples? Sure. Well, when you look at BDCs, a key sub component of the investor base are retail investors. We tend to approach private credit by focusing on structures where institutional investors are the primary investors or all the investors in the space. So we tend to prefer not to invest alongside retail investors. Retail investors target a certain yield and target a certain performance in their BDCs, we find that private credit managers tend to underwrite different or can underwrite different kinds of loans for the BDCs from a risk reward perspective to solve for that marketplace's needs versus what we're doing in senior floating rate sponsor back. So it potentially can be a different kind of loan. It's got a different investor base. And then the other part of the BDC landscape that gives us pause is the potential for overlap in these portfolios. Recent data suggests that in some of the larger BDCs, because they're all participating in club deals and joining a group to provide loans to these borrowers for these large loans, you may have situations where thirty five percent or more of the borrower base in a particular BDC overlaps with other BDCs. So if you're a BDC investor and you're choosing three or four or five BDCs to invest in to get that exposure, you really have to look under the hood and do your analysis from a bottom up, understand the line items you're getting exposure to, to make sure you're not getting this overlap across the portfolios. Because if you do, and the borrower has a problem, that's rippling across two or three or four BDCs you might have, and that might be a risk you were unaware of. So significant overlap potential across these BDCs. And then again, there's a focus on corporate credit generally speaking. Most investors think they're getting senior floating rate sponsor backed loans, but when you look under the hood on many of these BDCs, you're also getting exposure to second lien loans, mezzanine, the potential for pref equity or equity exposure. It's really important to know what you own and also to know who you're investing alongside of. That's a good point. I just want to talk about the financial press and their focus on defining private credit, particularly as direct middle market lending or senior lending. If common fund has less exposure to this, where are we tilting? Where are we finding other opportunities within the world of private credit? Sure. For many years, we've approached private credit more on a multi strat construct than purely focusing on senior sponsor backed floating rate loans. What that means is we've built pipelines over the last seven to ten years, and asset based finance and other opportunistic strategies, having conversations with managers, building pipelines, know, getting to understand their performance, but we tilt into these other spaces because we really like the diversification that we get. I talked before about these potential for concentrated portfolios in BDC space. Yes, we get good diversification in senior lending because of our bottom up manager research and understanding line items, but when we tilt into asset based and opportunistic strategies, we get exposure to thousands and thousands of borrowers in asset based space. We get exposure to different kinds of real assets in asset based space. So for example, real estate, aviation assets, shipping assets, rail cars, things that bring the portfolio different types of characteristics that you don't get in corporate lending. Many people in corporate lending like it because it's floating rate, and because in an inflationary environment, central bank tightens and you get inflation protection. Well, there are scenarios where the central bank doesn't necessarily tighten if inflation's running a little frothy, but isn't getting totally out of control. So if they're not tightening, how are you getting some protection? Having exposure to real assets in your asset based portfolio, either directly or indirectly, get you some of that additional protection without being entirely dependent on the central bank to provide it. Then in opportunistic space, we're able to tap into strategies like litigation finance, where you really see much lower sensitivity to things like equity market moves or moves in the ten year or the Fed funds rate. The type of diversification we see in those other two strategies really results in a much more well diversified portfolio, which should add value to our clients over time. Let's shift gears and talk about Europe. Is it attractive today? Often I hear it's a less efficient market. What makes it less efficient? Sure. Yeah. Europe is a market we've been committing to since the twenty seventeen, twenty eighteen timeframe. We made it a much bigger part of one of our recent vintages fund, twenty twenty two fund. We find a lot of opportunities, and because it is in part a less efficient market, we find niche opportunities. The reason why it's less efficient in part is the multitude of languages, the multitude of legal and regulatory jurisdictions, and really the fact that some institutional investors avoid the space because it is less efficient. I was on a panel at a conference in Florida, and an institutional investor on the panel that represented a pension fund says they really stay away from Europe because it's less efficient, less liquid, less more difficult to get into and out of. From our perspective, we approach private credit primarily investing in closed end drawdown vehicles where we're willing to earn the liquidity premium for locking up capital, we're patient capital that's able to deploy into these opportunities and take back capital over time, but that lets us access these less efficient opportunities. So then is it fair to say that, at least the way that common fund approaches it, we think of private credit as an all weather construct? Yes, definitely. We view it as a through the cycle all weather construct. In senior lending, you get floating rate exposure, but asset based and opportunistic bring you the potential for fixed rate characteristics as well. The other thing is the diversification in asset based. For example, we found a recent strategy in Europe focused on resi bridge lending where the annualized loss rate is two basis points. When you look at corporate lending in the US high yield, long term default rates are typically three to five percent with recovery rates around fifty to sixty cents on the dollar. The types of risk we're seeing in these strategies are meaningfully different than the types of risk we're seeing in North America and our corporate credit strategies for similar rewards. We find the opportunities we can find there to be particularly compelling and asset based and opportunistic and in Europe. Let's finish up by talking about the pipeline and the opportunity set that you see today. Yeah. I would I think it's fair to say that on a go forward basis, opportunistic and asset based will continue to be a meaningful part of what we do, while we're likely reduce somewhat exposure to senior lending. We think the alpha opportunity there has reduced over time. And we think, know, as we mentioned earlier, the potential for four zero one ks money to come into the space will continue to squeeze spreads at that end of the market. So we've been building robust pipelines around asset based and opportunistic credit. This real estate strategy that I mentioned, other opportunities in Europe, other opportunities in asset based and opportunistic that could provide good upside for our investors, but also take advantage of opportunities for what if there's a dislocation in the market. If there's a credit spread widening, there's a credit hiccup, the ability to go on offense is something when we can do through our multi strategy approach, which we won't necessarily find in other strategies that are just focused on senior sponsor back. Thank you, Ben. Thank you. Well, that concludes our Commonfund Point of View. Please join us next time as we continue our series where we provide our latest insights and thought.