Global Credit Opportunities and the New Normal
November 6, 2023 | 12:00 PM, EDT
DISCUSSION HIGHLIGHTS
As the global economy adjusts to a new normal of rising interest rates and inflation, the private credit space is set to continue its exponential growth. But while investors have for years been steadily increasing their allocation to private credit strategies, there are new risks on the horizon that mean some areas of the market will thrive and others will lag behind. While the private markets are compelling, institutional investors should not ignore the public markets entirely as the shift to private is creating opportunity in the syndicated markets as well.
In this Monday Minute, experts Karl Dasher and David Sudellari discuss global credit opportunities, including some of the most compelling options available right now, like short duration mispricing, primary and secondary markets, and economies like Latin America and Asia.
Senior Executive Managing Director, Head of International Investment, AIMCo
The Future of Energy in a Net Zero World
October 24, 2022 | 12:00 PM, EDT
While the global energy transition has given rise to new technologies and sectors focused on carbon reduction, it has also created a good deal of uncertainty for investors, particularly in countries like Canada where the energy industry plays a significant economic role. In this Monday Minute, we will look at the role policy can have in supporting the sectors and technologies that will help the world achieve Net Zero. We also dig into the data and how investors can identify real gamechangers — and avoid greenwashing.
Air Date: May 15, 2023 | 12:00 PM, EDT
Caroline: Good afternoon everyone, and thanks for joining us. I'd like to welcome you to this week's Monday Minute Live Chat hosted by the Canadian Leadership Congress. The topic today is Data Transformation and the Future of Pension Funds. Here to address the topic are Darcie James Maxwell, who is Head of Canadian Operations, Data and Platform Solutions with BNY Mellon. Darcie is also a member of the CIBC Mellon leadership team. We have Tristan Robinson who is Vice President Finance Platform, Capital Markets with OMERS. Welcome Darcie, and Tristan.
Tristan: Thank you.
Caroline: All right. Well, look, I want to learn a little bit about both of your backgrounds with regard to this topic, and how you are addressing it within your organizations or with your clients. I'm going to start with you, Tristan.
Tristan: Thanks so much, Caroline. Really happy to be here, and talk about this subject. I'm a big fan of transformation. I've had the privilege of leading several in my career, and data is something I'm very passionate about. In my current role at OMERS, I lead several platforms, so our trading platform, portfolio servicing platform, and data and performance platforms.
Part of my role is helping to chart out what our strategic roadmap is going to look like to modernize our platforms, and deliver new capabilities to my partners in capital markets, risk and corporate finance. We have a long road ahead as we build that roadmap. In prior roles, I have, as I mentioned, supported various transformation programs, technology-enabled programs, but data was at the heart of what we were trying to accomplish, and solve for. Really happy to engage in this topic.
Caroline: Great, Darcie.
Darcie: Sure. It's actually really a pleasure to be here. Obviously, I've worked with you before Caroline, but Tristan and I even did a transformation project once before at a client. I've been working with clients across Canada, and other regions for more than 20 years on some form of a data initiative. So, looking at how they maximize the use of that data, and then be technology-enabled to be able to distribute that, and really leverage the value-add that it brings.
In my current role as a member of the CIBC Mellon leadership team, and also representing BNY Mellon in the Canadian space is really all about how do we make sure that our clients are taking advantage of the data that we provide as an asset servicing partner. Also, how do they integrate that with the data needs that they have within their organization, so that they can effectively aggregate, distribute, make sure that there's a valid governance process in place to truly take advantage of what their either external clients or internal stakeholders do require.
Caroline: That's great. We can get into a little bit about that process in today's discussion. First though, I want to turn to the term transformation because you might agree, it's become a bit of a buzzword. It's used a lot. I'm wondering, Darcie, if you can give us a definition of transformation through your eyes.
Darcie: Absolutely. I would agree with you that everyone talks, "We're doing some type of a transformation." I equate it to making change. Recognizing that there may be deficiencies in your operating model, your technology processes, or even the talent that you manage. How do you adjust them to be future-proof for where the organization is going? Any bits, and pieces of that will constitute some form of a transformation for an organization. It's very much a large change management process to, how do I look at whatever technology legacy stack that I have, all of those things. Then really define that, and what's the problem I need to solve.
Many of the clients that I engage with start off with a conversation around transformation saying, "My front office is looking for risk models that I can't support," or, "I need to introduce additional instruments that I cannot support." That then starts a conversation that goes into those three key areas, either operational process or technology, and then that becomes the framework for a transformation exercise. I know, Tristan, you look at it from a different perspective than I do, so probably you need to add to that.
Tristan: Well, I think it's fundamentally changing the capabilities that you deliver as an organization. I couldn't agree with you more in the sense that it covers not only your technology. I think that's an element of it, but it's your people, your processes. It's adding new capabilities or enhancing capabilities in an organization. What I've found just in looking at transformations, one of the successes I've had is taking a business architecture lens to the problem. What are our strategic objectives? What capabilities do we want to enable with the work that we're doing? Then help to understand that gap.
That really crystallizes for organizations, where to invest in, and what to develop. Totally agree with you. It's a people, processes, technology problem. It's holistically how do we deliver a specific capability to the organization? That's a bit of where I see firms can really value or develop values by looking at it holistically across their architecture.
Caroline: Darcie, I want to pick up this topic with you again. You talked earlier about the conversations around transformation with your clients, and I'd like to get a sense of what that challenge looks like. We've heard a little bit about how you help people, but how are clients experiencing this challenge?
Darcie: Oh, sure. Like I said, and similar to Tristan's comment, it starts off with a business problem that is usually where a client will reach out. What we're seeing quite commonly is some of the sets that clients are really focused on is, I'll take for example, ESG data, where they have a need to be able to add those particular metrics to their performance attribution, or their risk analysis, or some other integrated reporting. ESG is essentially a large dataset problem. It's looking at multiple data sources, different definitions of those data. The people who may be consuming it may not understand the data sources, how do they actually store it someplace? How do they compute with it?
Then how do they then distribute that out to their stakeholders? That sometimes is one of the triggers that we get. We have a client that says, "I want to maximize my use of ESG data." Other common problems we find is, we hear about quite recently especially is alternatives, or derivative instruments, OTCs, all of those lovely creative things that are coming out and into the market. Well, they also pose either a technology or an operations challenge, and also sometimes a people challenge because you may not have the resources that understand those instruments, what do they look like from evaluation perspective, how do you generate performance or attribution on those things, how do we evaluate?
That may also mean that my legacy accounting technology may not be able to even be able to book a transaction of that particular instrument type. That then generates another problem statement that the client then has that doesn't look at, "If I'm going to make a change to accommodate for this business problem, how do I make sure that I'm looking at their step back?" Then I look at it holistically and say, "Where is the organization going?"
We're going to be going into these instrument categories, these regional categories, investment styles, analytic styles, quantitative analysis, and then start to work with what's the data that that is going to need? Then start to work backwards in terms of the technology needs, processes, or even talent that understand these pieces. That's usually the kickoff that I've been seeing a lot from the clients that we've been engaging with, in terms of how do they start the conversation around transformation.
Caroline: Tristan, what specific business problems were you looking to address through transformation?
Tristan: Each organization that I've worked with that has been on this journey is tackling a different issue. In some cases, it's just a lot of technical debt, and legacy architecture that's been built up over many years of growth, and acquisitions. It's really the driver is of an efficiency play at that point. There's other scenarios where it's really the quality of insights, and analytics that you can build off of your data that's really driving the desire to move to a more data-centric organization, and transform your internal capabilities.
I think there's in all of those different scenarios, be it you're looking to increase your efficiency as an organization, or you're looking to really improve your capabilities say as part of the investment management process, develop new decision support functionalities as an example. Regardless of it I've found out, at least in my experience, data's really at the heart of what needs to get corrected in order to fix that challenge. I think regardless of the industry, and again, I've worked on transformation programs in banking asset management, and now on the asset owner side, there is a common theme about some of the constraints organizations face in terms of their technical debt, and some of the legacy architecture, and data integrations that really restrict organization's ability to develop new capabilities and operate efficiently.
Really not an easy problem to solve for, it does mean fundamentally changing the way you think about data, and managing your data as an organization, and maturing those data management and data governance capabilities as almost a first step. Here at OMERS we see a tremendous opportunity in front of us to modernize our own stack of applications, and our functions. We're excited to start that journey as well.
Darcie: If you don't mind, Caroline, I'm going to add one thing to Tristan's. You said a word that really resonated with me, and reminded me about the point, which is data quality, and the build. In many cases, when clients come to us with these challenges, it starts off with, "Do I need to buy a platform? Do I need to build a platform? Do I need to build a data warehouse?" I think the answers that we would've given 10 years ago, even five years ago, that has really drastically changed.
Clients are looking at the expense pressures, "I got to solve this problem, but I don't have capacity to do a multi-year runway project that's going to unplug every system and come in with a new one." That's not necessarily the way that clients can look at it anymore. I would say even the term of how we will think about transformation has changed over the last couple of years because the approach has to be, how do I get time to market, and how quickly quality, as you mentioned Tristan, and then on top of that really expense reduction. They have to be able to absorb it effectively into the organization. It's just one thing I wanted to add to that.
Caroline: That's a really good point because when we talk about replacing legacy technology, you have to make that decision as to whether to build or buy, outsource. Tristan, how do you make that decision?
Tristan: It's a really interesting question. I think it starts with understanding, and really coming to terms with what your core capabilities are as an organization. What business do you want to be in? What value do you deliver? I think if you're looking at your peers and the service offerings that are out there, you start to really understand that, "Well, maybe a lot of these functions, even though we've been doing something in a particular way historically, maybe this is a commodity function that we can look at delivering that function in a more efficient or alternative way by leveraging as service providers."
It is a bit of an existential question that I think every organization will go through. What's really interesting, particularly in the asset management and asset owner space, is that the operating models have been evolving so rapidly in the last 10, 15 years. While 15 years ago, the standard might be an on-prem solution for many of our applications, operational teams supporting them, we've seen and proven that there are several different models out there that are interesting. We're going to take our time going through those, answering some of those questions here at OMERS, but it is encouraging.
I think, starting with what your core capabilities are, what your competitive advantage is as an organization is the first question. Are we in the business of generating alpha? Absolutely. That's something that we want to continue to invest in, and make sure that we've got those functions operating effectively. Do we want to be in the custody business? No, we've already outsourced that piece.
I think there's lots of other capabilities that we could take a look at in the future, but each organization's going to look at those questions differently. I think as long as you're asking the right questions, understanding what service offerings are out there in the marketplace, and getting the advisory support, and help to see what's been successful at other organizations, then you can start to form a view of what that looks like for your own organization.
Darcie: I think the one thing I would add is, we've been using the word the continuum of services in the last couple of years because what we see is that clients need a hybrid mix. It's either I'm going to a technology play, or I'm going to do a full outsource play, or I do a bit of a mixed bag in terms of the managed services. You look at all the components that I add to Tristan's point, it's going to drive benefit and value-add, and maybe that's the secret sauce that you want to keep as close in-house as possible.
Those things that are commodities, whether it's the overnight batch processing, looking at data integration, those things can be partnered with somebody else who can do it as scale, but you have a fixed cost that you can then protect and manage with that. We're seeing that hybrid approach of partnering in those areas that are truly, "Let somebody else worry about that. I don't want to invest in the skillsets or the overhead or the governance, I just want to manage that process, have somebody be accountable for it, and then I can focus on what is truly value-add."
That's really the question we're seeing that clients need to ask themselves is what actually is the truly value-add activity that I want to be able to retain and manage in as much as possible? I'll give you an example of that, where in some cases we look at performance data, it's a calculation process. The rate of return is fairly consistent regardless of industry. You may have nuances to attribution, the analytics that you want to derive from it, and some of the risk metrics that you might want to do to drive that.
Those pieces or components of performance that you can say, "Have somebody else take care of that, and give me the output so that I can enrich that information based on what my stakeholders want to be able to see." We're seeing that to actually to that level of componentizing different functions to say, "What do I really want to keep, and where do I want to spend all my time and resources?"
Caroline: It sounds really important to take those steps to really make sense or have or organize the data so that it really does provide value and drive solutions. Tristan, on the data side, when we're talking about organizing data, and ensuring that it is valuable for your teams and can be used, how are you making sense of how to order the data that you have?
Tristan: That's a great question. I think and again, I've seen this in a variety of organizations where you've got a legacy architecture, technical debt solutions that have been built on top of each other, data lineage becomes quite a challenge. Understanding your data assets, understanding how those data assets are maintained, are fed, understanding the quality of that data, these are all capabilities in, and of themselves. The way that I look at ensuring your data assets deliver value or can deliver value in the future as you continue to evolve and change is ensuring that you've got a strong data governance framework in place, ensuring that you measure the quality of your data.
If you can't measure it, then you can't fix it. Ensuring that you're very clear on the data lineage, so the hops and jumps data takes in order to get from point A to point B. Again, in a lot of organizations, these are quite complicated processes and workflows. It means really interrogating and researching really legacy processes, and how data's transformed along that path. It starts with maturing your data management, and your data governance capabilities. That's where if you're taking a data first or a data-centric strategy or approach to your transformation programs, that really has to be the beginning of where you start.
Caroline: Darcie, a data-centric operating model, is that what you're driving to?
Darcie: One of my favorite terms, quite frankly. [laughs] I always think of it as it's a mindset shift, and that treating data as an asset, and recognizing that value that it does have to what you do as an organization. Once you have that adjustment, then you really start to think about, "How do I govern it." That's just Tristan's point. Where is it going? Who's using what? How do you make sure that there's not duplications, not being replicated in multiple places? Where do you know it's coming from source? Where is it going from an end target? There's also the cost aspect of it. Many clients are leveraging third parties, say benchmark data, other analytics information, all those have licensing associated with it. You really have to think of all types of data as some type of an asset that needs to have some controls, and before you actually do distribute it. Also, I think the key piece to it is understanding that the stakeholder analysis as to who's using it. We see quite frequently clients are generating data warehouses full of data. Then when they start to see who's actually using it, the people are actually creating their own Excel spreadsheet somewhere else because it's a totally other different data set, and they didn't even know maybe that something's there, and available.
We use a lot of discussions with clients that talk about what's the stakeholder analysis, what's the quality controls that are in place, what does the data catalog look like? Do you even know what data you have available for others to be able to use? Then to distribute that, but again, it really comes down to that mindset that data is an asset and it should be treated as such.
Tristan: Just maybe if I could just add to that, the stakeholder usage is an interesting one as well because there's what you know of your reporting and analytics requirements today, but then there's the future. There's always a greater demand for regulatory reporting changes or deeper insights. It's not always easy to design assets for all of those future use cases. If you take an approach of capturing your data, and understanding your data at a real atomic level, then it at least gives you a better chance at meeting what the future needs of the organization, and those data assets will be.
It's a bit of work to really understand those data requirements, and capture data at that form. I think if an organization's on that path, it'll at least give you a better chance of meeting those future needs that you're not even aware of now.
Caroline: Organizations are also on a path at various stages in terms of their use of the cloud. I wonder where this fits within overall cloud usage. Should it be cloud-enabled or cloud-first in terms of the approach? I'd love to get your thoughts, Darcie.
Darcie: Sure. If you think of data management as a framework, it's been around for a long time. What's different I think of the opportunities that are different is cloud. Cloud provides a couple of different things that the storage capabilities, the cloud computing capabilities that brings a whole new dimension to how you manage data. When an organization's trying to define a data-centric operating model, they want to be able to consider, "Am I going to start off in the cloud on whatever I'm building out new, and leverage those tools natively that are built in the cloud?"
They've got those built in if you look at some of the various providers that are out there, or are they going to be looking at taking their existing processes, and moving it to the cloud to be able to just have from an infrastructure management perspective. It's two different considerations. When we think about data management, really it's about how do you take advantage of unlocking the cloud computing? That can do large and large data sets, and they can also manage unstructured data sets in a much more effective way than your traditional say, oracle relational database or something along those lines.
Caroline: Tristan, did you want to add to that?
Tristan: Yes, absolutely. We're very excited here at OMERS to leverage, just use it, cloud as a cloud, and the service offerings around cloud. We're well underway on our journey here looking at some of the analytic capabilities that have been unlocked by cloud technology, it's an exciting time. Ideally, we'd want partners that can enable our growth in a sustainable way, and I think cloud's a fundamental part of that story.
If a service provider doesn't have the ability to scale, compute or storage because they're not natively designed to leverage what cloud has to offer as a capability, that's obviously going to factor into our decisions. These are massive innovations in our space. Certainly, as you're picking your partners, you want to make sure that they're set up to leverage them.
Caroline: That's really key. What are some of the consistent challenges or pitfalls you're seeing in the process we've been talking about, Darcie?
Darcie: I think the first pitfall is where do you start? I think sometimes organizations struggle with what's the starting point? Where, I think the incorrect way to do it or challenging way to do that is if you start with technology decisions, "I need to buy X," and instead of starting with, "What are my users' needs? What is the business problem that I'm trying to solve?" That allows you to be able to define the technology to support whatever that business challenge is. I put that in the way of saying, there's some clients who'll say, "Well, I need to buy a cloud platform, I need to buy a cloud platform." What are you going to do with the cloud platform? What problem is it going to solve? If you start with, "I have a business problem that says I need to be able to amalgamate ESG data with my risk analytics together, how do I do that?"
Then that actually defines the business problem with the vendor, defines your scope, your use cases that you want to be able to go after, and then you can then decide what technology will enable that to be solved. That's one of the most common challenges that we do see. The second one I do think is that there needs to be some level of planning that goes into a data management initiative. We use a lot of buzzwords in the industry, data-centric, data transformation, data management, data governance, really need to understand how is that going to be executed in your organization?
As you transform, how do you maintain the day-to-day activities? You have to think about those two things as you go along. It's not just a matter of the change happening overnight, it's how do I also slowly, gradually absorb change while maintaining my deliverables to my stakeholders? Some of those are probably the top two that I see as some of the challenges that we encounter with clients.
Caroline: For sure. Tristan, I'd love your thoughts on any factors or considerations you'd like to put out there for people listening today when it comes to implementing a data-centric operating model. We've been talking about that a lot here today.
Tristan: Sure. Thank you. I couldn't agree more with Darcie's context around it really starts with what you're trying to accomplish. What are the outcomes you're trying to achieve? One of the other pieces that I think doesn't get enough attention generally is just the change that any transformation program like this, what it means to the people in your organizations. Going through a transformation program or moving towards a data-centric organization means an entire shift in the way organizations work within each other, how teams interact, the skills that are needed in order to be successful.
Embedding change management practices and really understanding the capabilities that you need your people to bring to the table, I think is extremely important. Change management shouldn't just be an implementation phase activity either. It's not just training and communications on a release, it's really fundamentally changing, and reskilling, and reengineering how teams interact with each other. I think that change management lens to any transformation program, data-centric transformation or otherwise is extremely important.
Darcie: If you don't mind, I'm going to add to that because that is absolutely so correct, Tristan. We have really recommended strongly with our clients to include in any program a work stream, they're actually called the operational readiness. That operational readiness incorporates what's the change to people, processes that needs to be prepared, and not only prepared to go live, but prepared to maintain and operationally run whatever we've done and as we go forward. That has to be a critical component to understand that how are people going to accept this change after it's done?
Are they going to be able to care and feed it, and be able to be comfortable in that new operating model? Definitely, absolutely agree with you on the change management that we've really, really strongly recommended clients have an operational readiness work stream with any transformation program and a particular sign-off process too so that all stakeholder groups are saying, "Yes, I'm operationally ready to adopt this as well."
Caroline: Great. A bigger picture question I'd like to ask is, why are we at this moment of transformation? Where do you see us in a few years down the road? I'm going to ask that of you, Darcie.
Darcie: It's a good question. I think every other week that the answer is going to change actually because I think that we're just really starting to figure out how do we take advantage of some of the technology and tools, whether it be AI, cloud computing, all of these different things that are available. On the other side, I think the investment industry is also changing and evolving in terms of the markets and the processes, things like that. Within those two, we're moving both quickly. I see that we're going to be having the same conversation around transformation in five years from now. The difference will be there's that word, we need to go from one level to the next level in terms of the level of data, the level of analytics. The speed is going to become so much more, where we think of an end of day set of data might be sufficient at the moment.
Then we want to be able to have start of day, "Okay that's good," but you know what? People are going to be looking for that same level of an analytics and drive of information throughout the day. How are we going to get to those things? Faster access to information I think, is going to be the next hurdle once people can at least catch up to what the data needs that are out right now.
Caroline: Tristan.
Tristan: I think we are at a crossroads, particularly from a technology standpoint in terms of the capabilities that cloud, and all the innovations around cloud, and service offerings around cloud are delivering to us. If you look at a traditional on-premise type of shop with lots of technical debt, there's a lot that needs to happen, even just to get to the starting line of any digital transformation, or to move to a data-centric approach. I do think that a lot of these innovations and how service providers are taking them and developing new solutions, leveraging that technology, it's really changing how we operate or can operate.
I do think that's a catalyst. I think from an operational and business context perspective, we will be asking this question every year. The question might change subtly from year to year, but there's always going to be an increase in analytic demands. There's always going to be changing regulatory context. There's always going to be real business changes in terms of growth and M&A, or divestiture, or otherwise. All of those change points or drivers lead to firms taking a look at their business architecture, their operating model and we'll have to start thinking about, "Well, what do I do about this situation? Where do I go from here?"
Caroline: Tristan, if you had one piece of advice for your peers listening today what would it be?
Tristan: I think it's people look at transformation programs as really daunting exercises. I think they take a lot out of you, they can be very costly. It's a significant impact to your teams and your people. I would say, pick your partners and your advisors wisely. I think that's one of the first recommendations. Really do your due diligence. You want to make sure that you're getting the guidance that you can trust.
If I can add another, it's because these transformations tend to be longer-term change programs, having the organizational buy-in at all levels is incredibly important. Making sure that incentives are tied to success and that from the top of the organization to the staff level, everybody understands why we're doing this and what the mission looks like, I think that's probably one of the keys to sustaining momentum on these programs.
Caroline: Darcie, key takeaway.
Darcie: The one thing I would take away is that transformation can be incremental. We think of the objective, then the strategy, and the long-term target can be a long-term or in a longer duration, but the change itself can be done in incremental small stages. We're really trying to actually get our clients to think about that differently, and because to your point, Tristan, we hear the word transformation program, they think ,"Oh my gosh, it's going to be multi-year. I'm going to retire before it's done. It's going to be exhausting."
What we realize now is that one, given the tools, the changes in what our partners are being able to do, whether it's your asset service provider, your technology providers, what they can do to accelerate and move quicker has been much different than when there was a couple of years ago. I also think is we try to break things into what change can I absorb into a three-month period, so that it's we're seeing continual success and be as agile as possible because as you can build success, it builds momentum. It keeps that motivation going as much as possible throughout it. That's really definitely the way that I can while you might want a long-term vision, think about short incremental deliverables.
Tristan: Couldn't agree more.
Transcript: Global Credit Opportunities and the New Normal
AIR DATE: November 6, 2023 | 12:00 PM, EST
Caroline: Good afternoon, everyone, and thanks for joining us. I'd like to welcome you to this week's Monday Minute live chat, hosted by the Canadian Leadership Congress. The topic today is global credit opportunities and the new normal. Here to talk about it is Karl Dasher, President of Polen Capital. Moderating this discussion with Karl, we have David Scudellari, Senior Executive Managing Director and Head of International Investment with AIMCo. I'd like to welcome both of you. I'd like to hand things over to you, David, to get us started.
David Scudellari: Thanks, Caroline. I'll tell you, it's certainly not a dull time to talk about credit. Karl, I'd love to throw it your way. Just tell me, where do you think we are right now when you think in the credit landscape?
Karl Dasher: David, I think we're sort of in a world of compounding policy errors, if I'm honest with you. I think that clearly, what we saw going back about three years ago, starting with the COVID crisis, and seeing both the combination of continued monetary stimulus combined with what we now understand was an overextended fiscal stimulus, just created an M2 money supply situation that inflated pretty much every wealth asset we have. If you look at history, it's really unprecedented what we went through, in terms of the M2 money supply expansion.
That combined with lockdowns and changes in labor market behavior, changes in the way workforce actually engages with work from home, combined with some societal changes. What we're seeing in certainly in certain cities, and the stress they're coming under, has really created an unprecedented set of circumstances. It's really hard for us to model that. The fact that we're in the inflationary regime we've been in, is not a surprise. By the same token, from where I sit, I think that the Fed may be going a bit too far too fast, if I'm completely honest.
When I look at where we are today, when I look at, for example, where mortgage rates are, where new issue mortgages are now in the 7% plus range, you've got a lot of people out there who their biggest asset is going to be the mark to market value of their mortgage. They're going to be locked into certain homes in certain situations for quite a long time, which in the US that's one of the reasons why the transfer mechanism is not coming through. In places like, I'm in London today, and I can tell you, being on the ground here in London and Europe, people are feeling the pain, because they have mortgages that reset more frequently.
I personally believe we're in the midst of another pause here on the other side, but because of the lag effects, just like we saw with inflation, we're not going to realize it for another 6 to 12 months.
David: How does that impact your approach to underwriting and also what markets do you get excited about or you try to stay away from?
Karl: Well, I'll tell you how it impacts us. I'll go back to my first experience. I'm in my mid-50s, and my first experience with the impact of tight monetary conditions goes all the way back to the '80s. My stepfather had a small business, and his small business was tied to prime loans. I can remember seeing him literally crying over his business interest rate going up to 20% plus. Now, we're not heading back to that. The world just can't sustain that. When you look at sovereign debt outstanding, what it would do to the debt service ratios, we're just nowhere near a situation where we could absorb that. The interesting corollary to that was that when I look at his situation, I look at the broader situation in the economy at the time, a lot of the effects of that weren't felt for years later. People would get behind, they would take on more debt, and even when the rates started to come back down, you felt it years later. I saw that in that particular context where five or six years later, we were struggling to actually keep the business afloat, because of all the compounding effects of that regime.
I personally think where we are is we're in the third inning of where, to use a baseball analogy of where this is going to play out, where to date, we've seen the default rates stay relatively muted, relatively low, and I think it gets back to that earlier comment that the transfer mechanism just hasn't been that responsive at the consumer side, but we're starting to see that come through. In the first place we're starting to see it come through is in the absorption of the excess savings. The excess savings that we saw during COVID, there are some data that just came out today and said only the wealthiest 20% of Americans, and I think you expand that to North Americans, have that excess savings.
I think that's going to continue to contract as we see some of the wealth effect get eroded more in equity markets over time, and eventually in the property markets. Then it's going to really impact some of the underlying weaker companies. Some of the weaker companies that don't have durable business models, their ability to reprice is going to be curtailed. They have, at the same time, labor taking up a larger percentage of revenues, and interest rates taking up a larger percentage of profits. That's going to lead to a pretty tight squeeze on certain companies in terms of their ability to provide capital to equity owners.
For us, sitting on the credit side, you've heard a lot of people out there talking about this is the golden age of credit. I would say that to some extent, we really agree with that. We like a lot of opportunities that we see out there.
Sitting from our vantage point of primarily being focused on high-yield credit, we're looking at $3 to $4 trillion of opportunity set from which we're trying to find several billion of opportunities, and we like what we see. Returns that are usually reserved for the equity part of the capital stack. From that perspective, we're quite constructive, but we do think it's going to be a very idiosyncratic market. It's one where you're going to have to pick your shots. You've got to think in multiple stages. This is something that's not going to be a flash response like we've been accustomed to. We've been accustomed to a Fed put for almost 25 years. In fact, there's a lot of interesting stories coming out right now about the original Fed put going back to LTCM 25 years ago.
What I would say is, we're at the end of the Fed put. There could be Fed moderation, but that Fed put where you have an immediate reaction to try to stimulate asset prices, we're not going to see that anytime soon. Think in terms of multi-stages, multi-year opportunity for select credit opportunities.
David: How do you position for those opportunities? Do you think the banks are retrenching? We also have historic amounts of capital being raised for this asset class. So, how do you position Polen to take advantage of it?
Karl: Yes, David, it's a great question, because when you think about it, we're saying on one hand, be bullish, on the other hand, be selective. To your point, there's a lot of money being raised, right? How do you square the circle on that? There's a couple of things. If you look at North America overall, in North America, only about 20% to 25% of the corporate at-risk capital in terms of credit capital is still within the banking system. Most of that is now either syndicated, or increasingly, a lot of it is moving into private credit. Still, that 25% to 30% is still in the banking system.
There's more on the real estate side, obviously. That's going to be dislocated for a little while. The reason it's going to be dislocated for a while is because one of the implications that goes all the way back to the GFC, and then was exacerbated during COVID, was that both monetary policy and regulatory policy really incentivized the banks to buy longer duration, what's deemed to be higher quality mortgages, and to put that on their balance sheet without marking to market.
A great example of what we've seen there, unfortunate examples, are Silicon Valley Bank and First Republic. These are two banks that if you looked at their credit quality, they were absolutely pristine. They were absolutely pristine. Very low losses. What took them under was that mark to market mismatch combined with the fact that they were counting on essentially zero cost funding through deposits that were fluid and able to move overnight. Now, we seem to be out of the fast reaction deposit crisis that we were in at that time with the confidence issue that we had, but I can tell you that every quarter point, it puts more pressure on the banks that they're going to lose assets to not just other banks, but to things like ETFs that people can move to for short duration ETF strategies, or other ways of getting short duration exposure. From our perspective, the banking side of the equation globally, is going to be under pressure from this new destructive force, which is fluidity of capital.
Now, if you're sitting there in Canada and you're a term match funder, an insurance company, a pension fund, that means there's opportunities for you, because in the past, you were playing a bit of an unfair game. You were competing with banking institutions that were getting essentially zero cost funding from the regulatory, the central banks of the world, while you, on your side, were dealing with cost of capital tied to longer duration liabilities. That means that you're now in a more competitive position, because you're not competing with somebody who's got a low or near zero cost of capital.
For you, you're going to have opportunities to go out and extend credit for three, five, and in some cases, 10 years, at much better rates than you were in the past. We think it's actually a pretty exciting time to be in your position, if you're one of those long duration funders of capital.
David: Yes. Listen, for us, we really like credit as an asset class. Part of it is the scalability, certainly the way it fits in the portfolio from a correlation, as well as from downside protected asset, cash on cash return. It has some special attributes, some which are relatively unique, which makes it attractive to a firm like [unintelligible 00:11:15], and for our clients. When you think of the whole, it feels-- When you're looking at the opportunity set, primary versus secondary market, I know that ebbs and flows. Where is it now?
Karl: It does ebb and flow, and it can ebb and flow fairly rapidly. If you had talked to me, about four months ago, even, the primary market was pretty shut. You had, for example-- Part of the reasons for that, let's take the largest market in the world, the US CLO market, and US broadly syndicated loan market as an example. Because you had CLOs secondary prices at such wide levels relative to primary markets, that market was shut down for primary issuance, which meant that the flow through when you had 60%, 70% plus of the broadly syndicated market being housed in CLOs, that meant that doing new BSL was difficult, because you couldn't do new CLO issuance. Where you had opportunities to really benefit from that was in shorter maturity broadly syndicated loans that were selling at fairly steep discounts because people were concerned about, will they be able to refi, as well as secondary opportunities in the actual CLO tranches themselves. What you've seen, just in the last three or four months, is you've seen that spread contract quite a bit. Market participants came in, they started to take advantage of that, and so now we're back to a market where primary CLO issuance is interesting, and the broadly syndicated loan market is priced a little more rationally.
That doesn't mean that the return opportunity has gone away. We see a lot of opportunities, for example, in interesting first liens that are 11% and above. For what we can underwrite to 50% or better LTVs on the underlying enterprise value. You can just tell, within three or four months, you can get these shifts, and they can happen in the other direction. One of the dynamics that we're dealing with right now, that is a positive for the underpinning in the market, is that the maturity wall, both in investment grade and in high yield, is fairly benign right now.
One of the things that was very harmful for the economy back in 2007, 2008, and early 2009, was you had a concurrence of a very poor maturity wall and poor capital structures coinciding at the same time. That led to a lot of forced selling and forced refinancing at bad levels. We don't have as much forced refinancing right now as we did. At the same time, we don't have that market clearing mechanism, for example, with private equity. You probably, David, have noticed just like I have, we see all the numbers of that dry powder that are sitting on the sidelines of private equity. There's not a lot of deal activity behind that dry powder right now.
It's not because people don't want to put it to work. It's because they're trying to reconcile the cost of financing versus the leverage ratios versus what they need to deliver to their LPs in order to make the private equity deal work. It's fairly muted right now. We're not seeing that big supply pressure coming through. What we are seeing is a lot of interesting idiosyncratic things. Where, for example, if you move a little lower down, you look down at some $200 to $300 million type issues versus a billion dollar types of issues, that's where you're seeing some opportunities that aren't as widely covered in the market. You can get some idiosyncratic pickups of 100 to 200 basis points. It's interesting to think that a $200 to $300 million issue in high yield is now considered relatively small. That's where the world is. In a world where you can have a billion dollar plus private credit issues now, that's considered a smaller end of the market. I think if you look globally, you see some opportunities too, David. We see it in areas that we call guilt by association trades. One of them that I'll highlight is in Latin America. There's a subset of the Latin American corporate market that is, if you line it up, the bond issue or the loan issue is a New York domicile law. It's governed under New York law.
The underlying issuer has a high degree of hard currency earnings. Yet, because the company is operating within Latin America, they get a guilt by association premium of 200 to 300 basis points relative to what you'd see a North American, a US or Canadian company issuing at. Those are the kind of things that we see that are a little bit orphaned, that create additional opportunities for investors with longer-term horizons.
David: Really, for me, I've been doing this since the early '80s, and very unique point in time in history. It won't last. The question is, how long do you think we're here? It's very hard to prognosticate with any accuracy, but what does your gut tell you in terms of, do we have months? Do we have years? What are we looking at from an opportunity set standpoint?
Karl: I think it's going to be multistage, and I think we're going to see some volatility along the way. In terms of where we are in spreads, probably one of the biggest thing that's keeping people a little bit on the sidelines is that if you had asked a wide group, if I sat down with you and we went to all the Canadian pension CIOs and said, "Hey, what are your views about the likelihood of a recession?" I'd be willing to bet that 70% plus would have said recession by end of this year or early next year. That was what market consensus was. That's why, if you look at the longer bond rates, they were talking quite a bit below where the front end of the curve was.
We've seen clearly a change in that view, and a change in that view to, A, it could be a soft landing, and B, that could be higher for longer. We were already into that higher for longer mindset. What's really changed is the view that maybe we get through this without a recession, and that might be becoming over price down. David, what I would say is that I personally believe we're going to see a fair amount of volatility along the way over the next couple of years as people toggle between, is it a recession? What is a recession? [chuckles] Because you can have recession by some metrics and not by others. We can have wealth destruction in some segments and not in others. There's a lot of discussion right now about, is this going to be a recession amongst higher earning individuals versus more rank and file workers who have the ability to continue to reprice some of their services in the market? Every economic cycle has its own idiosyncrasies. I think this one will have its own. To answer your question more directly, I do think that we're going to be in a somewhat persistently higher environment for credit returns for two to three years, but I think there's going to be a fair amount of volatility in terms of where those opportunities are along the way.
As people over extrapolate or under appreciate the various economic scenarios. One example I can give you, being right here in London right now, is that there are some interesting idiosyncratic factors in Europe and the UK where we now see Europe and UK as probably the most attractive market in the world, from a high yield and private credit opportunity set. It's the second deepest, behind North America. What's making it attractive is a bit of a confluence of factors. One of them is, is that the banking withdrawal, the banking rationalization, is not happening as rapidly as it happened in the US. It's still churning through.
Banks are now just getting their head around this whole deposit risk factor combined with what we saw in October last year with the UK, what I'll call LDI flash crash. We remember under the trust administration, we had that very rapid spike in government bond yields. UK had been building up, over many, many years, a very tightly managed with synthetics LDI framework. It was very, very tightly managed against the interest rate structure in the market. They were doing that with synthetics, with underlying pools of credit assets. That basis risk differential, what we call flash crash, it led to a fairly sharp sell-off of some of those assets.
It did rebound, but part of that rebound led to a change in attitude about, how should we be structuring our portfolio? We're seeing people start to pull back from that construct and start to rethink, how do they want to manage liability cognizant assets?
I would say probably moving more in the direction that we have in North America. There in Canada, where it's a bit more of a diversified portfolio, a bit less pure interest rate sensitivity. Now, over time, that's going to work its way through, and we're going to see, I think, eventually, a reallocation of more assets to areas like private credit and higher yielding opportunities and infrastructure debt. Right now, we have a greater supply of opportunity in Europe and UK than we're seeing absorbed by the local consumer and savings base. That gives investors like Canadian investors and US investors, with fairly deep and healthy pension systems, an opportunity to invest, and in addition to that, pick up some FX risk premium as well. Get more interest rates R. We think that's a pretty interesting opportunity to look at right now. Will that be available in 12 months time or 18 months time? I don't know. If I were in your shoes, I would be sharpening my pencils and looking at those kinds of opportunities right now.
David: Yes. Well, I certainly agree with your assessment on volatility. We're pretty vulnerable to one or two bad things happening. We got like eight potential bad things that could happen. The table is set where none of us will be bored in our day jobs. I do like where credit is priced right now. I do think those little periods of volatility will create some interesting opportunity for those that are nimble enough, or have the platform like you do, where you really have a broad scope of investment potential. I'm scared and excited.
David: I've seen enough to know just how interesting the next 12, 18 months, things have gone better than I would have guessed when I was looking at where the year started, but there's still lots of opportunity for some surprises.
Karl: I think scared and excited is, that's a great way of putting it, David. I think actually, that's where everybody should be. If you're overexcited, you're probably going to go too fast in your pacing and miss some opportunities down the road. If you're too scared to engage now, I think you're probably going to miss some very positive carrot. I think that what I tell people is, it's a good time to start. If you aren't in it, start your deployment now, and start looking for select opportunities to make deployments now. Look at opportunities to reallocate when you get opportunities to do some rebalancing.
My personal point of view earlier this year, a few months ago, a couple of months ago, there was probably a pretty good opportunity in some equity asset classes to say, "Hey, where's the market most mispriced?" I would have argued at the time, compared to equity markets, the equity markets were a bit overenthusiastic compared to where the credit markets. There was a pretty big disconnect two or three months ago. That's coming back into alignment a bit, as credit markets have improved a bit and as equity markets have declined a bit. We know how narrow the market has been led in certain equity markets as well. I think those are the kind of things. You hit a key point, which is, it's good to have strategic balance and strategic allocation that you're working towards. I think it's also good to have strategies where you do allow for more opportunism. That's for our-- The bulk of our clients, actually, they like that. They like being able to say to us, "Be agnostic. Don't be pure private or pure public. Don't be pure bond or pure loan or first lien or second lien. Help us figure out, within certain guardrails, how to allocate amongst that whole opportunity set and optimize the information ratio and the spread reward that we're getting at relative to default risk and drawdown risk."
I think those kinds of strategies can really fly in this environment. If you don't have that, I would recommend that you and your CIO staff take a look at that, and take a look at ways you can take advantage of that.
David: Karl, I really enjoyed this discussion. Is there any-- You get the last word. What do you want to say?
Karl: I think you nailed it, David. Be scared and excited. That's the right way to be. I think be scared and excited. What I said earlier is, look, being there in Canada, again, I'm here in London right now, but being there in Canada, you're in a really great, strong position. We all hear the same stories, and people are concerned about the property market, and where Canadian property is relative to fair value and all those things, but the reality is, you take a step back, you're coming from the vantage point of one of the strongest economies, one of the strongest financial systems in the world, and one of the best pension systems in the world.
You should use that strength to your advantage. Your competitors for capital are much, much weaker than they have been in the past. I would go into this, as you said, scared and excited. You have time to do some research, but you're not going to be able to sit on there forever. For the first time in a long time, time is money. It's real money. There's a real carry out there that's available. You don't want to sit back and wait for everything to line up perfectly before you start making some decisions and allocating capital. Great time to be scaling into these opportunities and doing some research and adding to your portfolio.
David: Yes. Again, thank you. Great to have this discussion. Caroline?
Caroline: Thank you, Karl, David. A terrific discussion. Very insightful. Thank you so much for being here, to both of you. That wraps this week's Monday Minute. Don't forget to send us your questions, and we'll get right back to you with our speaker's response. We've got a lot of exciting content, some great interviews lined up for our future Monday Minutes that you won't want to miss. Be sure to go to our website, leadershipcongress.ca, to sign up for our informative and timely CLC newsletter. Thank you all for joining us, and see you next time.
Karl: Thank you.
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President | Polen Capital
Karl is President of Polen Capital, and is responsible for investment team administration, developing our global credit business, and supporting the firm’s strategic direction.
Prior to joining Polen Capital in 2022, Karl served as CEO at Brigade Capital Management. Karl spent 12 years in various leadership roles at Schroders, including CEO of North America and Co-Head of Fixed Income. Before joining Schroders, Karl was Executive Vice President and Global CIO at SEI Investments, where he spent over 13 years.
Karl received a B.S. in Industrial Engineering from the Georgia Institute of Technology and an M.B.A. from Columbia University School of Business and London Business School. Karl is also a Trustee & IC Chair for the Georgia Tech Foundation.
Senior Executive Managing Director, Head of International Investment | AIMCo
Prior to joining PSP Investments, he held leadership roles at Barclays and Goldman, Sachs & Co., including as Global Head of Finance and Risk Canada for Barclays in New York. He also spent two years in Calgary, where he served both as Senior Vice President and Chief Financial Officer for North West Upgrading Inc., and as a Board member at Teine Energy.
David holds a Master of Business Administration from Pace University Lubin School of Business and a Bachelor of Science in Economics from the University at Albany, SUNY.
