The Credit Edge by Bloomberg IntelligenceOaktree Sees Private Credit Stress as Excitement Grows
Private credit markets are under pressure from high interest rates, while excess demand is keeping spreads low, according to Wayne Dahl, co-portfolio manager for Oaktree’s global credit and investment grade solutions strategies. “I think there will be some general stress,” says Dahl in the latest Credit Edge podcast from Bloomberg Intelligence. “When people get excited, they put money in — the end investor has no choice but to invest that, and therefore you’ll maybe see spreads compress a little bit more than would otherwise be warranted,” Dahl tells Bloomberg News’ James Crombie and BI Senior Credit Analyst Mike Holland. Also in this episode, Dahl and Holland discuss risk in the health care sector, as well as opportunities in consumer staples, insurance and securitized credit.
Hello, Welcome to The Credit Edge, a weekly markets podcast. My name is James Crombie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome Wayne Dahl from oak Tree. How are you Wayne, I'm great?
How are you?
James?
Very good?
Thank you.
Wayne. It's co portfolio manager for oak Tree's global credit and investment grade solutions strategies.
Thank you very much for having me.
Thanks so much for joining us today. We're very excited to hear your views. Plus, we're also delighted to have back on the show Mike Holland with Bloomberg Intelligence. Hello, Mike, Hey, James.
Great to be here. I'm Mike Colin.
I'm a senior healthcare credit analyst here at Bloomberg, part of Bloomberg's research department of five hundred analysts and strategists.
So great.
So, just to set the scene a bit here, credit markets are struggling a bit, not really living up to their year of the bond bill. That's mostly because of rates which remain elevated, undermining total returns and also putting pressure on weak companies that have a lot of debt. Shorter duration assets like high yield and floating rate loans are doing okay, though nowhere near as good as equities. Debt spreads are very tight. You're not getting very much compensation for the risk of default or downgrade of corporate debt, and we've seen a ton of issuance. The ball case is supported by strength in the US economy, which is good for US companies, but credit markets in Europe and Asia are doing better than the US. There seems to be a fair amount of complacency. They're given all the risks debt defaults, bankruptcies, commercial real estate, stress, war, geopolitics, elections. Everybody's loaded up on US assets going into a very noisy presidential election. A recession cannot be ruled out, So I want to start there. When the first half of the year hasn't been that great for credit unless you are long Chinese junk bonds. There's a little bit of excess return though, but not really a stellar year. So what's your outlook for the second half? More of the same or maybe a big rally if we finally get those rates cuts. Everyone was home earlier this year.
Yeah, James, I think you touched on a few things that are important to consider when looking at credit markets broadly. You mentioned the fixed versus floating. Floating has done better with rates. Higher fixed has done Okay, higher yielding fixed rate has done better just given the higher yields, where lower, higher quality fixed rate has has tended to underperform given its slightly longer duration and lower coupons. But I think the key is that you need to be diversified. There are trade offs across all these different markets. So if you can have the opportunity to have a portfolio that can you know, touch each of these areas and kind of balance out your exposure, you've done. You've done quite well. And you know you did. Mention equity markets, Yes, the S and P five hundred, Yes the NASDAC are both up very well. But if you look at small caps in general, they've largely underperformed high old bonds or broadly syndicated loans. Even the Dow Jones is, you know, maybe kind of in line with high old bonds through the first half of the year. So I don't think it's a stretch to you know, expect a similar outcome in the second half of the year. Income has been your friend for the last several months. I think that's going to continue to be the case. The one thing that we've seen with focusing on these income, high income generating assets is they do have a way of protecting you against some of the market volatility, which, as you alluded to, we could certainly see in the second half with US elections and other events that we're facing today.
Hey, this is Mike Collins Wayne. Looking at the ag right now. We're about five percent, you know on ig credit and five point seven on triple b's if you're looking at the index on Bloomberg and six point six for double B seven point seven for single bees. You know, last year, two years ago, we're looking at Yould bond paper coming below four percent. As you look forward to the end of this year and next year, where do you see that vaul driving spreads and yields?
Yeah, I mean I think you've you've definitely touched on some interesting things, Mike. I mean, and I think that's been the trade off for investors these days. Is is it fair to focus only on yield and ignore spread or should I solely focus on spread? I definitely see a situation where we could you know, kind of continue along these lines where spreads kind of stay where they are and you're kind of beholden to where to where rates go. I think you've seen a bit of a trade off there. Where As spreads have gone tighter in most cases, that has meant the interest rates have gone higher. So the yield, especially in high yield, has stayed relatively flat for the last couple of years, in a bit this year. So I think if you see a situation where, you know, what spreads wider at this point, it probably is some form of you know, negativity around the economy. And you know, I think most investors would anticipate that that could come with some rate cuts. So you know, do you get some sort of offset there where maybe a little bit of spread widening you know, is offset by some rate tightening and again kind of net net, the yield stays kind of similar and which which again would kind of benefit those who are in it for the for the carry and the long haul on.
The economy way and that do you expect a recession and do you expect a deep recession? What it's your vial on that and also interested in your rates outlook, when do we expect to see cuts?
Yeah, I mean, I think the recession backdrop is is an interesting one, and I think it's one that has I don't know if i'd say confused the market, but is maybe you know, colored the market view over the last couple of years, there's been so much talk about a recession and one hasn't materialized. And I think that that is why you hear a lot of the talk of spreads are too tight, spreads are too tight. If if we never had this conversation about a recession, would we feel the same way about spreads? I mean, going forward from here, it's it's difficult to see, you know, where where a recession would come from, the economy seems to be doing well, consumers seem to be doing well. Things are definitely slowing, but are they slowing enough for a recession. I think it's very, very hard to predict. And if you invest with you know, a very very you know, strongly defined base case of a recession will happen in three months or six months or nine months. I think that's led to, you know, a path of disappointment over the last uh, you know, several months.
You know, I listened to your lots of podcasts back in I believe it was September, and you talked about you know, we're both risk focused, you know, folks that have looking for downside versus upside on you know, be given that we're in credit and I wonder, you know, do we even need a recession when you have all this.
Uncertainty that keeps ramping up?
I mean I looked to last week and the Chevron doctrine the Supreme Court coming out talking about that. There's there's so many moving parts to this broader economic story and stuff that's happening around the edges. I wonder have you guys even focused on this Chevron doctrine.
I mean, that was something that came out yesterday or on Friday.
And as it relates to healthcare, I mean, we're thinking about legislative and regulatory uncertainty ramping up, and we clearly just had this conversation.
It's just in early stages.
But you know, how do you think about uncertainty on the edges versus you know, does it have to be you know, a binary recession or not? And how does that affect credit spreads and yields going forward?
Yeah?
No, I think you make a great point, Mike. And I think the one thing too, you know, kind of look at there is you're right, do you need a recession to have stress in certain parts of the market you mentioned healthcare. Health Care has been an area, especially in the leverage finance space where you have a lot of private equity involvement there, levered balance sheets. They have come under pressure, they've seen default rates tick higher as you've as you've seen some you know, whether it's regulation kind of shifting and changing on the state and federal level, where you've had some labor stress given you know the results of COVID and and you know wage pressures in in the healthcare space. So I think you're absolutely right that on a sector bi sector basis, you're you're going to see and continue to see. I think some pressure build in certain parts of the the credit markets. Now that doesn't mean that you should avoid the credit markets completely. I think it means that to have a kind of bottom up, fundamental approach to how you're thinking about investments and not just trying to own the entire index is the right approach. I mean, many people refer to that this period as a credit pickers market, and I think what they mean by that is exactly what you alluded to. You can avoid some of these broader challenges and take advantage of these very attractive yields, which again, if you can avoid those defaults in areas of stress, I think they serve a very good need for portfolios today.
Just the point earlier on spreads, when you know, we've talked about them being very very tight, and then when we talk about that and people just say, well, look at the yield, it's so big that it doesn't really matter. But the textbook would tell us that we should worry about the spread, and it seems that would only take a little bit of volatility to come back to actually push those a lot wider than where they are right now, which would presumably mean losses. I mean, are we just focusing on the wrong thing here? Should should we just not be looking at the index and we should be looking at as a dispersion, We should be looking at individual bonds much more closely instead of the index.
I do think there is an argument to be made to to look a little more closely at at individual bonds rather than just trying to take a take a market approach. I mean, and you can see this so far in in some of the performance data. If you look at the you know what, I would call the non tradable high yield indices that are out there relative to say ETFs in the first half of the year, you know, especially in this in this most recent quarter, you've seen some underperformance in UH in those ETFs relative to to the index. So again, I think just trying to you know, own that kind of most liquid, higher quality part of the market has has proven a little more challenging from a from a return perspective. But you know, the other thing to consider as well, and I think it's it's something to think about for high yield is we like to look at spreads and we like to look at them across time and compare them. Well, the index was you know, three hundred and fifty basis points today, it was three hundred and fifty basis points back in twenty eighteen. But you know, at the same time, for those who want to maybe get a little bit more what i'll call nerdy in the high yield space, you've seen a pretty significant drop in duration. And duration is that kind of measure of sensitivity to interest rates or credit spread. So with that number a lot shorter, then you know, I think you do have an easier time kind of looking at that market today, where again, your your sensitivity against those moves in rates or credit spreads give you give you a little bit you know, better return when it comes to thinking about how much can I lose and then most importantly how long does it take me to earn that back through the current yield? So higher current yield, lower duration, I think overall it is less sensitive. So again, if you can kind of pick those good credits, I think you're you're again going to benefit from what is a great opportunity to earn a higher yield.
We tilked about twenty eighteen and I had a chance to check the spreads on that, and the spreads did actually blow out at the end of twenty eighteen on how yield. Maybe that was completely you know, for the reasons that you know will not happen again. But it just seems to me that things too priced to perfection, that all of the risks that we see just being underpriced at the moment. Do you not feel the same way.
Look, I mean there's no doubt that you know spreads are tighter, and that you know people are kind of pricing things for perfection, as you say, and you're right, I mean, spreads did blow out at the end of twenty eighteen. Remember twenty eighteen was was a hiking cycle. The hiking cycle ended in December twenty eighteen, and that fourth quarter where spreads went wider. I mean, in a way, you could relate that fourth quarter move of twenty eighteen to something more like what we saw in twenty twenty two, where spreads definitely moved wider as rates went higher. But you know, today in the US, we've we've passed that period and I think everyone would agree, although there is probably a you know, a tail risk out there that rates could go higher again, that we're most likely going to see the next move in rates being lower. So again, as a high yield investor, if I think, well, you know what's going to cause those spreads to go higher, A lot of those scenarios are also most likely going to drive interest rates to come tighter. So there is a bit of an offsetting effect. And again, when I don't know the timing of that, what I want to do is make sure I'm in good companies that will accrue that yield in my favor while i'm you know, call it waiting for that for that event to hit.
Wan One of the sectors. Of the very subsectors in healthcare that I cover, obviously payers and if you look at where payer spreads are now today, you know, look United and SIGNA and out of vants ECBs kind of wider on the margin.
Price to perfection.
Meanwhile, Congress is talking about, you know, regulating PBMs and you know, maybe causing some changes to the way the payers operate. You see that spreads haven't gapped out at all. And I wonder, I mean, do you have do you have to have an incident to happen.
First before spreads widen?
And I'm talking regulatory pushback against payers and making acquisitions outside of their normal payer side regulated revenue. I wonder you know that that's something that I see as a risk. And I wonder you know across sectors. You know, obviously healthcare is very regulated. Are there any other sectors that you're interested in right now from a long or short perspective where you see trends favorable or unfavorable?
Yeah, I mean, you're you're right for sure, Mike, that you know, I think you will probably you know, people will try and hold on maybe for as long as they can. And again, I think that does speak to the power of you know, kind of active management versus passive management. And that's one thing that we have focused on over the last you know, call it year plus, is you know, looking across the market and looking at opportunities in various sectors where you have a chance to rotate into something that you may view as a little bit more defensive at you know, similar spreads and yields, which again, I mean you have to make those moves early. You can't. You can't wait and kind of after the fact is as you said in your example, you know, maybe a regulation does change spreads, move at that point it's too late. So you know, there certainly are are some parts of the market where there there's maybe things a little bit more attractive i mean food and beverage, you know, certainly a bit more on the staple front. You know, things like that are are good. I mean power is an area that that in certain parts of the market you've seen an increased demand for There's a lot of talk around you know, data centers and AI and their kind of demand for more power and maybe we're kind of underappreciating or underpricing the need for that to grow. You've also seen some pretty good strength in the various insurance sectors. So you know, there are parts of the market that I think when you kind of look at the landscape and think, you know, do I want to maybe give up a few basis points of yield or spread and lock into something which, again I think to your point has maybe less of that tail risk in it.
Yeah, that's helpful.
I think, you know, our food and beverage team on the credit side do have some interesting views.
For sure.
They've been talking a lot about GLP ones and potential impacts there, which we think will be a longer term trend. But I think stepping back, I mean, Bloomberg is Bloomberg Intelligence here has put out twenty years or twenty I'm sorry, twenty years twenty editions of our bi credit medians, and we're looking at trends recently for the last several quarters.
You know, Joe Lovington's the head of.
Our team, and he put this out last week basically showing you know, the sequential uptick and leverage across ratings classes, you know, from A to triple BB and you know approaching you know, higher levels that we've seen since you know, post COVID. What what are your views on broad sector trends and how that could and leverage trends and coverage trends which are clearly getting more coverage is declining, leverages rising. Do you think that we're on a glide path towards something you know, more negative or on the corporate side, or what signals are you seeing over at oak Tree, across the across the spectrum in terms of leverage and should that be a concern.
Yeah, I mean, I think you're right. I mean, leverage has certainly ticked up from from those lows. But if you kind of take a step back and look and go back a little bit further into the into the pre COVID days, you'll see that, you know, leverage for the most part, whether it's loans, whether it's bonds, it's you know, kind of at the median or below the median, below the average in many cases. So you know, it certainly shows you that companies have not been what I would call irresponsible over this most recent time period. They've been pretty measured in their cases for increasing leverage, whether that's through acquisitions or you know, large capital expenditures which would require the issuance of new debt packing on leverage. I mean, I think I think companies have been pretty responsible and I think overall from a credit perspective, that should be good for investors. On the coverage front, it's it's interesting, I think over the last few months you're seeing coverage almost go in the opposite direction if you look at the high yield market versus the loan market, where high yield borrowers, because they've been fixed rate, they've been able to kind of live out this term of higher rates for longer than floating rate products where they've immediately felt that impact. High yeld bonds are now just starting to refinance and have started to refinance into higher rates. So yep, you're seeing coverage tickdown, but again tick down from very very high levels into areas that are still very very reasonable. And on the loan side, in this year of pretty significant refinancings, you've actually seen loan borrowers be able to improve their coverage metrics because that loan that they issued two years ago or eighteen months ago is now being refinanced at a fifty basis points spread roughly lower. So you are seeing a little bit of relief there, but it's certainly an area that you still have to watch out for in companies with excessive leverage are going to be the ones that continue to struggle. Again, kind of making that case for active management over just purely trying to own the market.
A Now that really struggling end when there is increased incidence of liability management, which is coercive, it's violent, it's inflicting losses and a little of pain on investors. How much are you engaged in those sorts of transactions and what are you doing to fight back?
I mean, you certainly have to pay very close attention to the capital structures that you know seem most likely to go through that kind of activity. And again, as I mentioned with the idea of you know, kind of rotating away from trouble sectors, you have to be prepared for that. You have to do that in advance. It's very similar here. You don't want to be you don't want to be surprised by one of these activities, and that might mean you know, speaking to other lenders, talking to other parties, and again kind of preparing it. And in some cases it might mean you know, leaving leaving a bit of return on the table and switching out from a name or a sector rather than kind of trying to squeeze out those last few basis points.
In healthcare, there's been a couple of instances when where we've had just you know, discounted buybacks, but the agencies turned them opportunistic versus distressed.
And I wonder is that something you guys have looked into?
Meaning there are instances where liability management exercises are reducing PAR basically or haircut and par, but they're not getting you know, they're not being assessed as a distressed exchange. The company comes to mind as multiplan that I've been working on for many years, and they were they did it sell par buy back, And I wonder do you see much of that? I mean, are there instances where companies are doing are basically defaulting on their part payment and getting almost getting away with it. Maybe that's just a something that I'm keying in on here. It seems strange to me.
Yeah, I mean, look, I think one thing that you know, periods of I would call Marcus stress certainly seem to bring out, you know, creative solutions to problems that we haven't seen historically. And and there's no doubt that those are going to grow for those balance shees that have the most leverage. I mean, the other area that you've probably looked at in detail as well is just you know, what's going on in the private credit markets. We don't see those headlines as much, but we know that there are being you know, there are situations where companies are choosing to pay their interesting kind or a portion of their interesting kind, rather than pay it in cash. And again, you know, is that a default? Is that not a default? How do we treat that going forward? I think you know these periods where or again times are going to get tough for certain balance shees. I think you have to expect more and more creative solutions. And again, the companies, as you mentioned, tend to be ahead of how the rating agencies think about this. So you know, again, I think it's going to be one of those situations that we look back on in a few years and you know, everyone will try and kind of take the lessons forward, as typically happens, we always fight problems in reverse. But you know, again, it's it shows that there is just no replacement for a focus on kind of bottom up fundamental credit work, especially at times like this where you can and will probably continue to be surprised by some companies actions.
Can we talk a bit about securitize credit. A lot of guests on this show really excited about it. They see a ton of opportunity, they see more relative value that compared to you know, playing vanilla bunds. Where where's the where's the excitement when you even to securitize credit.
Yeah, I think securitized credit has been a great addition to UH to fixed income portfolios. I know some of your prior guests have spoken about the CLO market, and and rightfully so. I mean the CLO market has offered some pretty big premiums relative to other fixed income spreads that that we've seen in a while. And I think there's a there's a couple of reasons for that. Number One, if you look at a CLO, the spread for that will come, you know, as a result of the quality of the underlying collateral, and we know that that has you know, gone through periods of widening and tightening over the last year. But there's another element within securitized which is the financing piece of that, and that is where I think you saw a bigger premium come in, primarily in the form of of you know, US banks that were very very big participants in triple A securitizations following COVID, their reserves, you know, spiked dramatically once quantitative tightening came in. Everyone expected, well, if reserves went up during quantitative easing, the natural reaction would be reserves would decline. So in a way, you saw a pullback in anticipation of that, and that push spreads wider and created a great opportunity to invest. Reserves did not fall, So you've seen some of that normalized. But securities, I think is definitely an area that has been that has been great for fixed income portfolios.
Is it just sal were you also into consumer abs or even real estate? What's what's what are the assets are you looking at?
Yeah, I think all parts of securities have been good. I mean residential real estate I think has been very attractive over the last couple of years. You know a lot of people still you know, think back to problems in the mortgage market that happened in two thousand and eight, and this market is very very different. If you think back in kind of two thousand and six and seven, loan to values were very high, FIGHTO scores were low, in the non agency space today, you see the exact opposite. You see FIGHTO scores, you know, above seven hundred, you see loan to values near seventy percent, in some cases lower, just given the boost in real estate prices. So you could probably argue that, you know, mortgage or real estate prices, you know, should maybe be a little bit lower. We saw such a spike in mortgage rates, well, we had to simultaneously rise in in house prices. But there's so much cushion in the securities that you're very, very very well protected. And the one thing I like about residential mortgage backed securities, and I would say the same for commercial and some others, is that, unlike a CLO that when alone refinances in the collateral, the CLO reinvests, when an R and B S security has a loan refinance, the security de leverages and you actually kind of move up in quality. So you have some double B issued, you know, residential mortgage backed securities that look on a kind of credit enhancement or risk basis more like a triple B. So again it kind of goes to that point of spreading out your sources of risk and diversifying across I think a lot of pretty attractive areas in the markets.
What about the commercial stuff that the offices, so you taking into that, so a lot of our guests are getting excited about that given how cheap it became.
I mean, look, I think office is an area that's going to be you know, under stress or or under some sort of repricing for you know, it could be a number of years into the future. There's just not a lot of transactions happening. You do see them one off pop up here and there. Some are worse, some are better. So it is an area I think in a kind of performing or liquid credit strategy. It's it's maybe difficult to to get too excited about right now with the uncertainty. But that doesn't mean that there aren't very attractive areas of commercial mortgage backed securities right now. Commercial real estate clos again look quite attractive with good yields, good levels of protection. You even have new kind of areas into the market, data centers, for example. I mean, I think data centers are very interesting. The AI kind of boom from a from a credit perspective, it's you you get so many different areas that that touch. As we mentioned the power space, whether that's in a loan or whether that's in a bond. You have CMBs for the data center itself. You have fiber issued ABS which is coming into those data centers. So you know, kind of secular shifts like that can give you a lot of opportunity in many different markets.
So stepping back a little bit from the securitization, you know, talking about risk management. You know, we talk about the growth and private credit and you know, I'm not sure if we're still in the golden age this week, but you know, you think about risk management there versus the clo market, versus the bond market. I mean, having grown up in Loanland, I know what a you know, a matrix colo matrix is and wharf and weight to average spread and managing to the matrix and there's robust, you know, strictures in place to keep in underwriting standards in line. I wonder as the banks are no longer agenting so many deals and you're looking at some of these bigger private credit shops actually deals and the blurring of syndicated loans with private credit, you know, how does that affect risk risk management going forward? You know, do you see I mean I'm sure not all private credit operators out there are as rigorous as oak Tree has been for decades and underwriting, and I wonder do you see risks on the horizon there and how does that how would potential fall out if there were to be some you know, how do you see that sort of materializing if we play along with my hypothetical here.
Yeah, no, you're right, Mike, And I would just quickly touch on something you you know, kind of alluded to in your your breakdown of securitizations and and you know, clos in particular. I mean, those are the reasons that I think also kind of make clos relatively attractive and securitizations and those those are the reasons why I think ultimately default rates in those various tranches of various ratings has remained quite low because there are those kind of you know, stand or it's almost that you could call them that the market does adhere to. And you're right, private credit certainly doesn't have those, and it's a growing market and and you know, I think one of the keys for private credit is is flexibility. You know, you need to be able to you know, kind of pick your spots and where you want to invest. At one moment, you know, a large cap you know, sponsor back private credit deal might be the most attractive area in the market. At the next moment, maybe the better parts of the private credit market could be something in the non sponsor space, something where you have a little bit more control and negotiating leverage within those structures. I think there's just a lot of uncertainty that we're going to see in the private credit market. And again as I as I said before, it's difficult to always kind of get that full picture of exactly what's going on in that market. So yes, I think focusing on risk management, focusing on underwriting, and you know, to the best you can, you know, trying to make sure that the positions you're investing in are built to you know, work through a period that is that could be facing us with again higher rates for longer probably being one of the big ones. And then also being you know, kind of thinking ahead to what does some of the workout plans look like in these kind of deals, Where where can new capital potentially come in to you know, fix some of these broken problems and are we in a position to be able to take advantage of that.
So most stress when in private credit. I mean, people are quite right about how quickly it grew. And some people say that the tourist money coming in may may result in some blow ups, But do you expect more even if we can see them defaults, more sort of general stress in that market.
I think there will be you know, some some general stress. Again, I think part of it depends on, you know, again the path of interest rates. A lot of markets that are undergoing stress where certainly, you know, very excited at the beginning of the year when the market anticipated some very quick cuts and interest rates that that didn't that didn't emerge. But you know, I think those are just some of the some of the things that that investors need to think about when they're making these kind of investments where their capital is locked up and and you do mention tourists. I mean, you can only have so many tourists in that kind of market because the majority of the capital is still in a place where you're going to be locked up, You're going to be committed, and so you know, as as end investors, you don't have that same fear of your capital walking away as soon as you have to. You know, kind of think about think about or restructuring so that that will definitely, I think, kind of ease some of the pressure or at least kind of help this market get through. The bigger challenge with with private credit is probably probably that you know, in some of these kind of non traded products which have some form of semi liquidity, but I would primarily consider them relatively a liquid you don't always align those inflows with the opportunity. So when people get excited, they put money in the end investor has no choice but to invest that, and therefore you'll, you know, maybe see spreads compress a little bit more then then would otherwise be warranted if you didn't have that kind of surge in demand.
To what extent if there are problems in private credit, do they spill over to other markets?
Yeah, I mean, I think the one thing is that you know, you do have that kind of nature of locked up capital in there. So if you have you know a lot of capital that's kind of trapped in a certain area, then you do kind of see challenges in other markets. We did experience that, I think a little bit after twenty twenty two, where you know a lot of investors in in various kind of private markets that were used to some level of distribution and using those distributions to redeploy into other areas. You definitely saw those decrease. So, you know, I think yields in high yield loans and some of these public markets did stay a little bit higher for longer than maybe people expected because I think some of the capital that probably would have, you know, kind of come into those markets for that opportunity were constrained somewhat just given the kind of locked up nature of more and more capital today.
I think you bring up and it makes me think about an interesting point. As you know, we talk about risk kind of getting diffused across more shops basically instead of being held on balance sheet at banks, you know, does that I mean a lot of folks in the media and regulatory agencies look at that as you know, increasing systemic risk. But if the banks that are providing commercial lending and you know, are doing everything else that they're doing cash management are no longer holding I mean, I think back to two thousand and seven when there were a lot of deals like Leman but you know Archstones, the Archstone Archstone was a Tishman spare deal. A lot of these hung deals that got hung back then actually impacted the banks more broadly because the corporate credit was dragging capital and whatever impacts ahead and ultimately defaults. But were we safer now if Blue Owl or you know, oak Trees agenting a deal, is it a safer environment for the economy?
Well? Yeah, I mean, I think I think you bring up a good point as it relates to the kind of broader economy and really for banks to be able to you know, kind of cover the wide remit that they have, which is a lot it is, you know, providing financing to companies, but it's also providing financing to consumers, whether that's through mortgages and other forms of borrowing. And and yes, I think it's a you know, it's a good point that you know, you won't see that kind of same risk of kind of locking up the entire system in a situation where more and more of this these kind of let's call them almost riskier activities have been you know, pushed off into into people who have maybe the right you know, asset liability mix. Again, it's one thing if people can walk away from these kind of private credit deals in the middle. If they can't they're locked in, they will have to kind of work them out. A bank doesn't have to worry about capital tied up in those areas. Again, as I mentioned, at periods where you could see reserves start to decline in ratios adjust. So yes, I think you're right that, you know, from a broader kind of economic standpoint, banks should be able to continue to provide the servicing that they need to for the broader economy.
Yeah.
I spent a lot of time in a loan group at Credit Swiss, and we you know, we had exposure from IG to high yield and distressed and we did a lot of hedging, you know, single name ultimately single name CDs hedging there was uh became two cost prohibitive and we started you know, payers and put options on the index and hedging that way. And you know, the hedging strategy always evolved. And I wonder for private credit, how do you hedge that?
Yeah, I mean that you're right. I mean everything you just mentioned about hedging, you know, whether it's whether it's an index or whether it's an option. You know, there is an element of well, my hedge is going to benefit because I have some pick up in volatility, whether that impacts just purely volatility, the price of the option or volatility drives that kind of widening in credit spread. So I think when you look at that private credit market, and as you know, I mean from those days of credit Swiss and anyone out there who's you know, tried to hedge even a high yo bond or loan or CLO credit portfolio with credit derivatives, that there is a pretty significant basis risk one can move without the other, and you know, private credit obviously just kind of draws that basis risk even even greater. So I would almost look at, you know, adding a hedge like that is as almost like a second bet. It's difficult to kind of put that in the category of a hedge when one might move and one and one might not. But but I understand where you're trying to get at. Maybe you're willing to, you know, spend a little bit of that excess you know, spread and put that in some form of protection. But it's hard to say that your hedge will definitely make money when your you know, your other asset that you're hedging is losing money. I think that's that's one of the risks and things that I'm sure risk managers everywhere are struggling with right now, I want.
To flip to another risk that we mentioned at the beginning of the show, when politics. Obviously we've seen a lot of volatility around Mexico, around India, We're now going into very volatility in France and and obviously the US and you know even even Canada politics they were getting choppy. What do you how do you position for that? And you know, I mean again, Hedges, I mean, can you can you Hedge? Can you can you position for any of these things? I mean, that's that's just focus on the US. The significant change is implied by a Trump presidency for example.
Yeah, I mean obviously again for US, the focus is always going to be on on credit. I mean, our our cio Bruce Karsh always says, if you get the credit right, nothing else matters, and he's right. It's another way of saying, you know what, what our chairman Howard Mark said in his December twenty twenty two memo on the sea change. He spoke about these higher yields and your ability to earn them only if you can avoid defaults. So that really is kind of the first and foremost is thinking about, you know, how do these various regimes ultimately impact you know, our underlying barrowers' ability to pay. And I think Trump versus Biden and the is an interesting one. I mean, there are certainly some similarities. I think both will have you know, a higher deficit, a higher or you know, continued high deficits. That means that you know, there's going to continue to be a lot of issuance in the treasury market. Does that keep rates higher for longer? Do the threat of you know, increased tariffs maybe under a Trump presidency keep rates higher? I mean, it does make you again kind of think about how you position yourself and kind of maintaining that, you know, kind of mix, not not putting all of your eggs in one basket, which again I think a lot of investors have made the mistake of in the last couple of years getting a little too excited about the potential for interest rates to fall, leaning very very hard into duration assets, long duration assets, only to be disappointed. So I think the best kind of hedge you can have almost is to have a good diversified, you know, portfolio of these various exposures, two bonds, two loans, two securities that we talked about and making sure that you're not you know, leaning into just one sole factor that that you could easily get wrong. And I think nobody can really predict.
But Trump risk, higher inflation, FED independence potentially undermined, lower taxes, you know, demographic changes around immigration. How does that all shake out in credit markets if let's say the FED actually has to hike the next move.
Yeah, I mean a hike would definitely be a challenge for credit markets. You know, I think a lot of people are resigned to the fact that, you know, rates have peaked and they might stay high for longer, but at least we know the the next move is down. And I think again you need to really look at kind of where balance sheets are positioned today in which areas you know are most at risk. Again, you know, many of the things we've talked about today, and the answer to a lot of your questions has been that they're just there is no substitute for you know, digging in doing your credit work. And we're probably going to live in this kind of credit pickers market where we have you know, idiosyncratic defaults, whether it's you know, maybe idiosyncratic to a sector or an industry. As Mike mentioned, that could be driven by by policy, but you you really just have to be ready for for anything.
Other than that. The way and specifically in terms of like one opportunity, what's your edge? How do you How does oak Tree come out on top this year?
Well, I think the you know, one of the one of the things for oak Tree is that we've been a long time specialist in sub investment grade markets, and sub investment grade markets do tend to have higher yields, and I think, you know, being able to earn you know, a high amount of income has been a big benefit. The way I look at kind of higher yielding markets right now, that sub investment grade market is it has almost been a substitution for for equities. And you know, at times we've mentioned the ability to earn equity like returns. Others have said the same thing, and I think people confuse that sometimes by you know, implying that these these fixed income investments are going to equal their return of the S and P five hundred or the Nasdaq or other equity markets. But really what it means is, you know, where do these where do these investments have a place in your portfolio? And four or five years ago, many people were looking at equities to earn that kind of high single low double digit type return, and that is what you're getting today from these kind of higher yielding sub investment grade assets. That that income. That inability to time markets is really key in being able to kind of maximize your income over that period while avoiding the defaults and avoiding some of the trouble spots that we've discussed today. I think really is a key, and I think really is kind of where oak Tree has has maintained and gained its reputation over the last thirty years.
Does that mean buying triple C bonds?
It doesn't necessarily mean buying triple C bonds. I mean, if you look at the high yield market today, a little over seventy percent of that market trades with a spread below three hundred. Yeah, the index average is three point fifty. So you know, there are certainly, you know a number of single B rated bonds out there, single B rated loans, other structured credit securitized assets that we mentioned that can you know, kind of get you that yield maybe a little bit below where a triple C. But I don't think it's an environment where you do have to kind of lean into the riskiest parts of the market to earn that excess yield.
Great stuff, Wayne Doll, It's been a pleasure having you on the Credit Edge, Manny.
Thanks, thank you very much.
Wayne is co portfolio manager for oak Tree Capital Managements Global credit and investment grade solutions strategies. And of course we're very grateful to Mike Hollin from Bloomberg Intelligence. Thank you for joining us today.
Mike, great to be here.
For more credit analysis read all of Mike Hollins's work on the Bloomberg Terminal. Bloomberg Intelligence is part of our research department, with five hundred analysts and strategists working across all markets. Coverage includes over two thousand equities and credits and outlooks on more than ninety industries and one hundred market industries, currencies and commodities. Please do subscribe to the Credit Edge wherever you get your podcasts. We're on Apple, Spotify and all other good podcast providers, including the Bloomberg Terminal at b Podgo. Give us a review, tell your friends, or email me directly at Jcrombieight at Bloomberg dot net. I'm James Cromby, it's been a pleasure having you join us again next week on the Credit edge.
