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Private Credit Resilience Provides Opportunity for Yield

March 25, 2024 7 min 29 sec
Mitchell Goldstein
Ares Management Corp.
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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Mitch Goldstein, co-head of Global Credit at Ares, and I’m a partner. 

What role does private credit play in an investment portfolio, and how does it compare to traditional fixed income? 

What this asset class has proven without a doubt is how durable and resilient it is. It tends to provide hundreds of basis points of additional yield versus other asset classes. To compare ourselves with, is leveraged loans or high-yield bonds. And almost in any market, private credit is providing hundreds of basis points, 200-, 300-plus basis points of premium versus over leveraged loans and high-yield bonds. And we tend to do it in a safer fashion, we believe. 

Our defaults and then realized losses are a fraction of what you see in leveraged loans and high-yield bonds. So, when you put it all into the mix — higher yields, a safer asset class — it tends to perform, or better said, outperform almost any other fixed-income asset class. And again, with a group like Ares, you can test us and see how we’ve been doing it for a long time. It’s not as if this data is over two years or a small sample set. It’s billions upon billions of dollars over almost two decades that we’ve been doing this as a team. 

When should investors consider a private credit strategy? 

Well, maybe perhaps stating the obvious, we think investors should always be allocated to private credit. Again, it tends to outperform in almost all markets. It is less cyclical, as I said, it is less volatile. What we have found, most of our investors, once they get comfortable with the asset class and see how it performs and the consistency and the durability, and again, how it performs over all markets, benign markets, volatile markets, et cetera, they tend to start enjoying the yield. At its core, private credit is a yield product.  

As we all know, the aging population and the global demand for yield, what we have found is the sooner investors get invested in this asset class and start enjoying the yield, the more comfortable they become with it. Again, they see, as I stated, how durable and consistent it tends to be. 

How has this asset class performed in recent markets with interest rates rising, and how will it perform when perhaps central banks start cutting interest rates? 

We advise our clients to think about investing in this asset class over cycles. What the last couple of years have shown us is you enjoy higher returns as interest rates rise. Remember, we are a floating-rate asset class. As interest rates rise, our all-in yield increases. Obviously if interest rates decline, our all-in yield decreases. But always when you increase or decrease, you’re always still at a premium to other asset classes. 

When central banks raise interest rates or lower interest rates, it certainly affects our all-in yield, but as it does the entire fixed-income market.  

Today we are enjoying, as most people know, higher interest rates, excellent yields, low double-digit yields, and what is wonderful about this asset class most recently is the volatility in the markets allowed us to really invest in great companies at lower interest rates, better documentation, all the while enjoying these higher yields and higher spreads. 

We remain bullish on this asset class as we are seeing credit performance in the portfolio — it has been very resilient. In fact, we have stated publicly that our cash-flow growth, our EBITDA growth rates are actually accelerating. We have seen this asset class even through the volatile markets of the last 18 months, higher interest rates perform; our companies are performing. The industry certainly is performing, and we remain very bullish on this asset class throughout the rest of the year. 

What kind of diligence should advisors and investors perform before actually pulling the trigger investing in the asset class? 

Our strong advice is to get to know the manager. We make ourselves certainly available to investors. Do your work. Has the team been together over cycles? It’s very easy in benign markets for all managers to perform. In fact, that tends to be what happens. When there’s not a lot of volatility, all boats rise. Our advice is find a manager that has been together over cycles, have invested through benign markets and volatile markets, not a lot of turnover in the team, and has invested not just a couple hundred million dollars over a short period of time, but billions of dollars over an extended period of time. Make sure you invest with managers that have been doing this for a long time, not a lot of turnover in the team, and that have a proven track record in all types of markets. 

We tend to invest in non-cyclical companies. Companies with high margins, high free cash flow. What types of companies won’t you get in the portfolio? You won’t get low-margin cyclical companies: automotive, oil and gas, gaming, lodging, home building, housing, real estate. They tend to be consistent companies that perform in good markets and bad. 

An example of something like that is a company called Suave. Suave was bought by a private equity firm last year. It was a private equity firm that we have been doing business for over 20 years. This private equity firm specializes in corporate divestitures. They know how to buy orphan brands out of corporations, incentivize management, change strategy, invest in the brands where perhaps the brands were not being invested in properly, and then growing those brands, and then finally making acquisitions and diversifying the portfolio. 

We backed this private equity company for the purchase of Suave. It was purchased out of Unilever. Hopefully, people recognize the name; a large global consumer products company. This was one orphan brand that was underinvested. Still an iconic brand. Most people know about it. Consistent cash flows, but perhaps not growing as Unilever wanted it to grow and decided to divest it. We helped this sponsor buy it. We like these types of iconic brands that are consistent revenue generators and cash-flow generators. The cherry on top of this cake is that Suave and this private equity firm have announced that they are buying Chapstick, and it is our hope that this portfolio will continue to grow. 

What is amazing about our business, just taking another step back, is that 50% of what we do year in and year out comes from our existing book of business. We call it the power of incumbency. We tend to stay invested with our best credits, and these are companies we know for three, five, 10-plus years in certain times. We know how management performs in good markets and bad. 

You combine this investment philosophy of non-cyclical companies with the benefit of being able to invest in your best companies, and that’s really what drives a lot of the growth within the Ares model.