Capturing opportunities in today's credit markets

Teiki Benveniste

Ares Australia Management

Structural shifts in capital markets since the “Global Financial Crisis” or “Great Recession” have caused market dislocations to become shorter and more frequent. As a result, investors are choosing to outsource allocation decisions to managers with strong market presence that are better positioned to manage risk and capitalise on investment opportunities as market conditions evolve.

Chart 1 illustrates market dislocations that have taken place during the 2000s, as defined by periods when the credit spreads here represented by option adjusted spread (“OAS”) for the broader high yield market (measured by the ICE BofA US High Yield Master II Index) increased above 700 before returning to the historical median of 500. The Great Recession, along with prior dislocations, lasted two or more years. Conversely, spreads retraced within six months of the March 2020 dislocation. As market dislocations become shorter and more frequent, a dynamic and flexible approach has become critical to capturing attractive relative value opportunities that arise in episodic periods of volatility.

Chart 1: 2000 - Present Day, Market Dislocations

Note: As of April 14, 2021. Represents opinions of Ares’ investment professionals only and should not be construed as investment advice. For illustrative purposes only. Dislocation defined as periods when high yield OAS increased above ~700 before returning to historical median of ~500. Source: The BofA US High Yield Master II Constrained Index (“HUC0”) OAS from January 1, 2001 through April 14, 2021. Please refer to endnotes for Index Definitions and an important index disclosure.

It is also worth highlighting that in non-traditional credit asset classes, active management is paramount to capture above benchmark returns. Unlike in equities or traditional fixed income, passive strategies in bank loans or high yield are often unable to adequately replicate benchmark returns due to model limitations. Over the course of 2019, 2020 and 1Q’21, the market presented very different investment environments. As illustrated below, during each of these periods, Ares was able to consistently outperform both broad market indices and larger ETFs in the loan and high yield sectors, underscoring the importance of a dynamic approach across asset classes but also active management within each of those sectors.

Chart 2: Active Management Remains Critical to Unlocking Value

Source: ICE BofA Indices, Credit Suisse Leveraged Loan Index, as of March 31, 2021. Past performance is not indicative of future results. As with any investment there is always the potential for gains as well as the possibility of losses. For illustrative purposes only. Please see endnotes for Index Definitions, an important index disclosure and for performance notes.

2020: A Banner Year for Relative Value Investing

2020 was a complex, tumultuous year for global financial markets. We believe there was no single “trade”, as managers had several opportunities to generate alpha through active asset rotation and disciplined credit selection. Even as markets recovered from the March lows, the rate at which spreads retraced varied significantly across asset classes, rating cohorts, and geographies as market conditions evolved, presenting ample opportunity for managers looking to take advantage of inefficiently priced segments of the market.

Chart 3: 2020 Total Return by Asset Type

Source: ICE BofA HY Index, Credit Suisse, JPM. Data as of December 31, 2020. The time periods shown were selected to illustrate the performance of various market environments during 2020, and may not capture all market scenarios during this time period. An investor cannot invest directly in an index. Please see endnotes for Index Definitions and an important index disclosure.

By actively repositioning our multi-asset credit portfolios as market conditions evolved throughout the year, we were able to capitalize on air pockets of volatility and capture relative value opportunities. Below is a summary of notable market themes during each of the periods illustrated above, and how we positioned our portfolios accordingly.

  1. Early Covid: After a strong start to the year, credit markets came under pressure in early March, as COVID-19 began to spread outside of China to the United States and Europe. As a result of elevated volatility, the Federal Reserve (“the Fed”) pre-emptively cut interest rates to near zero. In February, we raised cash across portfolios as COVID-19 became more serious to be well-positioned to buy any oversold investment opportunities.
  2. Covid Crisis: The global pandemic drove an economic standstill and as a result, global financial markets experienced a severe downdraft in late March. Amid heighted volatility, we rotated up in quality into high grade corporate debt, which sold off alongside sub-investment grade credit amid indiscriminate selling.
  3. V-Shape Rebound: Risk assets rallied as asset prices were buoyed by unprecedented stimulus from the global central banks. We took profits on our high-grade corporate debt exposure and rotated into investment-grade CLO debt securities given the long-run total return potential for the asset class and a yield premium to similarly rated corporate debt. While structured credit lagged the recovery seen in high yield bonds and bank loans, the asset class continued to make substantial gains since March lows amid improving technicals.
  4. Summer / Pre-election: Credit markets remained resilient and spreads continued to tighten while default expectations improved, as accommodative fiscal and monetary support overshadowed rising COVID-19 infection rates and elevated U.S. Presidential election uncertainty. We remained overweight corporate bonds and underweight loans, as bond technicals remained supportive amid strong primary issuance, fund flows and the Fed’s backstop.
  5. Risk Rally: The significant rebound from March lows continued as election and vaccine related optimism lifted investor sentiment, despite the resurgence of COVID-19 cases and social unrest. Most credit sectors traded at or inside pre-pandemic levels by year-end. Within our below investment-grade corporate debt exposure, we rotated into bank loans, as the asset class screened more attractive on a relative value basis than bonds, given their short duration, convexity profile and senior secured spread. In addition to the attractive yield, loans offer protection against both potential rising interest rates and a potential stalled recovery given the security of the asset class.

Our agile approach in 2020 underscores the importance of a dynamic and flexible approach in shifting market environments. Informed by quantitative analysis and fundamental research, our demonstrated ability to express relative value across the credit markets drove strong performance for our multi-asset portfolios in 2020.

Conclusion

The “sweet spot of credit” encompasses a $5.0 trillion opportunity set across the U.S. and European leveraged loan, high yield, and alternative credit markets. To be a successful investor in these markets, we believe one of the keys to success is to employ a dynamic approach with the flexibility to select the most attractive relative value opportunities. 

Learn more

Ares are experienced credit evaluators who take a value-oriented approach, using fundamental bottom-up research to identify investments that offer attractive relative value in comparison to their fundamental credit risk profile. Stay up to date with all our latest insights by clicking follow below. 


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Index Definitions Credit Suisse Leveraged Loan Index (“U.S. Bank Loans”) is designed to mirror the investable universe of the $US-denominated leveraged loan market. The index inception is January 1992. The index frequency is daily, weekly and monthly. New loans are added to the index on their effective date if they qualify according to the following criteria: 1) Loan facilities must be rated “5B” or lower. That is, the highest Moody’s/S&P ratings are Baa1/BB+ or Ba1/BBB+. If unrated, the initial spread level must be Libor plus 125 basis points or higher. 2) Only fully-funded term loan facilities are included. 3) The tenor must be at least one year. 4) Issuers must be domiciled in developed countries; issuers from developing countries are excluded. Credit Suisse Leveraged Loan Index Split BBB is a subset of the CSLLI and includes only split BBB issuers. It uses a single “blended” Moody’s/S&P rating to compute averages sorted by rating. Excludes split B because the split B loan index is heavily represented by one single corporate issuer. JP Morgan U.S. CLO BBB Index tracks floating-rate CLO securities in 2004-present vintages, rated BBB. Additional sub-indices are divided by ratings AAA through BB, and further divided between pre- and post-crisis vintages. CLO 2.0, or post-crisis vintages, include deals issued in 2010 and later. CLOIE utilizes a market-value weighted methodology. Inception date: July 15, 2014. JP Morgan U.S. CLO BB Index tracks floating-rate CLO securities in 2004-present vintages, rated BB. Additional sub-indices are divided by ratings AAA through BB, and further divided between pre- and post-crisis vintages. CLO 2.0, or post-crisis vintages, include deals issued in 2010 and later. CLOIE utilizes a market-value weighted methodology. Inception date: July 15, 2014. The BofA US High Yield Master II Constrained Index (“HUC0”) tracks the performance of US Dollar denominated below investment grade corporate debt publicly issued in the US domestic market with a maximum issuer exposure of 2%. The returns of the benchmark are provided to represent the investment environment existing during the time period shown. For comparison purposes the index includes the reinvestment of income and other earnings but does not include any transaction costs, management fees or other costs. The ICE BofA BBB US Corporate Index “C0A4”, a subset of the ICE BofA US Corporate Master Index tracking the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market. This subset includes all securities with a given investment grade rating BBB. When the last calendar day of the month takes place on the weekend, weekend observations will occur as a result of month ending accrued interest adjustments. Note: This may contain information sourced from Bank of America, used with permission. Bank of America’s Global Research division’s fixed income index platform is licensing the ICE BofA Indices and related data “as is,” makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the ICE BofA Indices or any data included in, related to, or derived therefrom, assumes no liability in connection with their use and does not sponsor, endorse, or recommend Ares Management, or any of its products or services. Performance Notes Active Management Remains Critical to Unlocking Value 1. As of March 31, 2021. Total returns include the reinvestment of dividends and other earnings from securities or other investments held by the portfolio. Returns are unaudited and as with all unaudited estimates, they are subject to uncertainties and variations and may not be predictive of final results. Past performance is not indicative of future results. The performance inception date is December 12, 2008. Gross returns do not reflect the deduction of management fees or other expenses. Net returns are calculated by subtracting the applicable management fee and other expenses from the gross returns on a monthly basis. The fee schedule used in the net return calculation is as follows: 0.50%per annum. Returns are expressed in US Dollars. The Ares Institutional Loan Fund ramped close to half a billion dollars from December 2008 through August 2009, the resultant cash drag of which contributed to an underperformance of 1,000 basis points versus the CSLLI. Since being fully ramped, Ares ILF has outperformed the CSLLI by approximately 1,890 basis points on a gross cumulative basis as of March 31, 2021. Index provided for comparison purposes only. The benchmark for Ares Institutional Loan Fund is the CSLLI. Benchmark returns are provided to represent the investment environment existing during the time period shown. The returns for the Credit Suisse Leveraged Loan Index include the reinvestment of income and other earnings, but do not include transaction costs, management fees or other costs. 2. Invesco Senior Loan ETF (“BKLN”) invests in the fixed income markets of the United States. It primarily invests in high yield U.S. dollar denominated senior loans including leveraged loans, bank loans, and/or floating rate loans issued by banks and other lending institutions with minimum initial term of 1 year. The fund seeks to replicate the performance of the S&P/LSTA U.S. Leveraged Loan 100 Index, by using representative sampling technique. 3. As of March 31, 2021. Performance for High Yield Bonds is represented by the U.S. High Yield Composite, which includes all actual, fully discretionary, fee-paying, separately managed portfolios that primarily invest in U.S. high yield fixed income securities and are benchmarked to the ICE BofA US High Yield Master II Constrained Index (“the HUC0”). Benchmark returns are provided to represent the investment environment existing during the time period shown. The returns for the ICE BofA US High Yield Master II Constrained include the reinvestment of income and other earnings, but do not include transaction costs, management fees or other costs. Portfolios in the U.S. High Yield Composite have an emphasis on capital appreciation and income. The benchmark for the U.S. High Yield Composite is the ICE BofA US High Yield Master II Constrained Index, which tracks the performance of U.S. Dollar-denominated below investment grade corporate debt publicly issued in the U.S. domestic market with a maximum issuer exposure of 2%. The inception date of the U.S. High Yield Composite is May 2007. Investment track record of 15+ years dates prior to composite inception when Ares managed syndicated loans and high yield assets as part of its CLO strategy. Actual fees of the portfolios in each composite may vary depending on, among other things, the applicable fee schedule and portfolio size. Composites may contain accounts with performance based fees. Investment management fees are described in Part 2 of the adviser’s Form ADV. All returns are expressed in U.S. Dollars. Performance is preliminary and subject to change. 4. The iShares iBoxx $ High Yield Corporate Bond ETF (“HYG”) seeks to track the investment results of an index composed of U.S. dollar-denominated, high yield corporate bonds. REF: AAM-00125 DISCLAIMER The information in this publication is current as at the date of publication and is provided solely by Ares Management LLC (Ares). Ares is exempt from the requirement to hold an Australian Financial Services Licence. Ares is subject to regulation by the Securities & Exchange Commission of the United States of America under US laws, which differ from Australian laws. None of Ares Australia Management Pty Limited, Fidante Partners Limited, nor any of their associates, has prepared the information in this publication and accept no liability whatsoever in relation to it. This publication is only made available to 'wholesale clients' or 'sophisticated investors' under the Corporations Act 2001 (Cth) in Australia. This publication has been prepared without taking into account any person's objectives, financial situation or needs. Any person receiving the information in this publication should consider the appropriateness of the information, in light of their own objectives, financial situation or needs before acting on the advice. Persons receiving this information should obtain and read any disclosure document relating to any financial product to which the information relates before making any decision about whether to acquire that product. No reliance: This publication is provided to you on the basis that it should not be relied upon for any purpose other than information and discussion. The publication has not been independently verified. None of Ares, Fidante Partners Limited, Ares Australia Management Pty Ltd, nor any of their respective related bodies corporates, associates and employees, make any republications, warranty or undertaking (express or implied) and accepts no responsibility for the adequacy, accuracy, completeness or reasonableness of the publication or as to the performance of any product. The information contained in the publication does not purport to be complete and is subject to change. No reliance may be placed for any purpose on the publication or its accuracy, fairness, correctness or completeness. None of Ares, Fidante Partners Limited, Ares Australia Management Pty Ltd, nor any of their respective related bodies corporates, associates and employees shall have any liability whatsoever (in negligence or otherwise) for any loss howsoever arising from any use of the publication or otherwise in connection with the publication. Any forward-looking statements in this publication: are made as of the date of such statements; are not guarantees of future performance; and are subject to numerous assumptions, risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Ares undertakes no obligation to update such statements. Past performance is not a reliable indicator of future performance. Confidentiality and intellectual property: This publication is confidential and may not be copied, reproduced or redistributed, directly or indirectly, in whole or in part, to any other person in any manner. Risk: no person guarantees the performance of, or rate of return from, any product or strategy relating to this publication, nor the repayment of capital in relation to an investment in such product or strategy. An investment in any such product or strategy is not a deposit with, nor another liability of, Ares, Fidante Partners Limited, Ares Australia Management Pty Ltd nor any of their respective related bodies corporates, associates or employees. Investment in any product or strategy relating to this publication is subject to investment risks, including possible delays in repayment and loss of income and capital invested. Disclaimer - Fidante Partners Fidante Partners Limited ABN 94 002 835 592 AFSL 234668 (Fidante) has entered into arrangements with Ares and Ares Australia Management Pty Ltd ABN 51 636 490 732 (AAM), in connection with the distribution and administration of financial products managed by Ares or AAM. In connection with those arrangements, Fidante or AAM may receive remuneration or other benefits in respect of financial services provided by the parties. Neither Fidante nor AAM are responsible for the information in this material, including any statements of opinion. AAM is an Authorised Representative No. 001280423 of Fidante and is in the process of seeking its own Australian financial services licence. Ares is exempt from the requirement to hold an Australian Financial Services Licence. Ares is subject to regulation by the Securities & Exchange Commission of the United States of America under US laws, which differ from Australian laws. None of Ares Australia Management Pty Limited, Fidante Partners Limited, nor any of their associates, has prepared the information in this publication and accept no liability whatsoever in relation to it. This publication is only made available to 'wholesale clients' or 'sophisticated investors' under the Corporations Act 2001 (Cth) in Australia.

Teiki Benveniste
Head of Ares Australia Management
Ares Australia Management

Mr. Benveniste is the Head of Ares Australia Management and acts as a client portfolio manager for Australian investors. Prior to joining Ares Australia Management in January 2020, Mr Benveniste spent six and a half years at Macquarie Group...

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