How KKR finds the world's best investment opportunities
With nearly US$500 billion in assets under management, KKR sure know how to find winners. Now, you can hear about how they do it.
Every great investment house stands by three things: integrity, experience, and process. All these elements are put together to create a formula by which the best investors live. KKR's credit division has been around since 2004, and as partner Jeremiah Lane revealed to me, the way they seek out top investment ideas is as precise as they come.
The criteria for finding a great company's credit is simple but rare to find:
- Companies with durable cash flows
- Does it have any in-built downside protection?
- Is there a risk the company won't be able to honour its payments?
That process must count for something. Since the KKR Credit Income Fund was launched in Australia, it's paid out a cumulative distribution of more than 13%. And despite the torrid year that was 2022, the fund has still got a positive total return to report.
In this Expert Insights video, we're tackling the process and the opportunities within the credit market for 2023. You'll get to hear first-hand how one of the world's most influential money managers separates the great deals from the good ones.
Note: This series of videos was taped on Wednesday, February 8th 2023.
EDITED TRANSCRIPT
LW: What role will credit have in a diversified portfolio this year?
Lane: When we think about what opportunity has been available in credit in the last five years, we've seen both individuals and funds allocate away from credit just because the returns that were available were so paltry and when we look at the opportunity going forward, we think there is just much, much more return that's going to be available on a more sustainable basis for investors.
We see this as a time when investors are going to be increasing their exposure to credit. Both individuals and institutions will be increasing their exposure to credit and trying to rebuild some of that recurring income that historically played a big part of portfolios and it just diminished as part of portfolios in the 2010s because there was so little income available.
LW: What is one credit asset tipped for a big year?
Lane: We think that bank loans are more attractive than high yield bonds. When we think about what's happened in the rates market over the past two to three months, you've seen a big rally in the 10-year as market participants have gained conviction that The Fed was going to quickly stop raising rates and also would start cutting rates.
While the market has gained that conviction, spreads in high yield market have also come tighter, and so that combination to me feels somewhat overdone. I think that there's a scenario where if we continue to get strong economic data like we did last week with the jobs report, that market participants are going to have to capitulate on the speed with which they think The Fed is ending the rate hikes. And so, that's a risk for the high yield market.
On the loan side, we've haven't seen loans have less interest rate sensitivity, so they haven't rallied with the 10-year and we've really seen spreads stay at a wider level. They've rallied to some degree, but in a much more muted way.
And so, between those two asset classes, I like loans, the U.S. loan market better than the U.S. bond market.
I would also give a special mention for CLOs (collateralised loan obligations). These are portfolios of U.S. bank loans. It's a structure of credit, a structure, and we think some of those tranches are really attractive. Leveraged credit markets are traded loan and bond markets. There's also a private credit version of these markets. That's not where my team spends its time. Typically, these are businesses that are going to be sub-investment grade, so they're going to be rated anywhere from BB down to CCC. And, in many cases, they are private equity sponsor backed businesses. So, private equity sponsor identifies a business that they want to buy. They buy that business.
They put in 30 to 40% of capital to support the purchase of the business and then they borrow most typically in the loan market, although sometimes the high yield market, they borrow the remainder of the money against the cash flows of the business.
And so, what we specialise in is assessing the durability of those cash flows, the downside protection that these businesses have, and try to identify the opportunities that have strong durability of cash flow, the companies that will be able to have no problem paying us back and where we can earn an attractive spread for making those loans.
LW: What is your process for separating the great investment ideas from the good ones?
Lane: One of the things that we've developed since we started KKR Credit in 2004 is just a very structured investment process. So, we run a morning meeting every day where one of the analysts will report out the economic news of the day. One of our traders will report out trading environment that they're seeing in the morning. And, then individual analysts will highlight relevant news for all of the companies in their portfolios.
In addition to that, then my co-head of research, Terry Ing, and I will run a prioritisation meeting, so we sit down with all of the analysts once a week and go through how they want to allocate their time for the coming week, what businesses they're doing due diligence on, and what opportunities they're chasing down.
After that process, we have three types of investment committee meetings. We have a screening process where analysts can come with just the most rudimentary sketch of the opportunity where we can give them feedback on whether it looks interesting or not. We have office hours where we're expecting analysts to come with somewhat more prepared material. We expect them to have done more of the work assessing the durability of cash flow and downside protection.
Finally, we have our formal investment committee where they're coming with several pages that detail the way in which the company makes money, a three statement base case financial model, a downside case model. We ask them to inform the downside case model by looking at historical periods of stress in that industry.
And, then to the extent that we approve the credit and we end up investing in it, we then augment the monitoring with what we call our portfolio management committee. Once a quarter, the analysts update all of their models, submit those models, and we sit in a conference room for the better part of a week and kind of re-underwrite the portfolio.
Learn more about investing in credit
KKR Global Credit Opportunities Fund (GCOF) provides investors with exposure to KKR Credit's flagship opportunistic credit strategy in an Australian unit trust hedged to AUD.
For further insights from one of the world's most recognisable names in private equity and alternative investments, visit the GCOF website.
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Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.
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Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.
Expertise
Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.
Expertise
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