Avoiding loss for the long-term
“The best way to generate alpha in the loans market is to avoid losses,” says Brian Juliano, managing director and head of the US leveraged loan team for PGIM Fixed Income, who joined the firm in 2003 as a CDO analyst. He also holds the positions of co-head of PGIM Fixed Income’s US collateralised loan obligation (CLO) business and portfolio manager for PGIM’s investments in CLO tranches.
“If you’re looking at historical recovery rates on defaults, the penalty for being wrong is much more severe than the benefit of being right. It’s a long-term strategy that delivers superior returns over multiple economic cycles,” he explains.
The firm’s flagship floating rate mutual fund, which seeks to maximise current income by investing primarily in senior floating rate loans, is designed for investors seeking to enhance diversification away from the traditional fixed income asset class. The fund has achieved impressive top quartile three, five and ten-year percentiles according to Morningstar data.
Meanwhile, the open-end mutual fund being rolled out across Asia is subject to investors’ ability to buy in a local jurisdiction. Indeed, PGIM’s customised institutional capabilities have been recognised in Asia Asset Management’s (AAM) Best of the Best Awards 2022, winning the firm the accolade of Best Regional Alternatives House of the Year: Bank Loans.
“Some clients have very specific constraints they need us to maintain, whether those relating to ESG, jurisdictional concerns, or the ability or inability to participate in certain domiciles around the globe. Our aim is to be as flexible as possible in the mandates we offer,” Juliano says in an interview with AAM.
Jumping hurdles
He admits that the past three years have not been easy – a global pandemic, followed by inflationary pressure and rising energy prices exacerbated by the humanitarian crisis coming out of Russia and Ukraine.
“It’s certainly a challenge when managing credit, because it’s hard to forecast cost inputs over the next six, 12 or 24 months when you don’t know how customer demand is going to react to prices,” he comments. “We see investors around the globe sitting back and trying to figure out what they want to do in the face of that uncertainty.”
Looking forward Juliano is positive. The retail bid, he says, is going to remain fairly robust for the next couple of years for loans, and institutional accounts are approaching with more frequency, with some institutions investing in loans for the first time in their history.
“Investors are becoming smarter about the features of loans, on the intricacies of the mechanics of how they work and how they settle, and how you have to set up an account differently in terms of whether it’s the ability to borrow against your underlying collateral so that you can make withdrawals faster than you can settle sales,” he explains. “Institutions – pension plans, endowments and sovereign wealth funds alike – are doing their due diligence, approaching their boards, and recommending loans as an allocation. Meanwhile, CLO creation will likely remain robust as the arbitrage appears more compelling following the price declines in late Q1.”
Describing PGIM Fixed Income’s strategy and what makes it stand out from its peers, Juliano returns to his advocacy for long-term performance.
“Many of our competitors feel the need to manage more high-octane portfolios, reaching for higher yields further out on the risk spectrum. Discipline and the avoidance of loss through the pandemic and now through the Russia/Ukraine crisis is what sets us apart. As much as it is tempting to take that extra yield, we have found more often than not that companies with inappropriate cap structures with no cash flow and those with highly leveraged coverage are not worth the extra 25 or 50 basis points of coupon,” he says.
And with 40 plus individuals dedicated solely to leverage finance credit research, many of them with more than two decades of experience, he is confident that his team has the experience to manage working capital for these companies through recessions.
Juliano’s advice to investors is simple:
“Within the landscape of the leveraged finance loan market today the skill of the manager is as important as it’s ever been. Investors need to do due diligence on the portfolio management team, the resources of those portfolio managers, the firm itself and the credit research skills of the research team. With all the uncertainty we have in the world today – whether that’s inflation, credit risk or geopolitical risk – credit selection, portfolio construction and risk management are more important in the investment horizon than they have been for at least the last ten years,” he concludes.