Asset TV U.S.’s Post

Transcript

Welcome to this Asset TV Alternatives Master Class. I'm Michelle you. Thank you so much for joining us and we're going to have a great discussion today and get great insight from our guests. Joining us, we have Troy Gayeski, CFH Chief Market Strategist at FS Investments. He serves as the Chief Market Strategist for FS Investments and is also responsible for research generation positioning. And conveying the FS Investments suite of alternative investments in today's marketplace. And we also have in studio Shiloh Bates CF a Chief Investment Officer at Flat Rock Global. He joined Flat Rock Global in 2018 and is a partner and Chief Investment officer. And prior to that, Shiloh was a managing Director at Benefit St. Partners where he worked on corporate acquisitions. Thank you both for joining me gentlemen. And I want to start off by just having. Both of them give a high level overview of their firms and how they fit into the alt ecosystem. Shiloh, I'm going to start with you. Yeah, great. So at Flat Rock we manage about a billion dollars and we have three different funds. One fund provides exposure to middle market loans, a second fund provides exposure to Co middle market double B's and the 3rd is a Co equity fund. Now we got we started in business a little bit over seven years ago. And so to get a little bit over a billion dollars in AUM today, we've been growing at a very measured pace. We've been highly selective in the assets that we put on and we've been really focused on the track record at the end of the day. So I think some of the things that differentiate us from our peers are one, again this hyper selective slow growth approach. We think some of the other asset managers in the business are more asset gatherers rather than. Firms that are providing great returns for investors at the end of the day. And then we're also differentiated. We're going to talk a little bit about close today. The overall CLO market is about 1 trillion and most of that is broadly syndicated loan Clos, which is 90% of the universe. At Flat Rock, we actually focus on middle market Clos, which is the 10% of the universe. So that's our little niche and and expertise in the market. All right, Troy spotlights on you. All right, let's let's roll life story time yet. Life story time yet. Yeah. So inside joke for for the viewers know so FS investments were focused on alternative investments. We managed approximately $80 billion in total assets of plus across a wide range of strategies. You know, the firm was really founded back in 2007 with the mission to democratize alternatives to to bring strategies that once were only available to large endowments or foundations sovereign. The funds to accredited investors as well as smaller qualified purchasers. You know over time we we've evolved to be also institutionally focused with our recent purchase of portfolio advisors or merger with portfolio advisors I should say which is the 40 billion plus alternative asset management firm focused almost exclusively on middle market private equity with a little market, a little bit of middle market private credit as well. And so if you think about our firm what we're always. Trying to do from a platform standpoint, meaning there are some strategies that we run 100% in the house. There are some strategies that were the advisor with the sub advisor or Co advisor and there there are a few that we have very little direct investment oversight in. We're trying to think of a platform approach and and figure out the best way to deliver either income growth or diversification in as user friendly as structure as possible. So. Only one example that is we manage the largest senior spirit commercial real estate lending franchise that's packaged as a public non traded Reit's. You know most investors when they think are real estate focused on real estate equity. We have a very large footprint in commercial real estate lending and this is really important times like today we're real estates clearly been in a correction and you want to be senior in the capital structure where you not only have less risk, but you earn more income and. More total return potential. You know, another example would be middle market private equity. We'll get into some of the weeds of this in a bit, but if you think about the growth engine for the US economy, so much of it is driven by privately held firms that have somewhere between 5:00 and $100 million of EBITDA. You know, in fact 96% of all companies in America that have 100 more employees or privately held and there's been tremendous growth here. Percentage number as public market issuance has declined in in the amount of companies that trade publicly has declined. So you know, the idea there is how do you generate growth for investors away from mega cap tech, right, which most investors own. And we're very confident that middle market private equity should be able to provide a complementary growth solution without all the wacky volatility that you tend to get in publicly listed markets. So we're very proud to help democratize the asset class. We have a wide range of strategies to solve for growth, income, more diversification, and I can't wait to get more into the weeds with you. By the way, Troy, how can advisors consider putting cash to work to substantially increase total return and income without taking uncomfortable levels of risk here? Yeah. So it's really interesting when you think about alternative use cases. So I'm gonna date myself a little bit here. I've been in this business since April of 2001 and really from the early stages of the last decade through up till arguably 2016, 2017, you know, the principal use case for alternatives used to be either an equity compliment or an equity replacement. And of course so much of that was driven by the experience of the last decade, remember where equities were flat over a 10 year period and he had two. Really nasty bear markets. You know, it's benefit of hindsight looking back, obviously if you timed that wrong, you left some money on the table, you have a good outcome, but but obviously the S&P 500, NASDAQ, we've done tremendously well over most of the last 10 to 15 years. You've notable exceptions. By 1670 through today, you know, the use case really evolves as a fixed income replacement or compliment and that's been a huge Grand Slam for everyone. I mean, the fixed income has been incredibly challenging. The Barclays AG is, you know, basically flat over the last five years with a lot of volatility, you know, horrific 20/20/22 for instance. It's still disappointing gains this year, but what we're seeing really the last, call it 9 to 18 months is the use case of all has evolved. To enable investors, whether you're large institutions or smaller accredited investors and even those that are below that standard, to figure out how to put these massive cash files that have been built up since the pandemic and even starting prior to the pandemic. Where you can meaningfully increase your total return again, go from let's call it 5 to 5 1/2 and then money market or if you're rolling three month T-bills or a preferred bank savings program to to hopefully making somewhere in the high single digits to low teens without again taking uncomfortable as at risk. So you know, if you invest that in a volatile asset class or volatile equity position, you know, and you tie the entry wrong, you know you can have a. Take a real digger for a while if you think about a lot of folks this cycle have reached out for duration at an opportune times and gotten spanked or smoke by various spare sweeteners, here you certainly trading liquidity cash. There are lockups associated with these vehicles, but you can meaningfully increase your total return and or income without taking uncomfortable levels of risk like Chase and the S&P at 21 1/2 times Ford earnings right now, which is highly. Elevated or or investing in duration and really hoping and praying that something really bad happens the US economy or markets does that's really the only case where you have meetings upside. So we we think today and over the next three to four years, you know some of that 2.6 trillion, 2. 7 trillion in money market funds will will gradually get deployed and really the first stop should arguably be an alternative strategy that can provide those attributes. Now Shiloh wrote a book on CLO investing, specifically Co equity and B notes why these two areas in particular? Tell us more about that. Sure. So the genesis of the book was that in 2020 I realized I had some free time on my hands and I wrote a 60 page white paper on cello investing and I put it on our website. And wasn't sure how many people would read it, but it turns out that I think it really made its way around the market. And that kind of gave me the idea to really, you know, write, write a full book. And, you know, when writing a book about the asset class that you're investing in, you find that a lot of the material you've already written at some point or another, it was something that appeared in a in a marketing deck or in Q&A with, with, with investors. And so, so I finished that that last year and you know, close again today. It's a $1 trillion asset class and nobody had written a book on CLO. So, so I took the opportunity and for people who haven't read the book, you can easily Google Cielos find a lot of information out there. But this is designed to be the one stop shop for your, for your CEO needs. Now, in terms of how I, you know why I tackle double B's and equity in particular, those are the securities. We invest in at at Flat Rock that that's one, but also in the Cielo capital structure, about seven or eight different securities are sold. And the debt securities are rated AAA all the way down to double B. So the double B is the junior most debt security and then equity takes the most risk in, in a CL. And so my, my view is that if you can understand the double B, then you're also really going to understand the triple B and, and all the way up the stack. Now equities are different. It tends to, you know, March to its own drum. But if you understand double B's and equity, you should be able to understand. Close in, in total is is my view. Now, there is a misconception between Clos and CDOs. They do have structural similarities, but they are different. I want to point that out. Can you tell the audience a little bit about that? Yeah. So the nomenclature is very similar, just one letter different. But everybody or lots of people watched The Big Short. I love the movie. I read the book a few times actually, but the CDO's in that. In that movie, the underlying collateral was subprime mortgages of dubious credit quality. And so securitization, which is used both by CDOs and Clos, it's a very sharp tool. It's powerful. But if you're not securitizing high quality assets, the outcome is going to be poor. So in the case of close, what we're securitizing is first lien senior secured bank loans to large US corporations usually owned by private equity firms. And so these loans have been around for about 30 years. They performed very well over this this time period. And now again, with the Cle market being a trillion dollars in AUM, what investors have realized is that, you know, very different from the failed CDO's of the past. One example I look like to give is that if you bought as CC DO AAA before the financial crisis, most likely it defaulted and the recoveries. Were pretty minimal. And if you in contrast bought a cello equity piece which takes the most risk in the CLO and you bought that in 2007 and you held it 10 years or so, you would have clocked an IR in the high 20s. So that's the performance difference of these two, two vehicles to see if I could jump in really quick, I would agree wholeheartedly that. When you look at securities, tradable securities Clos have offered excess return per unit of risk over the last 10-15 years. You've been through downturns and and you know, probably kick out of this number going on Bloomberg was June of 22, you know, when financial conditions are tightening and there was a lot of concerns about recession and I've made the argument that, you know, double BCLO's had incredibly attractive risk adjusted returns right here. Displays and lighting and yields have gone up and if you're earning you know 12 to 15% in yield, you can tolerate much higher default rates than one would expect. And you Fast forward the clock to today, you know Co double B sets that time and since October really offered tremendous return. So in in the strategies that we focus on that are focused on securities as opposed to private assets like equity, private loans to commercial real estate, private middle market loans. That has been and continues to be one area very bright opportunity. So well done Shiloh building your business focused on that. Well, the CEO, the CEO Double B just to be to be clear today it's floating rate and it offers yields of over 10%. And if you look back over the last 30 years, the default rate on these assets is about 25 basis points per year. So we see that as very attractive risk adjusted returns to to Troye point. Well, I want us to go into a little bit more detail about. ELO equity, how it performs, how much is added on by the alpha from managers Shiloh.