Loan Note: Time for a portfolio allocation rethink; lenders struggle to engage borrowers on ESG

A KKR paper suggests the traditional portfolio allocation model needs replacing – and alternative assets stand to benefit. Plus: the challenges of engaging with borrowers on ESG and signs of an uptick in defaults. Here's today's brief for our valued subscribers only.

They said it

“It’s going to be hard because inflation is going to scare the living hell out of everybody. We have a problem we have to deal with”

US President Joe Biden speaking at a Democratic Party fundraiser in Chicago, quoted in The Guardian.

First look

Portfolio allocation under scrutiny: alternative assets should claim a slice (Source: Getty)

KKR: Why the 60/40 model needs rethinking
A new piece of analysis from fund manager KKR suggests that the classic 60/40 stocks/bonds portfolio construction model may have had its day in the face of a challenging new environment. The model needs to find a way of incorporating alternative assets, the firm argues.

In a way, it seems like something of an uphill argument. As KKR admits: “In today’s world of heightened uncertainty in the global capital markets, the natural inclination for an asset allocator might be to go back to what has worked or seemed ‘safe’ in the past.” The safe impulse is the traditional 60/40 mix.

Moreover, up to now, the performance of the traditional approach has been strong. Quoting Bloomberg data, the paper reveals that the 60/40 portfolio has delivered 10-year and three-year returns of 11.1 percent and 17.5 percent, respectively.

So why change? In KKR’s view, the past holds few clues to the future. Beset by rising interest rates, higher levels of inflation, slower economic growth and heightened geopolitical risk, we have a new situation that KKR describes as one of “regime change”. It believes that 60/40 returns will be lower going forward as bonds “no longer serve as shock absorbers or diversifiers when paired with equities”.

The good news? More alternative assets. KKR advocates for something akin to a 40/30/30 model, in which 20 percent is taken from the traditional equities component and given to private infrastructure and private real estate, while 10 percent is taken from the traditional bonds component and given to private credit.

“It is not business as usual in the investment management business and now is the time for all investors to revisit their asset allocation game plan on a prospective basis,” says the paper, authored by Henry McVey, partner and head of global macro, balance sheet and risk and chief investment officer of the KKR balance sheet.

The struggle to engage borrowers on ESG
Private credit firms are finding it difficult to get the environmental, social and governance data they need from borrowers in order to keep investors happy, according to a new Insights report from the European Leveraged Finance Association.

The report found that a lack of ESG data availability is the main challenge, with managers having to press for greater disclosure. Investors told ELFA that in some cases borrowers were not responding to engagement attempts and, even if they did, subsequent actions were sometimes not satisfactory.

Investors said it was essential to raise awareness of why they need ESG data and how they use it in their investment decision-making process. The view from investors was that “businesses on top of their ESG profile and able to engage well on ESG topics with lenders demonstrate how well the management team is managing their business”.

Has the default cycle taken a turn for the worse?
After a continual decline from the 8.1 percent covid-triggered default rate in the second quarter of 2020, law firm Proskauer’s Private Credit Default Index is showing tentative signs that the trajectory may be heading up again.

Having tumbled all the way to 1.04 percent in the Q4 last year, Q1 2022 showed a slight increase to 1.12 percent. While the default rate for companies with more than $50 million of EBITDA remained the same as the prior period at 0.4 percent, that for companies with $25 million to $49.9 million of EBITDA climbed from 0.8 percent to 1.1 percent.

Despite the rate nudging upwards, Stephen Boyko, co-chair of the private credit group at Proskauer, was bullish in his assessment: “Although the headwinds in the economy continue to grow, private credit is extraordinarily resilient to macro forces, as evidenced by these historically low default rates.”

The quarterly index tracks the default rates of senior secured and unitranche loans, including data from 893 active US loans representing $144.4 billion in original principal amount.

Data snapshot

North America leads
Despite concerns over inflation and consumer confidence, North American debt funds continued to raise significant capital in the first quarter of 2022 with $24.2 billion collected, according to the Private Debt Investor Fundraising Report. Europe is lagging far behind with just over $2 billion raised. However, due to a very small number of large funds dominating the field it is expected that Europe will regain some ground later in the year.


CEO for Bellinger Credit
Sydney-based fund manager Bellinger Asset Management has appointed Greg Hampton as chief executive officer of its recently established Bellinger Credit business. Hampton will lead the credit strategy, focusing initially on secondary market debt and aviation lending “while also exploring credit opportunities in other real asset classes over time”.

Hampton has been in asset finance for 25 years within global banks, most recently as the executive in charge of National Australia Bank’s global asset finance business, having previously held senior roles at Royal Bank of Scotland, Bank of America Merrill Lynch and Commonwealth Bank of Australia.

PE backing for debt servicer
GLAS, a provider of institutional debt administration services, has received a strategic investment from mid-market private equity firm Levine Leichtman Capital Partners. Terms of the transaction were not disclosed.

Headquartered in London, GLAS has more than 180 employees across its global offices in the UK, US, France, Germany and Australia. Since inception in 2011, it has acted as an intermediary among borrowers, lenders and other deal parties in the global capital markets.

The firm was founded in 2011 to provide dealmakers with a commercial counterparty to step into complex situations. It has a portfolio of over $130 billion of assets that it services across its global platform, providing services to deal parties in bankruptcy, private credit, capital markets and leveraged finance.

Ex-American Capital duo team up at new GP
Altimer Capital has been launched as a new US manager targeting credit opportunities in digital transformation. The private credit and structured equity firm will offer financing solutions to support small and mid-sized companies “that provide or deploy technology to drive business agility and resilience”.

Altimer is a women- and veteran-owned firm led by Natasha Fox and Patrick White, former colleagues at alternative asset manager American Capital, which was acquired by Ares Capital in 2017. The firm will focus on the lower half of the mid-market, where the firm says deal activity has more than doubled in the past five years, driving a growing need for tailored capital solutions.

Prior to launching Altimer Capital, Fox was a founding managing partner of Avante Capital Partners, where she raised and managed two institutional funds and served on the firm’s investment and management committees. White was a managing director with Benefit Street Partners in San Francisco, where he led the firm’s credit investment activities in the Western US