Integrated Asset Management’s private debt group has been active in the Canadian investment grade loan market for more than 25 years, so it comes as something of a surprise when chief investment officer Don Bangay describes the investment opportunity in the country as if it were an emerging market.
“It’s something that’s emerging and becoming clearer and clearer,” he says, commenting on investor demand from Canada’s private and public pension systems.
It wasn’t always so.
Integrated Private Debt (IPD) – previously known as First Treasury – was acquired by Integrated Asset Management in 2000, having established its reputation managing loan assets on behalf of trust and insurance companies. When the insurance and trust industry consolidated around the turn of the century, the firm shifted its business model and began raising Canadian dollar denominated investment funds from the country’s private and public pension systems, which it then put to work providing loans to investment grade companies in Canada’s mid-market.
“We found ourselves in the uncomfortable position of having, (A) not enough customers and (B), being in a place where we were doing a lot of the work, originating and managing the portfolio, but we did not have the credit authority. We were forced to syndicate every loan we did,” says Bangay, who has been with the firm since 2001.
The investment staffs of Canada’s public pensions are generally considered to be forward thinking in their management of alternative investment portfolios, but even the most progressive institutions need time to evolve. And although the steady yield enjoyed by investment grade companies’ creditors in Canada’s even-keeled mid-market should have been an easy sell to investors, reaching critical mass in demand proved to be a difficult process through the first few years as a part of Integrated Asset Management.
“We referred to it as missionary work, really, because we were taking a… new asset class and a new manager, knocking on the door of mid-sized pension plans [and] educating them [on] a fixed income investment opportunity that would provide them with significant yield pickup without compromising credit quality,” says Bangay, describing the marketing effort for its debut fund, which closed in 2005.
“It was a long sales cycle, not because people weren’t interested, but primarily because of inherent structural and process issues. Pension plans are quite prudently managed with respect to changing investment policies. They have trustees that make the key decisions and within many of these organizations the decision timeline was 12 to 24 months, so it was a slow process,” he says. “It took about two and a half, three years to raise that first fund. But once we got those people onboard, they have been loyal customers and repeat customers as we’ve sequentially gone from fund to fund.”
For its part, IPD has given investors good reason to stick around through Funds II, III and IV, which closed last year. Fund returns have bested what one would normally find on investment grade bond indices, which has allowed IPD to expand its investor base to a point where it will expand to include international LPs in the near future. IPD has raised more than $1.3 billion since 2005.
Of course, the firm’s success owes itself to a core strategy that has remained constant through IPD’s growth over the last decade. Private loans provided by those funds have tighter covenants than those on public bonds. This adds another layer of security on what is an already investment-grade asset. Furthermore, interest rates on those loans tend to be greater than those typically found in the public market, which translates into elevated returns for fund investors. But the real secret to IPD’s success lies in its origination of investment grade lending opportunities from Canada’s surprisingly fertile mid-market, says the firm.
“It surprises us all the time, that we don’t have more direct competitors, because it is such an attractive space,” says managing director Theresa Shutt, who is being groomed to replace Bangay when he retires. “As a result of that, there’s market inefficiency, which gives us our higher yield. We’ve found we have a great deal of success originating unique lending opportunities in the mid-market space.”
Canada offers a relatively stable economy, a legal framework that supports the rights of creditors and a roster of corporations with healthy balance sheets. The opportunity set has been further amplified by the onset of banking restrictions similar to those being implemented in the US and Europe, says firm president Philip Robson.
“The Canadian banks too are subject to the strictures and the rules of Basel II and Basel III. The impact that is having on their balance sheets and how they lend money is causing the banks to be increasingly focused on shorter tenors, [which] provides an opportunity for other institutions to provide long-term money,” he says.
That trend is particularly relevant to the firm’s latest fund, which is targeting opportunities in long-term project finance.
“That was a market in Canada that for a long time was dominated by the European banks here, but they have all gone home,” he says.
Within the corporate loan sector, IPD’s size relative to that of the banks has allowed it to operate with greater freedom and agility, which in turn has improved its due diligence of credits, giving them more time to prepare for what the team dubs, “bumps in the night”.
“We have rigorous and consistent post-closing monitoring processes and in-house skills to be able to deal with the bumps in the night that occur during the holding period,” says Bangay. “That significantly reduces credit risk, which from our customers’ point of view is a very good thing.”
IPD’s due diligence and investment process is an intense one, which sometimes leads to “lively debate and discussion. We don’t say yes on every deal,” says Shutt. “Our clients are our investors, and we have to be comfortable that it’s investment grade, that we’ll get our money back.”
When considering an investment, the firm takes several factors into account before determining whether the mid-market company they are considering is truly investment grade.
“We’re looking at historical financials, cash flow volatility as well as the future prospects for the business and its industry. If we suspect the cost structure isn’t as efficient as it should be, if it’s a borrower in a heavily cyclical industry – how are they managing that? We’ll look at the historical performance, how they’ve fared,” says Shutt. “A significant factor we evaluate is the depth of experience and expertise of management teams, you’re not just betting on the horse, you’re betting on the jockey. At the end of the day, the management team is key.”
The latter point is one of particular emphasis for IPD, and the firm is quick to point out that its investment staff has seen relatively limited turnover during its life. Even as Shutt prepares to take on the role of CIO and IPD prepares for the possibility of expansion into new markets, its dedication to its core principles remains key to its ability to differentiate itself as private debt takes on a bigger role in the global investment marketplace. The team is working diligently to transfer its culture and principles to those younger members who will be the next generation of leaders in IAM.
“We renamed ourselves in 2005 when we closed the first fund. We previously had been known as First Treasury,” says Robson. “We thought it was appropriate to come up with a name that would align us more closely with our publicly traded parent company, and would also say something about what we do. So we called ourselves Integrated Private Debt. We then spent the next six years explaining what ‘private debt’ actually meant. Now we find ourselves saying, ‘well, we’re not like those other guys in the private debt space. We are a buy and hold investor with a solid track record in building and managing investment grade-like portfolios for institutional investors. We’re different.”