For the optimists who have flagged the swivel from fixed income into the more illiquid asset class, the announcement that Oppenheimer was ready to start ramping up its credit partnership with Apollo was perfect proof of concept.
OppenheimerFunds’ Global Strategic Income Fund (GSIF), which had $5.8 billion in assets as of the end of September, has signed Apollo Global Management on as sub-sub-advisor. Apollo will source a range of different private credit assets for GSIF and ramp up the allocation to 3-4 percent of the fund.
That process will take six to nine months, says Kamal Bhatia, senior vice-president and head of investment product and solutions at Oppenheimer.
The partnership is structured as a separately managed account with Apollo, customised to the specific requirements of GSIF. The capital provided by GSIF will be committed to opportunities sourced by the credit specialist alongside its other investors and pooled funds.
GSIF traditionally focuses on fixed-income investments aiming to maintain low volatility. The new agreement will give the vehicle exposure to structured credit, mid-market loans, direct real estate investments and insurance-linked securities.
Oppenheimer’s own portfolio managers will select the weightings they want from within that basket of private credit opportunities and the various teams at Apollo will select and allocate the assets, says Adam Rochlin, senior vice-president and product director within Oppenheimer’s taxable fixed income and alternative strategies group. Rochlin negotiated the terms of the agreement with Apollo.
As of 30 June, GSIF was 46 percent invested in high-yield corporates, with investment grade corporates and securitisation both at 17 percent, the next highest asset allocations. The vehicle has returned -2.06 percent over the last 12 months, as of 14 October, according to Morningstar.
And that brings us to the heart of the matter. Fixed income is not delivering the necessary yield.
GSIF has always been innovative, say Bhatia and Rochlin, adding that it was one of the first mutual funds to begin investing into bank loans. The firm started scouting for alternative strategies that would boost their falling fixed-income returns, but still fall within the fund’s low risk, low volatility mandate.
Oppenheimer analysed infrastructure and other real asset strategies as well as more esoteric alternative investments before concluding that private debt was the best option. Many of the other alternatives introduced too much equity-like risk for the fund’s appetite, says Bhatia, while private credit also offered a wide range of sub-sectors so the firm could mix mid-market direct lending in with more opportunistic loans alongside secured real estate finance.
They were in negotiations with around half a dozen global debt managers but opted for Apollo.
One of the great attractions of Apollo was Oppenheimer’s view that the firm would deliver top-class performance across the full range of credit sub-sectors that GSIF wanted to be able to tap into.
“[Apollo was] clearly a manager very much focused on the credit spectrum, that had an excellent track-record and had a very strong legacy of managing these assets through both bull and bear markets,” says Bhatia. “And they have a very deep team that could work with us.”
Along with that experience, Apollo’s depth of origination also convinced the mutual fund. And when performing due diligence on a credit manager, Rochlin argues that assessing their origination capability is one of the most important factors.
“There’s a lot of money chasing after alternative credit strategies, whether it’s middle market loans, commercial real estate, opportunistic credit. So one of the keys is we need to work with someone with very good origination sources. When you compare Apollo to some other players, they’re among the top tier. They are networked into seeing deals across the spectrum,” Rochlin says.
SHOW ME THE MONEY
Yields are key to this leap into illiquid alternative credit, but both Bhatia and Rochlin say that the agreement with Apollo does not outline a specific yield target, not even a blended projection. The credit weighting mix is in the hands of GSIF’s portfolio managers so it is easy to understand that a precise figure may be hard to project, but the Oppenheimer guys remain tight-lipped on even the range they anticipate.
The return boost expectation must be there, though, because asked about the future, Bhatia says that he can envision the GSIF alternative credit allocation doubling over time.
As a regulated mutual fund, GSIF is capped at a 15 percent illiquid allocation and Bhatia says that they have no desire to risk coming close to that limit. But Oppenheimer has a number of other vehicles that could consider putting a portion of their assets into credit, he notes.
The partnership, which was constructed with customisable open architecture, is now in place, adds Rochlin, meaning it can be replicated elsewhere.
“There are a lot of folks in the private debt universe that would like to access retail/ultra-high net worth investors,” says Rochlin.
He’s not wrong. Asked about the Oppenheimer deal on Apollo’s fourth quarter 2014 earnings call in February, Apollo chairman and chief executive Leon Black said that credit is the alternative investment option most likely to benefit from retail investor capital.
“The retail investor is getting wise about this and saying why is it that endowments should be allocated kind of 30 percent to alternatives? Why is it that sovereign wealth funds and state pension funds should be allocated 10-15 percent alternatives, and why am I only allocated 1 percent? And so how do I get part of this?” said Black.
Tracking GSIF’s performance over the next couple of years will be a telling exercise. Can a private debt bump signal the return of positive yield for such a massive vehicle?
The other big question is whether the current low-yield environment continues long enough for a significant enough volume of mutual funds and other fixed-income investors to swivel their investments. Oppenheimer has been working on this all year and only began ramping up investments at the start of October.
So back to waiting to see if Fed chair Janet Yellen raises rates…
Oppenheimer has negotiated a graduated fee structure with Apollo. The credit manager will charge 90bps on allocated assets under $600 million, 85bps on allocated assets between $600 million-$1 billion, falling to 80bps on anything over $1 billion, according to a filing with the Securities and Exchange Commission. There is no mention of carry or other performance-related payments in the document.