This article is sponsored by Schroders Capital
Can you start by giving our readers a picture of the speciality finance asset class that you are operating in, and the types of deals you are involved with?
One of the biggest challenges with what we do is helping investors understand the lane we are in, which is not commonly defined at this point. We use the terms asset finance or speciality finance, and we have an interesting twist on those that has evolved over time.
The team began as credit specialists across different asset classes, who in being together for more than two decades, have developed a common language to assess value across quite disparate groups of assets, and therefore have the flexibility to move across sectors based on that marriage of specialist expertise and common ground.
Most people think of private debt as corporate direct lending, real estate debt or infrastructure debt – at least those are the most established. We analyse debt secured by some kind of asset or receivable, so that might be a loan on real estate – as we do in the US – or it might be buying a pool of auto loans or leases. We look at assets like homes, buildings, cars, equipment, consumer debt, even financial contracts like insurance claims.
When we are considering opportunities we like to see some kind of inefficiency: a dislocation in the syndicated debt market, a lack of access to financing, or a need for capital to aggregate a larger grouping of assets for sale or securitisation. We like to move away from the crowds and find places where capital is not flowing efficiently.
But opportunity in a given asset can be present in both public and private markets. Being flexible as to how we access the asset means blurring the lines between what might have been considered fixed income or opportunistic income, with private credit or private debt.
This is not about timing markets, but about having the flexibility to move to where the market is affording opportunity.
It is our role to help our clients and partners understand how this type of investment can complement the more typical allocations in their investment portfolios, and to see the benefits this diversifying income can provide.
What is the background to the Schroders Capital securitised products and asset-based finance team? How have you seen the business grow over time?
Our business has been on a journey. Initially, I was part of a company that focused on mortgages and commercial mortgage credit, and one of my partners in that business is still with me today. He leads the commercial real estate lending portion of our business, but that initial credit expertise was our foundation.
When you start with a group of people with specialist backgrounds in leveraged finance, mortgage finance, real estate, consumer finance, structuring, underwriting and trading, and you allow them to build together systems and strategies through calm and crisis, that becomes compelling and flexible. You discover investments that add to the toolkit and develop a flexibility and a means to priority cashflows based on their return profiles. Each time we navigate a crisis together we learn about another tool we want in our toolkit that will enable us to exploit opportunities in the next cycle.
We went into the global financial crisis in 2008 quite specialist in the residential and commercial mortgage securities market and then we realised that in a crisis we wanted more control over the quality of the assets in commercial real estate, and more flexibility in workouts than what being a syndicated securities participant allowed. The only way to get that combination of quality and control was by owning the whole loan. Our journey has laid the path for the type of strategy that we run today.
How would you describe the differentiating characteristics of a flexible speciality finance strategy?
Traditional corporate and government debts are most often a bullet maturity, which is exposed to refinancing risk, and as access to capital becomes more scarce, or as liquidity is pulled back, less maturity risk is a strong differentiator. The fact that our debt has a different underlying risk exposure offers diversification, which we think is a critical characteristic given the growth in corporate debt and corporate lending over the last decade.
We find our clients, partners and fund investors have to take a bit of time to understand the flexibility that we have and how we use it to maximum advantage in circumstances like covid, where central banks intervened too quickly for many narrow strategies to be able to act on any opportunity. That flexibility allows for a much more dexterous portfolio. When you match what we have seen with what we think we are going to see, hallmarked by dislocation, it is really important to have that embedded flexibility to take a holistic view and channel our capital to where it is most valuable.
The role of private credit has been to do what the banks can’t do and step in to earn that additional liquidity premium, primarily to improve overall income/yield in a low-yield environment. We are operating in a different regime today, so as markets evolve, so too are the solutions and strategies that are needed to navigate that.
What role can this type of investment play for investors? Given the current market conditions, how can it be useful as a portfolio tool?
For the people that invest in private debt, private credit or opportunistic credit, what we do will typically be a differentiated source of income. With the flexibility of our toolkit (accessing both liquid and illiquid markets), our role can be quite broad as we can deliver income across a range of different return points with differing degrees of liquidity.
When it comes to liquidity, people learned a tough lesson last year, when everything they thought would be liquid didn’t feel very liquid at all.
We can create liquidity using tools such as amortising loans. Many of our credits amortise, so they can self-generate liquidity, and they do not have the same type of maturity risk as a bullet maturity corporate loan/bond. We also offer shorter lock-ups, which give our clients options on their own capital. The more volatile the market, the more those options, and flexibility, are worth.
Most investors are over-allocated to corporate exposures, not just via corporate credit but also through regular debt, regular equity, private equity, high-yield bonds and leveraged loans. It’s a large exposure in combination.
Historically, in times when access to capital is more limited, companies or individuals often use assets as collateral to achieve a lower cost of capital on debt – secured lending rather than unsecured. We will likely see more secured finance in a period when governments and central banks are not being so generous with their own liquidity.
One of the principal reasons institutions/pensions like to have an allocation to real estate or infrastructure in their portfolio is to diversify away from corporate exposure, and these assets offer cashflow with different degrees of return, correlation, volatility and liquidity, at a time when that is all incredibly valuable.
In today’s market, we believe idiosyncratic risk is likely much higher, and in asset finance in particular, when we deal with large numbers of assets or loans, there is much less idiosyncratic risk and little “issuer”/name risk – the so-called Twitter tape bomb – so that can be comforting given the increase in these risks overall.
What excites you most about secured credit, and how do you see the market evolving over the next few years?
The thing I like most about this strategy is that it makes it very easy to attend to a dynamic market – the ability to move alongside opportunity is really exciting. Many people build teams in complete silos, but we can pivot across assets like equipment, as well as real estate, mortgages, auto loans, consumer exposures as opportunities and dislocations persist.
The problem is that most teams won’t arrive at this point. Credit managers love their brand of credit… they love what they do and carry on loving it at all times, and there is a risk to that. Sitting in a silo sometimes it is hard to see the storm if you’re an asset allocator. You ask a specialist what they like in “their” sector and it’s rare that the specialist would find nothing to like. Show me the auto analyst that doesn’t like auto companies – if you find her, trap her, study her, she is a unicorn.
“Having the ability to assess value across asset classes, to be geographically broad and to be capital structure agnostic, is both compelling for our investors and exciting for us as managers”
I was blessed early in my career to find that unicorn, to study what allowed him to say he hated his sector and to work together to build a process to create specialists who can offer that most valuable information – allowing for shared perspective to identify best ideas with consensus.
Our strategy gives our people the freedom to say they want to find the best opportunity – for that moment in time – across many asset types and have the flexibility to deploy into it when and where they see it, because our opportunity evolves over time. As we look at what is needed, it is about marrying our ability to understand and underwrite the assets with flexibility around structuring them and making use of leverage. There are a lot of levers we can pull.
At its heart, this is simple: first find the opportunity with attractive fundamentals, determine risk and return budgets and use structure or liquidity to dial the risk up or down. This asset class is becoming more mainstream but it is not a commonly understood or mature space, and the way that it is being delivered is pioneering. Funds or investors use aspects of this, but very few put it all together into a fund, because of the complexity and the type of team required.
Having the ability to assess value across asset classes, to be geographically broad and to be capital structure agnostic, is both compelling for our investors and exciting for us as managers. We assess many ideas and we are trying to capitalise on a set of the best ideas at any one time, moving across the opportunity spectrum in a dynamic environment. That is an approach that evolved in the public markets as multi-asset, and now we are doing it in the private space, and in fact blurring the lines so we can access assets in whichever market has the most attractive return.
Michelle Russell-Dowe is head of securitised products and asset-based finance at Schroders Capital