Uncorrelated returns: The holy grail

Frank Barbarino, senior investment officer at the Office of New York City Comptroller, offers insight on his organisation’s private debt strategy in conversation with PDI.

Frank Barbarino

How does private debt fit into your overall portfolio construction?

Private debt is included in the opportunistic fixed income (OFI) mandate at the Teachers’ Retirement System of the City of New York, the New York City Employees’ Retirement System, the New York City Police Pension Fund, and the New York City Fire Pension Fund, collectively ‘the systems’. New York City’s Office of the Comptroller’s Bureau of Asset Management (BAM), my employer, advises the systems on their allocation of capital to investment managers.

Within the OFI mandate are both private and public underlying credits, but by and large the strategies being utilised are non-traditional in nature. We break the credit landscape down into three verticals – private par lending, stressed and distressed, and structured. We think about private debt in broad terms; the three verticals can include credits that are backed by a range of asset types including corporates, commercial real estate and other hard assets, consumer loans, and intellectual property. The systems access these opportunities through both co-mingled funds and separately managed accounts.

Why have you decided to have a focus on distressed debt?

If you were to drill down on our managers and the individual credits you would see that the lion’s share of the exposure in OFI is to corporates. My sense is that most large institutional investors have this exposure bias. It’s probably the area of the non-traditional credit markets in which there is the most investment talent, so the bias makes some sense. Much of OFI’s corporate exposure is to restructurings, liquidations, and other areas of distressed, but a lot of it is also in performing credit. About 30 to 40 percent of the OFI mandate is in credits that are trading above 80, with roughly half of this in companies that are doing fine and have credits marked near par and the other half having some level of stress.

We think that the money the systems have allocated with managers, that can take advantage of a counter-cyclical move in credit by moving into stressed or distressed credits, adds a lot of value to their portfolios.

Are any other strategies under consideration?

I think that today the holy grail in credit investing, and perhaps all of investing, is finding opportunities that can generate uncorrelated returns. To be more specific, we want investments that should be somewhat insulated from an economic downturn or a broader sell-off in risk assets.

Even better in my view is if these returns can be generated consistently, namely via current income. Finally, we don’t mind strategies that will be relatively insulated against higher interest rates, though I personally don’t see material increases in long-term rates on the horizon.

It seems to me that these are attractive characteristics to have in a portfolio. The market seems to have the perception that risk is low but I, and I’m sure others, would argue that actual risk is now considerable. So finding assets that offer downside protection is tantamount. To that end, we are helping the systems look at credit strategies that are less trafficked such as lending against hard assets or investments that are backed by esoteric cash flows.

On the whole, are private debt funds as transparent as you’d like them to be?

We find that reporting in private credit is as varied as the underlying strategies and credits. We continue to work with managers to try to improve reporting and are looking to integrate some new technologies to help us more effectively and efficiently monitor the investments across both private and public debt. With the incredible innovation going on right now in fintech, we believe there is a real opportunity to replace tired old technologies with some exciting new tools that solve the problems faced by allocators.

The views and opinions expressed herein are the author’s own and do not necessarily represent those of the Office of the New York City Comptroller or its staff.