The biggest risk to loan markets today

And so, the COVID recovery in many of these stories has really played out over the past 12 months or longer, depending on the business that we're talking about. I would say we're getting to the final innings of that recovery, but that's been a sector that we've been pleased to see the fundamentals play out like we thought they would over time. 

The other parts of the investible universe that I would say have been a little bit more resilient, relatively, have been investments on the shorter end of the curve. I think one benefit that we see from an investor standpoint with the changes in the cost of capital is that issuers are starting to show a willingness to address their maturities earlier. 

We think in this environment, the higher for longer view is becoming more consensus around the market. 

And as a result, issuers are realising that by waiting an extra year to deal with the maturity, their cost of capital a year from now probably won't be significantly better than where it is today. So, that's A. 

And B, the risk of waiting too long to deal with the maturity poses a critical fundamental risk to the business' survivability. And so, we're seeing companies address maturities earlier. There's better execution for doing so, and that'd be a part of the market where we see opportunity amidst the higher rates from an investor standpoint. 

LW: Have any sectors' resilience surprised you? 

There are a variety of sectors that I think we've been surprised at their resilience from the perspective of expecting an impact on these businesses. A lot of the building products, manufacturers and distributors are certainly exposed to interest rates. Clearly, construction and what's going on in the real estate market are very central to interest rate risk. 

We've been surprised that the supply-demand imbalance in the US, meaning there's just a lack of supply of new homes available, has led to better resilience in the fundamentals of these businesses. I would say that's still a sector where there's real risk in the market and we're treading very delicately, but I would say it has performed better than expected. 

And then we have other businesses, like insurance brokerages or certain segments of the tech ecosystem - like software businesses, where you've got more recurring revenue that is resilient, strong top-line growth has continued to hold despite a weakening market environment. 

Many of those businesses, because of the resilience of the top line, have historically been viewed as being worthy of more leverage. That leverage is a potentially delicate thing in this type of market. And so, I wouldn't say holistically those sectors are insulated, but I think the top-line performance has been somewhat resilient. 

LW: Where do you have the highest conviction today? 

The way we view the world is more through the cycle lens of businesses that we think can sustain their performance in good and tough markets. In this market environment, clearly, there's a lot of crosscurrents of what's going on with company fundamentals and growth, the margin pressure we're seeing, the cost of capital going up, geopolitical tensions in the world, that I think what we're really looking for is durability of cash flow, downside protection, and looking only to build a portfolio around those high conviction fundamental stories.

There are a number of businesses that have shown both smart balance sheet management and also are exhibiting strong fundamentals. And so, I think across the board, we are finding opportunity at the higher quality side of the spectrum. 

LW: What’s the biggest risk?

I think technicals are something that we spend a lot of time thinking about as a team. By technicals, I'm thinking about the investor base in our markets. On the loan side of the equation, 70% of the buyer base of loans in the US are CLOs (collateralised loan obligations). 

CLOs are very constrained in terms of the assets that they can and cannot own, exposure to CCC-rated assets, for example. And so, I think the biggest risk that I see is, in a world where we're seeing the risk of potential downgrades outpacing upgrades, or expecting to see more downgrades than upgrades, the biggest buyer of loans is under real pressure.

Now, I think that will create trading price volatility - in particular, for companies that underperform expectations. But when I think about creating opportunities for a flexible pool of capital, that's the other end of the sword. And so, I think we see a lot of opportunity in that as well. But I'd say from a near-term perspective, that technical feels tougher on the loan side of the market.

Richard Schoenfeld 

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