Jeremiah Lane Podcast

The environment for global liquid or traded credit has changed dramatically over the past 10-15 years. Sub-investment grade debt has increased its quality – leverage is significantly lower than historical levels, and the volume of BB quality credits (one rank below IG) in the sub-IG universe is very high. Roughly 50% in the US and 60% in Europe. While some argue that spreads are not wide enough, in this episode we unpack the often-overlooked opportunities available across a range of different security types; where and how KKR can access favourable terms and why investors should be considering this asset class as part of their more aggressive fixed-income portfolios, or as a substitute to some of their equity allocation.

Please see the full transcript below -

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Jeremiah Lane

[00:00:00] Ryan Loehr: Welcome 

[00:00:09] Ryan Loehr: to the exchange podcast by EWL. As advisors to some of the most successful families in the country, Craig Emanuel, Tim Wyburn and I, Ryan Lurr, draw upon some of the best minds in the country. We believe that by exchanging ideas, we can deliver better advice and better outcomes for the families we worked for.

[00:00:32] Ryan Loehr: Now, we're inviting you on this journey in this podcast. We interview some of the country's best investment managers, business advisors, bankers, and founders to share their valuable insights. And our hope is that with better information comes better decisions, helping you to achieve more financially.

[00:00:53] Ryan Loehr: Welcome to another episode of the exchange. My name's Ryan Lurr and I'll be your host today. We have the great [00:01:00] pleasure of speaking with Jeremiah Lane, a partner and senior member of KKR's Traded Credit. investment team. Jeremiah joined KKR in 2005. He's a portfolio manager for KKR's leveraged credit funds and portfolios and a member of the U.

[00:01:17] Ryan Loehr: S. Traded Credit Investment Committee and also KKR's Credit Portfolio Management Committee. Before joining KKR, Mr. Lane worked as an associate in the investment banking and technology media and telecom group at JPMorgan Chase and holds an AB with honors in history. From Harvard University. For those that don't know, KKR is one of the largest, most reputable private asset managers globally, responsible for over 519 billion in assets with over two and a half thousand employees across 24 offices and 27 billion of staff or firm capital is invested alongside it.

[00:01:55] Ryan Loehr: Investors in the same products and that alignment is always key. So [00:02:00] Jeremiah, just to start, can you talk about how and why the KKR platform gives you and gives investors a distinct advantage in this asset class?

[00:02:09] Jeremiah Lane: Sure. I think that one of the things that we talk about firm wide is our one firm approach.

[00:02:15] Jeremiah Lane: And really this gets at the goes all the way back to when KKR originally set up a credit business in 2004. And We made a decision very different than all of our peers, all of our peers elected to set up siloed investing businesses where credit executives were, would win, win and lose on the basis of just credit outcomes.

[00:02:37] Jeremiah Lane: Private equity executives would win or lose just based on private equity outcomes. We chose. What we call the one firm model. Everybody is incentivized based on the outcomes that KKR delivers as a whole and we are compensated based on the success or failure of different parts of the business across the firm.

[00:02:59] Jeremiah Lane: And that [00:03:00] makes us economically. Incentivized to both contribute to other strategies that we have within KKR and to ask for executives and other strategies to contribute to us. And so, where we really see this show up in our business is around diligence. And we'll be looking at a business that might be new to us, literally hundreds or in some years, thousands of times we will do wall crosses.

[00:03:30] Jeremiah Lane: We sit on the public side of a Chinese wall. We'll do wall crosses to private equity executives, private credit executives, capital market executives to ask for their perspective on specific companies that we're analyzing industries that we're investing in, that we haven't been active in before maybe, maybe perspective on, on the management teams of companies that we're investing behind and perspective on.

[00:03:58] Jeremiah Lane: The partners and other private equity [00:04:00] firms that are maybe backing these businesses that we're investing in. And we find that differentiated angle that differentiate diligence that we're able to get through being a part of KKR and the one firm approach to just consistently add at the margin. A lot of times those conversations, the best ones are when we talk to them and we don't make an investment.

[00:04:24] Jeremiah Lane: Because it looks like a good company to us and, and we get on the phone with our partners and other parts of the business and they say, well, we see actually a risk lurking in this part of the market. And so I think that's been the biggest differentiator. We also have a lot of support from the balance sheet.

[00:04:40] Jeremiah Lane: It's helped us scale our business. This is a business where scale really matters. You want to not only be a part of a syndicate when you're investing in a loan or a bond, but you want to be a large part of the syndicate if you're a large part of the syndicate management teams have more will give you more time will give you more access to for conversations.

[00:04:59] Jeremiah Lane: Private [00:05:00] equity teams view you as. A more significant partner when you have a problem in the portfolio and inevitably with the large portfolios that we're managing and changing macroeconomic conditions, we will sometimes have problems. You want to be big because being big means that you have a seat at the table and means that you can get a really differentiated outcome in terms of how the situation is resolved.

[00:05:22] Ryan Loehr: Yeah, look, you've just answered my next question, which was going to be wider scale matter in this asset class. And I guess, given you've already partially answered that, I mean, who would be the competitors to KKR? I mean, who would have kind of a similar level of scale? And I guess there's not the volume of those competitors as opposed to those participating in smaller deals, smaller private lending or other types of transactions.

[00:05:45] Jeremiah Lane: Yeah, look, I think that I think that the large alternative managers, Blackstone, Carlisle, Apollo, those are all competitors that have scale and credit. I think that that, when I think about the one for a [00:06:00] model that I already talked about. That's a really significant differentiator to the strategies that those other firms have, have pursued.

[00:06:08] Jeremiah Lane: And we have a depth of integration that I think is just, is just unmatched. So other players will come with, with scale. They will have a similar amount of holdings in the loans. Or the bonds that we're investing in but, we, we really feel like having that, that edge on, on diligence, on ability to understand just the durability of cashflow downside protection, these businesses that we're investing in we really feel like that gives us.

[00:06:34] Jeremiah Lane: A big advantage and we've seen that show up as names that we pass on. It seems that we've seen it show up as names that we really lean into that the market doesn't like. We see it as a valuable differentiator. 

[00:06:46] Ryan Loehr: Yeah, absolutely. I guess for our listeners, before we dive into things, global traded credit, liquid credit, high yield bonds, bank loans, structured credit, opportunistic credit.

[00:06:58] Ryan Loehr: I mean, these are. Terms [00:07:00] that probably don't resonate as much as more vanilla fixed income for a lot of listeners. So can you provide, I guess, a bit of a summary of what are these instruments? Where do they sit in terms of the capital structure? Is this conception or misconception warranted that these are all high risk, lower quality instruments?

[00:07:20] Ryan Loehr: I mean, give us a, I guess, a bit of a flavor and perspective for. What they are and, why they're potentially attractive. 

[00:07:29] Jeremiah Lane: Sure. I think, I think what I'd start with is that even though these are markets that people are less familiar with, these are big markets, U. S. bank loans outstanding over a trillion dollars U.

[00:07:41] Jeremiah Lane: S. high yield outstanding over a trillion dollars and they are highly liquid markets. You can regularly trade when we're ramping a portfolio for a new client, we will regularly trade hundreds of millions of dollars in a day. So these are, these are big markets and they [00:08:00] are very liquid markets.

[00:08:01] Jeremiah Lane: A bank loan that we would hold in the portfolio is typically originated by a bank, JP Morgan, Bank of America, Goldman Sachs, et cetera. Put together a syndicate and we'll be a part of that syndicate and new issue that after it is offered to the market, it actively trades and, for performing loans, we see them.

[00:08:22] Jeremiah Lane: Regularly trade right around par a hundred cents of the dollar, except for periods where there's a significant disruption in the market. Obviously with COVID we had a significant disruption. Over the last couple of years, we had a significant disruption with this, the huge changes in that policy.

[00:08:40] Jeremiah Lane: High yield bonds are actually maybe just rounding out bank loans. Bank loans are almost always senior secure. So tippy top of the capital structure with a security interest in the assets of the company having that security interest in the assets is incredibly important and valuable. When companies [00:09:00] run into trouble, you want to make sure that you have a claim on specific assets to make sure that you're first in line.

[00:09:07] Jeremiah Lane: If a company has any challenges, a high yield bond comes to market in the same way. There'll be an underwriting bank. The same banks dominate the market for, for high yield bonds. It is much less common. For high yield bonds to be secured. Mm. We do see secured bonds as becoming a larger part of the market, but more typically bonds are unsecured.

[00:09:31] Jeremiah Lane: Mm. So they sit at a more junior spot in the capital structure. One of the interesting differences that's developed in these two markets over the last handful of years is that private equity owners of businesses. Have tended to prefer the loan market. And so we see fewer private equity backed businesses in the bond market.

[00:09:54] Jeremiah Lane: The big public companies that are sub investment grade that are ranked below, [00:10:00] that means right below triple B rated below triple B by Moody's and S and P. Those big public companies have tended to prefer high yield bonds. And so we see some differentiation in terms of the composition of the issuer base.

[00:10:16] Jeremiah Lane: These are markets that like, as I said, over a trillion dollars in size highly liquid. They also have, somewhat different. Buyer basis in the loan market, you have a very large percentage of the overall loan market is owned by a specialized structured credit vehicle called a CLO. In the bond market, it's more typical that bonds are owned by insurance companies pension funds and individual investors.

[00:10:41] Jeremiah Lane: And one of the things that we really like about these markets is that many of the investors. In both loans and bonds, leverage loans and bonds have, what I describe as high amount of rules based activity. And so, as an [00:11:00] example, in CLOs CLOs are allowed to hold a small number. Of lower rated loans.

[00:11:08] Jeremiah Lane: And so when a loan gets downgraded from B3 to triple C as an example, all of a sudden it becomes much less attractive for a CLO to hold. And all of a sudden, the price goes down, and you see a number of CLOs begin to offer the loans. And we think that that's really interesting. Opportunity to just do more work.

[00:11:33] Jeremiah Lane: We don't necessarily want to own the loan, but if we do more work and we do our wall cross to talk to private equity executives and private credit executives and gain a high degree of conviction that there's durability of cash flow and downside protection in the loan. Then that's an incredible opportunity.

[00:11:51] Jeremiah Lane: It's traded down just because an analyst at Moody's or S& P has said, we now assign these letters instead of these other [00:12:00] letters. It's now just worth less, and that's an opportunity for us to step in. We see similar areas of kind of discontinuity in, in high yield bonds from triple B to double B. A huge number of insurance companies have a lot of sensitivity around.

[00:12:18] Jeremiah Lane: Owning things that are triple B and not only things that are double B, that's a a consistent discontinuity in the market and similarly between single B and triple C. And so, one of the things that we really love about these markets is this rules based activity which we feel like is.

[00:12:35] Jeremiah Lane: Is a structural opportunity. It's an opportunity for us to take advantage of again and again and again, provided that the businesses that we're investing in meet our criteria for durability of cash flow and outside protection. 

[00:12:47] Ryan Loehr: That's a helpful, helpful overview. I think one of the points that you touched on, which I'd like to unpack a little bit more, you mentioned.

[00:12:54] Ryan Loehr: periods of dislocation and how it impacts credit markets. And clearly, first, as you mentioned, we had [00:13:00] COVID, then we had a much more aggressive fed central banks globally through 2022 and some part of 2023, regional banks had their issues. So how have these events, how have the macro economic conditions really impacted, as you said, appetite for different parts of the credit market and what opportunities does that present investors? 

[00:13:22] Jeremiah Lane: One really interesting issue that arises from COVID is that most, most loans and bonds are offered to the market with a three year look back in financial performance. And I would argue that at the start of 2024, if you got a three year look back. There's almost no value in that data because you have 2020, which is a period of massive dislocation.

[00:13:52] Jeremiah Lane: You have 2021, which was a huge rally a boom for many businesses. You have 2022, which is a [00:14:00] hangover and, and now you have 2023, which, would appear to be a more normalized period, but you, you really can't discern much trend. From, those three or four years, I think that one thing that's arisen from COVID and the policy response to COVID is that it's actually harder to diligence businesses now than it was in say 2019 when you look back and you'd say, okay, I have 16, 17, 18, 19, 16 was a tough year in the U S with entered a lot of.

[00:14:33] Jeremiah Lane: Issues around energy, but then 17, 18, 19, those were pretty normal years. And then if you really had a longer look back, you can go back to 2011, 2012 and have you be able to really establish trend line. One issue that's, that's come up is that it's much more difficult to diligence businesses. And that's actually, I think, a big structural advantage for us, because 20 years and, we've effectively accumulated a database of.[00:15:00] 

[00:15:00] Jeremiah Lane: Financial performance for many of these companies over really long periods of time. Another thing that I would say I hear a lot from investors is, are you worried about recession? Are you worried about the macro economic outlook dimming? And our response to that has really been that we think there's already a recession happening.

[00:15:21] Jeremiah Lane: It's just it's a rolling recession. And so instead of having this single moment where many sectors are cycling together. As a result of COVID, you've had, you've had individual sectors cycling asynchronously. And so, the examples of, of a handful of sectors that I like to use are consumer businesses that in the U S primarily.

[00:15:48] Jeremiah Lane: Manufacture in China and import via ship. Those businesses had a collapse in profitability at the end of 21 and beginning of 22 because the cost to ship, went up so [00:16:00] dramatically in a very short period of time, and that really hit them throughout 2022 and 23 has already been. A story of of real recovery in those markets, focusing, moving out of 21 and into 22 in the 2nd half of 22.

[00:16:15] Jeremiah Lane: And I'd say really throughout 23 health care had a huge number of problems really driven by a shortage. Of nurse labor service providers that were labor intensive business models had poor ability to fully staff their facilities and when they did fully staff their facilities, they were really having to pay up.

[00:16:39] Jeremiah Lane: And if you had a lot of people in and we're having to pay up for that labor, it really crushed your margins. We're starting to see signs of normalization there. In 23, we saw a lot of a couple of industries going through D stocking. So these were businesses that had kind of boomed in 21 and continue to show strength in 22 and our end [00:17:00] market demand is lower.

[00:17:01] Jeremiah Lane: And so they're going through a de stocking cycle, I would call out chemicals and packaging as 2 businesses like that. I'm looking forward to 24, probably the sector that we're watchful on. I wouldn't say we're calling it as necessarily cycling, but that we're very watchful on is housing housing has been.

[00:17:19] Jeremiah Lane: Surprisingly robust, despite the huge increase in rates, and I think that that's really been driven by the strong backlog that the building businesses came into, the rate increase with at this point, they've really burned through that backlog. And so I think the question is going to be. Can they, can they refill their order book when, it costs six and a half percent to borrow the money to buy the home in the way that they were able to do when it was much lower.

[00:17:52] Jeremiah Lane: And so housing is, is the sector that we're, we're watchful of for 24. But I think the picture that emerges is that, [00:18:00] these cycles are happening and it's not, it's not that everything is going along smoothly for every company. Individual sectors are cycling it's just that they're cycling asynchronously and that, and that's the reason why it doesn't become a recession, but businesses are getting disrupted and that's an opportunity for us to take advantage of the knowledge differential that we have as part of KKR with the one firm approach, roll up our sleeves, do the work, figure out if there's durability of cashflow and make an investment or not.

[00:18:33] Ryan Loehr: I mentioned earlier that I was at an advisor conference, an invite only advisor conference with roughly 100 other wealth firms last week. And, we have round table discussion and, speaking about fixed income, credit markets, private debt, the trend. Consistently seem to be that if you think about the macro challenges, you've got companies with higher debt, higher interest rates, or if we are in a higher for longer regime, and clearly defaults will go [00:19:00] up and back to my point earlier, I think we talk about, say, high yield is an example.

[00:19:05] Ryan Loehr: There can be this misconception that high yield, it's always high risk and in an environment where you've got challenging or deteriorating macroeconomic conditions, why would you want to be in the high risk category? But to your point, I think it's much more nuanced than that. And if you do the due diligence, you can uncover plenty of opportunities that are largely unappreciated and, reading through.

[00:19:27] Ryan Loehr: KKR's annual report last night on credit markets titled credit vintage to remember, which I thought was, was clever looking at high yield. Most people wouldn't expect now that in the U S roughly half of the high yield market or 50 percent sits at double B, one rank below investment grade.

[00:19:45] Ryan Loehr: And in Europe, I think the figures higher at 60%. So in response to the round table discussion that basically. Consensus is that you're not getting a wide enough credit spread for high yield. So you're better off being in investment grade corporates [00:20:00] or other parts of the market. I found that really interesting.

[00:20:02] Ryan Loehr: And at the same time, while many had that view, private debt, private credit also seems to be incredibly popular at the moment. Yet you've got parts of liquid markets that are offering, a similar level of return, a lot more transparency, perhaps hard assets, securing them. And I think, again, another point that you made, Jeremiah, is around differences in vintage.

[00:20:25] Ryan Loehr: Clearly, some of the instruments or securities that were offered through 2020, 2021, compared to some that have been issued more recently, there's a big divergence in quality. So, I mean, what's your Perspective. And I guess if consensus out there is that, you don't want to be in high yield or you don't want to be in these other asset classes that people are less familiar with.

[00:20:46] Ryan Loehr: I mean, what's the counter argument?

[00:20:48] Jeremiah Lane: I think that where I would start is, I think comparing traded credits or private credit as an example, I think the story around private credit's really been one where the private [00:21:00] credit businesses have been able to lend to larger companies at still, very wide spreads.

[00:21:06] Jeremiah Lane: And my view is that that's largely over that there, there was a moment in time where they were able to do that through 2023 because the traded credit markets were so disruptive, because, as you said, it was a vintage to remember we were, we were using this tagline last year, kind of, it's a great time to be a lender.

[00:21:27] Jeremiah Lane: It was a great time to be a lender in 2023, because the traded credit markets were disrupted. So if you were, if you were. Making a new loan or buying a new bond, the borrower had to really pay off and they had to agree to tighter credit documentation and, better provision of information, everything.

[00:21:45] Jeremiah Lane: And what we've seen this year, or what we saw, I'd say in the later part of 23 and into this year is that as the traded credit markets have healed, those higher quality big businesses, they're going to prefer to finance themselves in the traded credit market and a little [00:22:00] bit tighter spread because it saves them money.

[00:22:02] Jeremiah Lane: And ultimately that's. That's a big priority for them. And so I do think that we've started to now see a real trend where we're even seeing some financings that were put in place in the private markets last year. We're seeing them now get refinanced out into trading credit at, substantially tighter credit spreads with respect to, to, are you, are you getting paid enough?

[00:22:27] Jeremiah Lane: I think what's interesting is that in trading credit, maybe it's a function of. The transparency of the spread, I can literally say that at all times, I've had investors argue to me that they should be getting paid more. And so, we see spreads today as normal. When you compare them to long term averages, there were not at a at a bottom in the market.

[00:22:50] Jeremiah Lane: There isn't blood in the streets. It's not the financial crisis. Everything is in dirt cheap. But we think that it's appropriate that they're normal because. [00:23:00] The outlook is pretty solid. And we see that that individual sectors in the, in the U S are cycling and by and large, they cycle, maybe a few companies in that sector will file for bankruptcy, but most companies will come out the other side.

[00:23:17] Jeremiah Lane: Okay. And, we expect the default rate kind of going forward to be. In line with historical averages, you might have a short period where they're elevated. If some, if particularly some large issuers default, it's not so much that there's going to be a spike in the number of companies default. If it, if it just happens that some of the larger issuers default, you'll have a reading that will be a higher percentage default rate.

[00:23:43] Jeremiah Lane: What we do in this strategy is, we, we find concentrated high conviction bets. And so. We're not holding 100 percent of the names in the index. We're not holding businesses that don't have those core credit qualities that we're [00:24:00] looking for durability of cashflow and downside protection.

[00:24:02] Jeremiah Lane: And so when you marry a concentrated high conviction approach. With a really good diligence capability, we think you could have great outcomes even when the overall spread available in the market feels about normal, which is, which is how it feels now. 

[00:24:20] Ryan Loehr: Yeah, makes sense. And I guess as a follow on to that in terms of, being a high conviction strategy, an active manager.

[00:24:27] Ryan Loehr: Where is the relative value in the investment universe? 

[00:24:31] Jeremiah Lane: So, so the, one of the things that we have really liked is over the last, I'd say at this point over the last three years has been being invested in shorter duration names. So names that have near term maturities, especially in sectors.

[00:24:47] Jeremiah Lane: That were disrupted by Colvin and we've seen a big opportunity in building large positions in these loans and bonds and then [00:25:00] approaching sponsors to, propose an extension on terms that we find favorable. And so typically these are. Typically we'll be buying these loans and bonds at a substantial discount to par.

[00:25:16] Jeremiah Lane: So, maybe 90 cents of the dollar, 95 cents of the dollar, something like that. And then as maturity approaches, we'll be engaging a dialogue with the sponsor to get often hundreds of basis points increase in the spread that they're paying us. So maybe they were paying us. So for plus three 50, that'll become silver plus five 50, something like that.

[00:25:37] Jeremiah Lane: And then typically they pass several points of upfront fees associated with it. All of those fees get passed on to our investors. We're not taking any of those fees ourselves. And and it creates just a really nice economic opportunity. It also creates a situation where we feel like we're really delivering value to the owner of the business.

[00:25:57] Jeremiah Lane: We're approaching them, not as a. A sharp [00:26:00] elbow distressed credit hedge fund trying to take over their business or pushing them as a sponsor. Listen, you have a maturity in a year or two and you don't want that to become current. You don't want that to be due in just a few months. You want to resolve it early.

[00:26:16] Jeremiah Lane: If you. Engage with us. We will give you a proposal to resolve it early. And so you're, you won't have to, as the owner of the business, you won't have to worry about finding that capital at the last minute. And so that's been, that's been incredibly fruitful area for us over the last 3 or 4 years. I'd say through 2023.

[00:26:37] Jeremiah Lane: We also, we were starting to pivot to more, what I would just describe as new issue loans. Those COVID disrupted loans. Those are often loans that existed. Okay. Loans and bonds that existed before COVID hit. So 2018, 2019 origination last year, we were starting to really prioritize some of the things that were newly originated in 2023.

[00:26:58] Jeremiah Lane: What I loved about [00:27:00] that was that if you, if you bought a business in 2019 or 2020, a lot of those businesses were bought on the belief that rates were going to stay rock bottom for a really long period of time. If you bought a business in 2023 and you borrowed money to do it, you, you knew that rates were going up and so you built a capital structure that was fundamentally more conservative because you knew that you were going to have to pay a lot more interest.

[00:27:26] Jeremiah Lane: And so, we found that to be a really good opportunity. We also invest in some structured credit products where we have embedded in the structure, a lot of. Protection against defaults in underlying portfolios. We really liked that last year. You could make investments in the structured credit space where what you were investing in would experience zero loss.

[00:27:51] Jeremiah Lane: Even if there was 25 percent cumulative losses in the underlying portfolio. So that, that would be like a financial, the back of the [00:28:00] GFC level of losses or beyond the GFC level of losses. And you were able to do that and earn, so for plus 500. Which in today's at today's sofa would be, more than 10 percent and also had a little bit of appreciation potential embedded in there.

[00:28:17] Jeremiah Lane: So those are some of the areas that we've been more active in. I think that there's, and I think, one of the, one of the things that we've run this strategy now for 15 years, this is a strategy that we started in 2008. We'll have our 16th anniversary of the strategy over the summer. And one of the things that's been great about the strategy is that.

[00:28:38] Jeremiah Lane: You think about the range of economic environments that we've had over that period, we caught the last year of the financial crisis when we started. So the first things that we bought, it went down immediately. It was incredibly difficult period that you had several years of, of real boom in the credit market that at 15, 16, you had the.

[00:28:59] Jeremiah Lane: [00:29:00] Energy sort of crisis in the U S oil price collapsed. A lot of those businesses were financing loan and bond markets. We really outperformed in that period. Fast forward to COVID recovery from COVID change in fed policy. You've had just incredible range of policies. Macroeconomic environments, geopolitical events happening over that, that 15, 16 year period.

[00:29:27] Jeremiah Lane: And so these are areas that we're focused on now. One of the things I would really emphasize is that we really view this as an all weather strategy. We've had success with this strategy in a huge range of environments. And, I think that's one of the reasons why. As whatever develops over 2024 2025, we approach it with a lot of confidence because of the range of environments that we've invested in.

[00:29:52] Ryan Loehr: I mean, I think that's really interesting, right? Because, some people might see this as having a place in, part of the [00:30:00] allocation for portfolios in fixed income. But, if you're delivering total returns of, 9, 10%, basically in line with or above what equities have typically done, but, you've got security, you rank higher in the capital structure, a lot of it is paid coupons and distribution as opposed to price and getting that price volatility.

[00:30:19] Ryan Loehr: I think it's a really compelling asset class for investors, because if you do think that we're in that higher, longer regime, if you do think there's going to be, black swan, big macro events that are unpredictable, we seem to be getting more and more of them from conflicts and geopolitical issues and so on. Do you take

[00:30:37] Ryan Loehr: perhaps a more consistent path to achieve those objectives, which you can arguably do in global credit. One thing I wouldn't mind asking is, you mentioned that for the past several years, I mean, you've been pretty short duration. Is that changing now that perhaps we're getting towards what seems like the end of elevated inflation?

[00:30:56] Ryan Loehr: It looks like it's coming down in the US, in Australia. What's your [00:31:00] view on that? When you say higher for longer, does that mean we're still going up from here? Does that mean, maybe we come back down a little bit, stay elevated and how you position. 

[00:31:09] Jeremiah Lane: I would say that I don't see it a huge change in our duration positioning.

[00:31:16] Jeremiah Lane: We do not think that rates are going to continue to go up. We do think that rates are going to come down on the margin. We think that it's less than what the market thinks. Last week. Last I looked at my Bloomberg, I think the market's pricing in, five cuts this year, I think we're sort of in the two to three camp, back half loaded.

[00:31:36] Jeremiah Lane: I don't see that rates are going, I don't, I guess I don't believe that we are going back to zero interest rate policy. And if we're not going back to zero interest rate policy, that, that would really be. The case for loading up on bonds, a longer duration, adding a lot of duration to the portfolio. I also would [00:32:00] say that I think that this strategy.

[00:32:02] Jeremiah Lane: Really succeeds based on the individual credits that we're identifying. And, we don't want the strategy to be about, a macro call of zero to trade policy. We want the strategy to be about, we've identified businesses that are out of favor by the market and. We've done our work and validated durability of cashflow and downside protection, and so we've leaned into them.

[00:32:28] Jeremiah Lane: And so, we see a lot about that. Those opportunities in the loan market. The loan market is floating, so it always has short duration. We'd love to be more invested in bonds at the margin, but I don't see that as a sea change in terms of our duration position.

[00:32:44] Ryan Loehr: In terms of each category of global traded credit.

[00:32:46] Ryan Loehr: I mean, what is the highest conviction view right now? 

[00:32:50] Jeremiah Lane: Across leverage credit? We really like what we're seeing in in structured credit. In particular, we like that ability to. [00:33:00] Invest in tranches that can withstand a large number of defaults and still earn, great, great spread. That's been an area of continued interest that asset class had a great run last year.

[00:33:14] Jeremiah Lane: It can't replicate just sort of the fact that it appreciated as much as it did last year means it can't be replicated this year. But we think that's going to be a continue to be a good place to add spread to the portfolio. Without taking a lot of risk, especially if you monitor those, those investments very closely, which we do.

[00:33:34] Jeremiah Lane: I think that we continue to see a lot in loans that we like. I think that I described this kind of rules based activity that exists in all of these areas. And I see that as in many ways. Strongest in loans, the largest percentage of the buyer base is, is acting according to rules, ratings, rules, spread rules, other [00:34:00] rules that they have.

[00:34:01] Jeremiah Lane: And so, we see that creating opportunity in, in how things price. 

[00:34:06] Ryan Loehr: And why is that? I mean, is that that you've got a lot of passive money out there that are kind of governed by, whether it be kind of. Index type. Yeah. Yeah. Managers. Is it, they don't have the resources or the, the human capital that KKR has?

[00:34:19] Ryan Loehr: I mean, what, what's the reason? It seems, seems like... 

[00:34:22] Jeremiah Lane: Why is there, yeah. Why are there, why do they invest according to these rules? Really, really what it is, is that in the CLO market 'cause the clo o CLOs are the largest investors in loans. And in order to get the ratings of the different. Tranches of the CLO.

[00:34:40] Jeremiah Lane: There's a triple A rating down to a double B rating and then a residual in order to get all of those asset classes rated according to what they want. They have a percentage of Triple C that they're allowed to hold. They have an overcollateralization test that they have to meet. They have a. An interest coverage test.

[00:34:58] Jeremiah Lane: Basically, there has to be enough [00:35:00] interest coming into the structure to pay all of the underlying truncheons of debt. And so just the complexity of the CLOs means that they read to a lot of rules. And then specifically you have, I'd say the top 10 managers of which we are one. To have really strong access to the market, to create new CLOs, but then you have a huge tail of managers.

[00:35:26] Jeremiah Lane: There are over a hundred managers of CLOs in the market. You have a huge tail of managers that have a much more tenuous ability to access the market. And what we see among those managers is that when they start to experience downgrades in their portfolio or, or actual credit losses, they. Act to protect their ability to continue to access the debt market.

[00:35:53] Jeremiah Lane: And so they, they want to keep the portfolios clean. And so they, they sell first, ask questions [00:36:00] later. And we think that that just creates opportunity again and again, and again, and again, as our own CLO business has grown. Our understanding of all of these tests that are embedded has gotten more sophisticated, and I think it makes us a better shopper of the assets that are available in the market, because we really can see.

[00:36:26] Jeremiah Lane: The things that start to trip up the CLOs and you can see the price reaction. You can really focus your analytical capability on understanding those cash flows and whether or not they, they are durable. Yeah. And so, but that, that's the reason why it exists. 

[00:36:40] Ryan Loehr: Yeah. And you mentioned within your own portfolio, I mean, Portion of the CLOs that you hold will need to experience something like 25 percent in total accumulated or cumulative losses before there's any impairment to your capital.

[00:36:53] Ryan Loehr: I mean, why is that? Is that because you've got obviously security behind it? Is that, what would be kind of the quality of the ranking [00:37:00] of those CLOs? Where do they sit? 

[00:37:01] Jeremiah Lane: So typically in that example, we're investing in the triple B rated tranche. It's got two tranches below it. It's got a double B and an equity residual piece.

[00:37:13] Jeremiah Lane: The combined value of the double B and the equity residual piece are about 12 and a half percent. Usually it varies within, 1 percent of that. So sometimes a little more, sometimes a little less. When I used, when I cite that 25%, I'm assuming. A 50 percent loss when you have a default, which is historically what you've actually observed in loans is more like a 30 percent loss.

[00:37:38] Jeremiah Lane: So even assuming a worse than historical experience in terms of loss, given default you're incredibly protected. So that's really why it is, is that there's, there's 12 and a half percent of value below you. And so you have to have. 25 percent experiencing a default. And then you have to [00:38:00] have that 25 percent losing 50 percent of value to get to the point where you've wiped out 12 percent.

[00:38:05] Jeremiah Lane: It just, it just hasn't happened. Yeah. One of the reasons why the CLO market exists, the CLO market existed before the financial crisis, as did. Many other structured credit markets. Most of those structured credit markets don't exist anymore. The CLO market still exists because it really rode through the financial crisis.

[00:38:25] Jeremiah Lane: The structures worked. A lot of equity investors actually did really well through the financial crisis. And so, AAA investors all got their money back, sort of the product performed as people expected it to. And so, that's the reason why. 

[00:38:40] Ryan Loehr: You mentioned the strategy has been running for, roughly 15 years or, through the background of OA.

[00:38:45] Ryan Loehr: Reflecting across that time, because I know you've been with the firm for quite a long time, I mean, something like 20 years, so you're there through the thick of it. Which have been kind of the vintages or rather than point to years, I guess the environments have led to the best [00:39:00] performing years for the strategy.

[00:39:01] Ryan Loehr: And then what are the kind of drivers behind that? 

[00:39:03] Jeremiah Lane: Our biggest years of, of alpha are our biggest years of outperformance have been years following. The blood in the street moment. So coming out of the financial crisis in 2009, the bottom was really like March of 2009, but then the second, third and fourth quarter in oh nine were an incredible rally coming out of 15, 16.

[00:39:27] Jeremiah Lane: The bottom was in February of 16. The ballots that year was really incredible. Coming out of Covid was really incredible. And then I'd say the sell off associated with the Fed policy change was more muted than those other three. But it was, it was still significant and we saw a really nice outperformance over the course of last year as the market recovered from that disruption, those moments have been the moments of, of peak alpha.

[00:39:55] Jeremiah Lane: But I think when you observe the. The return stream over time. [00:40:00] It's not that the other moments haven't been good. It's just that, that the highest amount of alpha has been generated in the aftermath of those blood industry moments. I think the reason why those have been so such profitable periods for us is that this is a trade credit strategy and we can rotate and.

[00:40:18] Jeremiah Lane: We tend to keep the portfolio relatively short. So, we might not have as much price volatility in the sell off as the rest of the market. And so what we're able to do is we're able to pivot from assets that we were holding before the sell off hit into the things that we think the market is really just giving away that have the most upside potential on market normalization and, and that's really a big reason I gave the example of.

[00:40:44] Jeremiah Lane: Of using the COVID disrupted names earlier, and that's one of the reasons why we like those so much is that, you could, you could see those businesses normalizing, but the market wasn't giving credit for it and you could buy them at incredibly discounted levels and, and [00:41:00] just take advantage of.

[00:41:01] Jeremiah Lane: The fact that activity in the world was resuming, but it was just going to take some time for it to fully resume. 

[00:41:08] Ryan Loehr: Following on from that. So the best vintages is, as you put it when there's blood on the street, when people are really under appreciating quality or kind of doing the work, the due diligence to find.

[00:41:18] Ryan Loehr: The good quality assets. Are we there yet? Because some people would arguably say that we haven't seen an uptick in defaults to a level because there was a lot of easy money from earlier years. And there's still, a number of maturities that haven't rolled over yet. So I guess you've probably got quite a bit of capital on the sidelines waiting for something to get worse.

[00:41:38] Ryan Loehr: But I guess there's no certainty over. Will things get worse? Or, how worse or, will they get better? And we're doing it, rate cuts and other questions. I mean, what, what would be kind of your answer to that for people that are wondering, do I wait for things to potentially get worse?

[00:41:54] Jeremiah Lane: I want to be clear. There, there is not blood in the streets right now. This is not the financial crisis. It's not [00:42:00] COVID. This is a normal environment. And that's why I think that, that's why one of the things that I was highlighting was that this is not our moment of the absolute peak amount of alpha that will generate because, we're not at a moment where there was just blood in the streets.

[00:42:15] Jeremiah Lane: But this is a, this is a moment where we absolutely will thrive and we absolutely have thrived over many, many moments exactly like this over the last 15 years. And so I think that that's, that's the opportunity today. For a lot of investors, I would also say that a lot of investors intellectually want to invest.

[00:42:37] Jeremiah Lane: They prefer to invest at the moment when there's blood in the streets, observing people's behavior over a long period of time. That is a really hard moment to invest that it's really hard when, when everything in your portfolio is marked down, you go back to think about the financial crisis, think about how much equities went down, how much credit assets went down, how much fixed income [00:43:00] assets people were questioning the value of traditional fixed income assets and.

[00:43:05] Jeremiah Lane: It's hard, it's hard to put incremental capital to work in that moment. And so this is a nice moment where there's relative calm in the market. I think there's a lot of ways for us to earn terrific returns over the next handful of years in a more normal. Economic backdrop, and it's not a blood in the streets moment, but that's also to people's benefit because it's a little bit easier to pull the trigger.

[00:43:33] Ryan Loehr: Yeah, I noticed. So within the portfolio, within the strategy, there's a sleeve or a component that can be allocated to opportunistic credit. What fits that or feels that? Bucket and, if times are normal, I guess you're waiting for times to not be normal to kind of exercise or, utilize that.

[00:43:54] Ryan Loehr: Would that be a fair comment?

[00:43:55] Jeremiah Lane: Yeah, look, I think that that really, I mean, this is a very flexible [00:44:00] strategy and. When we occasionally we'll see really unique opportunities in the market, it might be to participate in something that's a little bit more clubby. So it's a, there's a little bit less liquidity in it, but it's a really high quality with a really high return.

[00:44:17] Jeremiah Lane: It could be, dipping into alternative asset classes today and structured credit. We're really focused on CLO tranches and we like the defensibility of that. If you go back to much earlier in the history of the strategy, we did a lot in aircraft abs coming out of the financial crisis because there were there's a lot of disruption to the, in terms of the, the value of, of aircraft assets and you could you could really invest for high return there.

[00:44:46] Jeremiah Lane: So I think that we think of that, that bucket as. When we do do things, a little bit outside of our normal day to day strategy, which is loans, bonds, and structured credit. And um, you know, [00:45:00] it has to be an extraordinary opportunity either at, at a moment in time or just a really interesting risk reward.

[00:45:08] Jeremiah Lane: Mix. Yeah. But that's what that's what we use it for. 

[00:45:11] Ryan Loehr: One final questions. I mean, for investors, for clients of our firm that are listening, how should they be thinking about, this strategy and where does it fit, across. Portfolios. I mean, should it be part of the fixed income sleeve?

[00:45:24] Ryan Loehr: Should it be a substitute for equities and, more volatile conditions? On a relative basis, how does it compare to, other parts of fixed income? What would be kind of your. Um, you know, not recommendation, but suggestion and how are some of your institutional investors thinking about that?

[00:45:43] Jeremiah Lane: Everybody's portfolio is a spectrum from, government bond, theoretically, no risk to, to equities high risk. This definitely, bar has elements of each. I think one of the interesting things of the last couple of years with the change in central bank policy [00:46:00] globally is that there's been.

[00:46:02] Jeremiah Lane: A lot of price volatility in what we're historically thought of as the really safe assets. And so I think that, in some, we experienced less price volatility in this because we didn't have that embedded, incredibly long duration. And then, when the market is recovering, we can deliver really high returns, much, much closer to, what we do in equities.

[00:46:27] Jeremiah Lane: So, I would, I would say that it's. It's definitely a hybrid. We see we see institutional investors borrowing from kind of return seeking fixed income allocation. So they might be thinking about something private credit where they're seeking a higher return. This can fit in that same bucket.

[00:46:48] Jeremiah Lane: When people are more skittish. About equities. There's a lot being written right now about just how high valuations are in equities and what is the return outlook from here, especially if you don't get [00:47:00] central banks priming the pump with lower rates. I think that in a moment like this, it could make a lot of sense to borrow from an equity bucket to have something that's generating regular income and using that income as a little bit of a buffer on your overall return stream.

[00:47:16] Ryan Loehr: Jeremiah great to have you in the office today. And I know you're flying straight over from San Fran. So thanks for making the effort and yeah, a lot of great takeaways for our clients.

[00:47:25] Jeremiah Lane: So appreciate it. Yep. Thanks for having me.

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