Top alt credit investor predicts CRT boom

Ares Management, founded in 1997, is a leading investor in alternative credit products. It has US$395bn under management, of which some US$32bn, or a little under 10%, is invested in alternative credit. It recently closed Pathfinder II, one of its alternative credit funds devoted to illiquid instruments, with US$6.6bn in commitments, measurably more than the US$5bn target. It is also almost twice the size of its predecessor, Pathfinder I, which had total commitments of US$3.7bn.

SCI caught up with Joel Holsinger, portfolio manager and co-head of alternative credit, based in both New York and Atlanta, last week.

SCI: Joel, thanks for finding time to speak to us and good to meet you. So, what are the features that, in your opinion, make Ares different from others in the field of alternative credit investing?

Joel: Nice to meet you too, Simon. We have two big advantages. One of them is our flexibility. We do all alt credit products in one bucket. If you only do aircraft leasing, you’re looking at only relative value within aircraft leasing. For us, if it’s not interesting, we’ll say ‘why are we looking at this? There’s nothing to do here, so we should do something else.’ We did almost nothing in fund finance three years ago, and recently we’ve been very active. We’ve done nothing in credit risk transfers (CRT) in the last several years, yet we’ve recently been very active in this space and Ares’ view is that we’re only going to get more active. When it’s not interesting you rotate. We have relative value skills and capacity across asset classes, and we walk away from things when they’re not interesting.

SCI: You’re also a pretty big shop as well, aren’t you?

Joel: That’s right. That goes to our second big advantage, which is scale.   If you have a US$50m investment, you might meet 30 competitors. When you get to a US$100m cheque, you’ll see fewer. When you get to US$200m or US$300m, you see less than five, and there are some pretty well-known names in there. We can do scale, and we couldn’t do it if we didn’t sit on this platform because one-third of what we do is sourced from other parts of Ares.

SCI: You mentioned that you have been very active in the CRT space and are going to get bigger. Could you tell me a bit more about this.

Joel: Well, we did a US$5bn portfolio of super-prime auto loans from a US regional bank at the end of Q3, for example.

SCI: I know JP Morgan has been in the CRT market with a reputed US$25bn pool of assets in the last few weeks. Have you taken a piece of that?

Joel: We’ve been very active across all markets. We see the potential for record levels in CRT for this year and next year.

SCI: We’re hearing this a lot, of course. What’s your take on it?

Joel: Look, if you’re a bank, your liability costs have gone up because of rates. They rose 80bps between Q1 and Q3. But asset yields aren’t going up because they’re mainly fixed rates or floating rates that have peaked. If I have short duration high quality assets, and you can sell it at a good price, it makes sense. (As an example of this, Ares bought a $3.5bn specialty loan finance portfolio from PacWest in June).

But if it’s a longer duration portfolio of fixed rate assets, it’s tough to sell it so you can either securitize it or do a CRT. But if you have a low weighted average coupon, you can’t find the debt service ratio and can’t get the rating agencies on board, so a CRT makes more sense. For legacy assets like consumer loans, mortgages or auto loans, this is the better option. Remember that these are low-yielding assets but still carry 100% risk weighting, and you’re facing Basel III endgame as well. The fact that JP Morgan is out there should tell you something. The healthiest of healthy banks needs to do a lot. What does that say about everyone else? Unless we have a collapse in rates, we believe that CRT is going to get bigger.

SCI: What other areas are you looking at?

Joel: Our big areas are bank portfolio purchases, CRT, fintech and funds finance at the moment. We’re also looking at digital infrastructure, like data centres. We believe these are great assets, with great contractual cash flow, and great diversity. The downside is that there is huge amount of capex in these projects, and the borrowers are highly levered. But CRT is our biggest area, not perhaps by number of deals but by size of deals.

SCI: Do you look at deals outside the US?

Joel: Yes, we do. We do European deals and have recently added an Australian component. But the US is our biggest market by a long way.

SCI: How has the alt credit space changed in your career?

Joel: Twenty years ago, it was all run off the prop desks of big investment banks like Goldman, Deutsche, Morgan Stanley. You had players like GE Capital as well, which financed it through commercial paper. But then the crisis happened, a lot of new regulations came in, like the Volcker Rule, and it was pushed out of banks. GE Capital lost access to their cheap liability, which was commercial paper. So, specialty alt credit funds arrived, but they were generally small players that did one asset class, like aircraft leasing and fund finance.

We acquired Indicus Advisors in 2011, which was our big start in the business, but Ares has been organically evolving and growing the business over the last 12 years.

SCI: What else makes Ares special?

Joel: The charitable component of what we do is very important to us. Ten percent of Pathfinder I carried interest profit is being given to global health and educational charities, half from the house and half from the team. We partner with non-profits that have an identified track record of delivering high value per charitable dollar contributed.

SCI: That’s great Joel. It’s not all about profit for Ares then. It’s been great to chat to you and let’s keep in touch.

Joel: It’s been a pleasure, Simon.

Simon Boughey