Chris Barris, managing director of multi-credit at Benefit Street Partners (BSP), part of Franklin Templeton, speaks to Room151 about the growing role of alternative credit in meeting LGPS income needs.
A lot of LGPS investors are currently reviewing their SAA, what would you say is the case for expanding alternative credit allocations?
The LGPS 2024 Scheme Annual Report shows that 78% of funds experience a deficit when comparing contributions to benefit payments (excluding investment income). With schemes maturing and the number of pensioners increasing by about 10% from 2022 to 2024, cashflow management becomes increasingly important.
Multi-Asset-Credit (MAC) can help, but investors need to find their right balance between liquidity, risk and income. MAC spans traditional and alternative credit, ranging from gilts to private credit and everything in between.
Often, daily liquidity funds can fail to generate sufficient income to meet liabilities, both short- and long-term. These are typically composed of more traditional fixed income assets, such as emerging market debt, traditional asset-backed securities and investment grade corporate bonds, which historically struggle to meaningfully outperform SONIA.
However, high yield (HY) bonds, bank loans and other alternative credit products, such as structured credit CLOs, have demonstrated strong excess returns over SONIA. These assets, when mixed, can offer monthly liquidity and have historically generated high-single digit average returns.
The stronger income profile reflects the risk premium earned from lending to corporates rated below investment grade and potential default risk. However, the incremental return far exceeds the realised loss, making alternative credit MAC an attractive asset to meet and exceed your liability needs.
What does a holistic approach to alternative credit investment look like?
We strongly believe in our “one integrated portfolio” approach, which contrasts with many managers who distribute allocations across various internal portfolio managers.
Under a single portfolio, we effectively optimise across opportunities within a capital structure. Take Virgin Media, which issues bonds and loans across USD, EUR and GBP. We will invest in the security that offers the most attractive risk-adjusted returns within the capital structure, whereas a strategy that parcels out allocations may deliver numerous investments in a capital structure with inferior management of risk control and yield.
Managing holistic portfolios requires a disciplined, collaborative, team-driven approach. Our portfolio management team has worked together on multi-credit mandates for over 10 years, and we bring over 25 years of average investment experience to these conversations. Moreover, we have one of the largest research teams in the sub-IG industry with size, depth and scale in European and US markets. We spent more than a decade honing our network to source opportunities where we often get a “first look” at deals.
Analysts specialise in sectors, not asset classes, so they analyse capital structures to determine the most attractive opportunities. Importantly, our extensive resources provide deeper insights in asset classes where information is more nuanced, enabling value creation from opportunities both bottom-up across issuers and top-down across asset classes.
Can you give us examples how you capitalise on those opportunities?
Consider the recent tariff tantrum in April. In the month leading up to “Liberation day”, our asset allocation committee recognised that the incremental yield premium for going down in risk was unattractive amidst the tariff threats coming out of Washington. Moreover, US HY looked particularly rich relative to European HY, so we improved the fund’s quality by reducing lower-rated credits and US HY in the weeks leading up to the sell-off. When US HY spreads widened 200bps from the year’s highs that week, we believed that US HY was relatively oversold and quickly shifted back into it. We therefore capitalised on HY experiencing 130bps in spread tightening by the end of May, which sharply outperformed global bank loans.
How are you navigating default risks?
Our first line of defence is our highly skilled research team. We have over 45 credit analysts with extensive ‘boots on the ground’ coverage in the UK and US. They have developed deep ties with management teams of issuers and carefully assess the competitiveness, financial integrity, liquidity flexibility and covenants of each company. When an investment becomes stressed, we will leverage our US and European Special Situations teams’ expertise who offer insight and analysis speedily on challenging situations.
Finally, we strongly believe in diversification and are continually reviewing better relative value investments to build a portfolio offering the highest risk-adjusted return opportunities at all times. This approach resulted in a stellar default loss track record, significantly below market experience.
Let’s talk about your geographic exposure, where do you see the opportunities?
We allocate where we see the opportunity across US and European markets. There is no ‘hometown’ bias in our allocations – we seek to capitalise on the opportunities that are available. For example, we will allocate meaningfully to European loans, including UK issuers, if we think it looks more attractive than US HY, which happens to be over 3x larger in market size than European loans. One reason we can do this that we benefit from having great scale, capabilities and relationships in each of the markets we invest, so we are able to source opportunities in the primary and secondary markets across the developed market spectrum.
In fact, in today’s environment, we are more skewed towards European and UK opportunities than in US. The underlying fundamentals and technicals in each of our asset classes remain firm, but we see a valuation premium in European credit versus US. Additionally, the default outlook is relatively more benign in Europe, Germany is engaging in fiscal stimulus and the central banks more accommodating than in the US.
What role does ESG play in selecting the right investment opportunities?
ESG is integral to our investment process, and we believe that companies with strong ESG characteristics generate better long-term returns for all stakeholders. Our process helps us make real-time ESG risk-based decisions and allows for continuous monitoring, including our exclusionary policy, ESG checklists and climate risk scores.
Moreover, BSP have publicly committed to net zero by 2050, including an ambitious goal for a 50% reduction by 2030. This has required considerable investment, including a proprietary database that gives us and our clients detailed and granular information about each of our investments, including carbon emissions and climate data.
How will the alternative credit market change going forward?
We believe the attractiveness of alternative credit asset classes aligns really well with the income needs of local pension schemes. Traditional fixed income has many benefits but can be challenged to consistently generate sufficient income and, as a long duration asset, its realised return can be susceptible to gyrations in the risk-free rates.
We are seeing growing interest in alternative credit based on customised liquidity, risk and income. Alternative credit is diverse in terms of sectors and geographies and even expands into structured credit CLOs. These are all growing markets, and part of that is fuelled by investor demand for income generating assets with strong collateral.
We think experienced managers who have a discipline, rigorous and repeatable process and a stellar, proven track record over multiple time periods are best positioned to capitalise on and deliver returns for their partners.
