How the cautious approach of a $ 1.5 billion bank loan fund pays off
For fund manager Brian Juliano, protecting other people’s money is personal.
“My mother was a teacher then a secretary”, the co-manager of
PGIM Variable Rate Income
said. “My father worked in the building industry.
Juliano, 43, credits his blue collar experience for giving him a strong work ethic and helping him recognize the importance of risk control, of what is at stake when investing in business. other people’s money.
Its conservative approach is evident in the credit quality of its fund, which is consistently better than its peers in Morningstar’s bank loan fund category. And it paid off. The $ 1.5 billion PGIM the fund’s annualized return (ticker: FRFAX) of 4.3% over the past decade beats 91% of its peers, and its expense ratio of 0.97% is also below average. It carries a charge of 2.25%, but this commission is waived at brokers such as Charles Schwab and Fidelity.
Now is an interesting time to invest in bank loans, which are debt securities issued by banks to corporate borrowers and whose yields rise and fall with interest rates. After hitting zero during the pandemic, interest rates can only rise from here, especially if an overstimulated economy triggers inflation, as many investors fear.
Although bank loans can benefit from rate hikes, they do suffer from credit risk. They are typically rated below investment grade or junk quality, so weaker loan issuers may find it difficult to keep up with their payments when rates rise. In addition, many companies have borrowed heavily in recent years as rates have remained ultra-low. In addition, many of the covenants on these loans – or loan terms in times of financial difficulty – have weakened as investors become more thirsty for yield and willing to accept more risk. That means the amount investors will recover if a company goes bankrupt is less than it once was – around 40 to 50 cents on the dollar, Juliano says.
“The market has moved away from the traditional protections offered by senior secured leveraged loans,” so investors should look to high-quality assets and do “thorough credit research,” he says. . “You have to pick up the phone and talk to the [loan] dealers, the [company] management teams and private equity sponsors. You need to get as much information as possible about the [companies’] end markets and keep an eye on leverage and cash flow.
Most bank loan borrowers are not well-known blue-chip companies, but are often small private companies, which makes it essential that the analysts looking for them do their homework. Fortunately, a strong work ethic doesn’t just apply to Juliano. Three of its co-managers — Parag Pandya, Ian Johnston and Robert Meyer — are long-time experienced credit analysts. A fourth co-manager, Robert Cignarella, specializes in high yield bonds, in which the fund occasionally gets involved. PGIM’s 40 credit analysts support them.
(PRU), of which PGIM is the investment management division, in 2000 as a chartered accountant to help transform the private mutual into a listed company. (He previously worked at Deloitte and holds an MBA in finance and accounting from New York University.) But he aspired to do something more challenging. “I had made contacts in our credit business, which was very young at the time,” he says. He joined the loans team in 2003 and began working on his Secured Loan Obligations, or CLOs. Today, he heads PGIM’s US bank lending team and co-head of its US CLO business, which collectively oversees $ 30 billion in loan portfolios.
CLOs are sets of loans managed by managers, like PGIM, and sold to institutional investors. Most CLOs struggled during the 2008 financial crisis, experiencing defaults and collapsing with other forms of pooled debt such as mortgage-backed securities. But the carefully managed CLOs by PGIM handled the crisis well, says Juliano: “The great financial crash has solidified our view on our risk management techniques. This reinforced our opinion that we could launch a mutual fund product. PGIM Floating Rate launched in 2011.
Having an accounting background helps when analyzing loans, especially to “spot fraud and spot things that just don’t make sense,” says Juliano. For example, drug testing company Millennium Health issued $ 1.8 billion in debt in 2014, but PGIM avoided the sale after digging into its numbers, he recalls. “One of our research analysts asked [Millennium’s] management, “I don’t understand why your sales are increasing the way they are. That does not make sense. Can you help me understand? ‘ And the management team could not give a good answer. The following year, Millennium declared bankruptcy and agreed pay $ 256 million to resolve allegations of false medical claims.
Before investing in a loan, the PGIM team creates a risk model to see what would happen if its issuer saw a 20% drop in revenue. But once they’ve done their homework, they’re ready to take risks. For example, they more than doubled their CLO exposure from 5% towards the end of 2019 at more than 13% by May 2020 during the pandemic slide. CLOs are designed like pyramids, with levels, or bands, of credit risk, and they only bought the highest CLO bands. (They will not purchase any PGIM managed CLOs to avoid conflicts of interest.)
Even though CLOs are well diversified, Juliano said at the time of the crisis last March, these higher quality tranches were earning much more than individual loans as they were trading at discounts of up to 20% of face value. loans.
By November, the value of the CLO allocation had recovered along with the rest of the market, and Juliano started selling them to buy back individual loans. By February 2021, the CLO weighting of the fund was only 1.5%.
Lately, the team has bought floating rate preferred shares of major banks such as
(JPM) because they have high yields but good credit quality. Juliano also likes loans from companies in the process of acquisition, such as the truck manufacturer.
Navistar International (NAV), which is acquired by Traton Group, a
subsidiary company. Debt will be repaid at the close of the transaction and buyers are encouraged to repay investors with loans, thereby reducing the risk of default.
As always, Juliano tries to win by losing less.
E-mail: [email protected]