Episode 298: Public and Private Asset-Backed Markets: A Symbiotic Relationship

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back. So nice to have you. We've got such a terrific audience of dedicated listeners, a small audience of insurance investment professionals. People sometimes ask me, how do I know that these are insurance people? Are insurance investors listening to the podcast? And I always say, try and get your significant other or your kids to listen to it and you'll find out quickly that this is specialized air over here. We've got a really interesting podcast for you today. There's a lot of content and a lot of information that you're going to get, and it's on public and private asset backed markets. And we're joined today by Connell Hasten with Victory Park Capital and Sukh Grewal with Janus Henderson. Gentlemen, thanks for being on. Thanks for taking the time. We look forward to hearing from you today.

Sukh: Thanks, Stewart.

Connell: Yes, thanks Stewart.

Stewart: So, Connell's a repeat guest. So we got to start with you. Can you tell us a little bit about where you grew up and what was your first job? Not the fancy one.

Sukh: Look, I was born in India, grew up in a small town in California. What we're most famous for is we're probably the strawberry capital of America. So if you get a Driscoll strawberry box, it probably was grown in Santa Maria, California, so very small town right in the middle of California, right between LA and San Francisco, on the coast. Nice quaint area, beautiful weather. And I decided I'm going to leave all that and go live in New York. And so that was really the foundation. And if I think about my first job, I guess the most unpaid job was really working for the parents, right? Any immigrant, you go in and you work and you stock shelves at the store and that was really it. My first job, actually post one that I actually got paid for was luckily at KKR. I was at NYU for college, and this was in the early/mid 2000s and I still don't really know why KKR had an internship program and for sophomores in college. But I got the opportunity and I would say I was fairly overwhelmed. I was a small town kid, I had no idea what I was doing there. And with fancy offices on 57th Street in New York, I just tried to make sure I didn't mess anything up. And I think I did pretty well, but that was kind of my first foray into the fancy world or the complex world of finance.

Stewart: Just kind of to both of you, it makes sense. I think that folks haven't listened to your last podcast. Maybe give a little background on yourself and let's talk a little bit about how you got into the role that you're in today. I take it for granted that nobody starts out at 22 going, I am destined for the insurance asset management business. So, how did it happen for you?

Stewart: One of you is from Victory Park Capital and one of you is from Janus Henderson. So, how about you could maybe explain a little bit about your relationship and how the two firms collaborate in the asset backed markets.

Connell: Sure. For the audience, Victory Park is an investment manager focused on private credit, headquartered in Chicago. We were founded in ‘07 before the GFC and our flagship investment strategy focuses on asset backed loans, which is one of many categories within private credit. At Victory Park, I lead our investment teams and I also lead our insurance services platform, which basically interacts with our insurance investors to make sure they can access our product in the form and fashion that they need. Before Victory Park, I joined Guggenheim, actually as a portfolio manager in real estate and Guggenheim was buying insurance companies when I joined. So my real estate portfolio manager job turned into that plus learning all the various rules of insurance—the state statutes, the NAIC rules. And then after Guggenheim, I worked for one of the insurance companies that Guggenheim purchased, EquiTrust Life and ran the private investments on the balance sheet. So, my entry into insurance was an accident. You're right, Stewart. And then prior to Guggenheim, I started my career at Bank of America in lending and special situations.

Sukh: So look, Janus Henderson acquired a 55% interest in Victory Park Capital. We closed 9/30 of last year. And really what I think Janus Henderson found as the opportunity was the growth and the changing atmosphere around how assets are sitting with institutional clients, whether that’s insurance companies, whether that's sovereign wealth funds, whether that's pensions, and where we saw a lot of success within our public asset backed market, which was really around the ETFs and how we're democratizing access into the broader securitized landscape. And then when we looked over to the Victory Park side, they were dealing with either the same originators or originators who were eventually going to tap the public securitized markets earlier on. And you saw this kind of symbiotic relationship where we saw a shift happening in the general capital markets around how assets are formed, right? 

Back in the day you used to go to a bank, your community bank and basically go and ask for a loan and the loan officer would say, what do you need? And can I get an equipment loan? Can I get a small business loan? Et cetera, et cetera. And now what we tend to see is more and more that happens on non-bank originators, a Rocket Mortgage or anything else in that manner. And really what we tend to see is those folks like a diversified pool of funding. Some of that comes from places like us where we're providing through the public securitized markets. Some of it comes from people like Victory Park Capital who provide much more bespoke structured products. And some of it should come from banks who will provide a very specific credit box that they like at a very different cost of capital. And really, the way we think about the whole ecosystem working on a go forward basis is: all of those make a ton of sense in terms of how credit is created in the economy and we want to be as part of the backbone and solve as much of that as possible. And so, Janus Henderson will continue to develop and grow the public side. And then what Victory Park really brought was the relationships, the origination and the underwriting know-how, and really a brand and reputation within the asset backed space. Really wonderful in terms of really bringing on a symbiotic relationship.

Connell: I think we have overlapping insurance expertise and Janus Henderson has a diverse insurance client base that they offer a lot of expertise to. And we focus on the private side. We also have an insurance investment base and we're focusing on one part of the investment landscape. So combining the publics and the privates to offer our insurance clients almost a one-stop shop—not only on the investment side, but ancillary services too—is a pretty powerful tool. So really Janus buying Victory Park allows Victory Park to accelerate our growth, not only on the sales and distribution side, but also on the ancillary investment products. And I think Victory Park allows Janus to offer its clients a private credit investment option and solution, which is becoming more and more interesting to all investor types, but insurance investors as well.

Stewart: Yeah, you're kind of leading me in my next question, which is: we've seen a lot of interest from insurers in private credit and asset backed lending, also known as ABL. What is driving this trend? We did a survey, it was number one by a fairly wide margin from insurance investors. What is driving this trend, Connell, and why do these things fit into insurers' portfolios as well as they do?

Connell: I mean, first of all, the supply side, meaning the asset class is growing and a lot of that growth is because private credit, historically, was direct cashflow lending. Now if you bring in the asset backed lending part of it and just with all the types of collateral that you can lend to, it really increases the market size substantially. So on top of that, private credit is becoming a part of the asset allocation process for insurers. And within private credit, there could be asset allocations to specific types, like cashflow lending versus asset-backed lending. 10-plus years ago, the asset allocation process was privates only. Private equity, private debt combined. And I think asset-backed lending, if we just honed in on that category within private credit—It's attractive for insurance portfolios for a few reasons, one, relative value. if you look at the loss adjusted yields, they compare very favorable and offer a healthy illiquidity and complexity premium to other private credit benchmarks - not only private credit benchmarks, like the leveraged loan index, but also securitization comps within that specific collateral type. 

Two, from a credit perspective, the asset back loans are senior secured loans, plus they're asset backed and they're usually covenant-heavy. It offers higher recovery rates in a higher default environment. And, three, from a portfolio perspective, it’s good for diversification just in the investment portfolio. It's also low vol and low correlation and it's also an inflation hedge because our loans are floating rate with a base rate floor. So if rates were to go down below our base rate floors, our yield to worst is still above the market at that time. And lastly, I'd say it's current pay, so interest is paid monthly, so there's no J curve and offers a nice cashflow match to a lot of the liability sets in the life and annuity and p&c worlds.

Stewart: Sukh from your perspective, can you talk a little bit about how you see ABS ETFs complimenting private ABL investments for insurers? Right so, I assume that part of this equation is liquidity. Can you just kind of walk us through that, that relationship?

Sukh: Sure. I think if you foundationally think about what ETFs are doing to the fixed income market, what's really happened post 2008, and then I think it doubled down after COVID, was generally banks were the liquidity mechanism in fixed income markets, right? Their balance sheet used to be where you would go to tap that liquidity. Banks have massively retrenched and that's partially regulatorily, partially due to ROIs on their own balance sheets. What we now see is ETFs actually are a liquidity provider and actually provide more liquidity than the underlying assets. So if you take our biggest product, which is J AAA, we trade $300 million daily. Those underlying CUSIPs for the most part are nowhere near that liquid. And that ability to go in and out in size is a very efficient way to either represent a tactical asset allocation perspective, right—I want to increase my exposure very quickly to AAA CLOs, or other parts of the ABS market. Or, just generally if you want to come in size in $1 billion, you're going to have to buy a lot of CUSIPs, there's a lot of frictional trading costs that you're going to go through relative to putting in 2 to 3 tickets, and having us actually handle all of that on the backend. And so we're seeing a lot more insurers take this seriously as a mechanism where you have this view of, okay, I can use this both for SAA and TAA. I can get the exposure in a very high quality manner. Our fund is rated five stars. We've proven to have really good liquidity throughout even stress periods. And I think more and more so, and more importantly I guess, we get look-through treatment. So our J AAA is NAIC-1 rated, and so the SVO and others have gotten comfortable with how to look through these products. And the only thing we tend to work through with folks is, you do have to either fair value or do a systematic valuation relative to amortized cost if you actually held the underlying loan. But some of that is far outweighed by the fact that it's a very efficient way to get the exposure and the speed and liquidity of the actual mechanism. So we continue to see that, we think we'll continue to diversify into more asset classes and the size and quality of the insurers we're having these discussions with is making us feel like this is going to be a way in which you can get exposure on an ongoing basis relative to historical basis, which was always having the direct bonds underlying it.

Stewart: We've talked about ETFs and the liquidity they provide above and beyond the underlying before on our podcast. It's really interesting Sukh that you bring that up, because we've heard on our podcast prior that it is the case where ETFs are considerably more liquid oftentimes than the underlying. So I think that's an important consideration for insurance companies. We see time and time again, liquidity is a significant consideration. Given the evolving market environment, how do you see investor preferences between public and private offerings and what do you think is influencing those decisions?

Connell: So there's pros and cons to liquid options and illiquid options, right? And I think you have to be in the position, especially in this environment where publics and privates are part of everyday asset allocation. So if you can be in position to offer both, it's a competitive advantage. Like I said, there's pros and cons to each. So, the benefits of more liquid strategies like Janus's J AAA or J BBB is there's liquidity, there's scale, they're SVO recognized, and the limitations to purely liquid and actively traded is there's mark to market and they offer very good relative value from a yield perspective. But then if you want more yield, now you go into the private credit space and look at perhaps Victory Park's asset backed lending approach. The benefits of going down to the more illiquid investment options are enhanced yield, lower vol, but the limitations of that, it's harder to scale, it's more complex and it's more illiquid. So having both strategies within your portfolio, and this is not just necessarily an insurance investment portfolio. It could be pension funds, insurance companies, endowments, et cetera. You probably want a mixture of both depending on the investment needs and nuances of that specific investor.

Stewart: Did you want to add there, Sukh?

Sukh: My only quick comment was I think going back to where the demand is coming from generally given the retirement needs of America, spread based products are just having incredible sales, right? If you think about the FIA market, the RILA markets, and so going into ABS generally has proven to be a better place, particularly on the public market side in terms of the relative spread you could get to corporates. So we do tend to see more of that in terms of just the absolute relative value that you're getting by moving into the asset-backed market without what, in our view, taking meaningful excess risk. And then the second thing is really around, honing in on what Connell said, which is privates require origination and time to get deployed. Insurers are originating assets or originating liabilities at a pace that may not match the origination on the private side.

So, having the ability to deploy and then be able to rotate into the private side where you're able to get that durable spread is a thing that we're seeing a lot of insurers have conversations about, which is, can you get me deployed faster so I can match my liability sooner? And then over time, I know I will be able to get that and I kind of know where spreads are once I'm fully ramped, but if it takes me 12 months to get ramped, that's a problem. So I'd rather be able to deploy in a high quality asset-backed security while it's not messing up my SAA. So you do tend to see the similarity of the underlying assets combined with liquidity to facilitate moving to privates.

Stewart: That makes a ton of sense the way you've explained it. So, you both mentioned the relationship between Janus Henderson and Victory Park Capital. And what I'd like to kind of understand, and you know as well as I do that whenever there's ownership change and whatever else, investors tend to perk up and take notice. But in this particular case it appears to be, at least from my seat, a symbiotic relationship. Can you talk a little bit about how the tie up between your two firms enhances your access and enhances your capabilities in the asset backed market?

Sukh: I think where we're seeing a lot of success is really starting with the fact that Victory Park Capital's origination engine starts with having discussions with companies early, finding new originators, and being one of the first sources of capital that folks do. And with that they do really, really deep diligence. They do really, really good underwriting, but those companies eventually will graduate to either diversifying their funding source or graduate into cheaper cost of capital. And that is where we like the handoff, which is we now have all the intellectual capital that Victory Park Capital put into underwriting it, and we can come in and say, okay, if this is actually pricing wider than a similar credit, well we actually think the underlying assets are better quality than someone who may have a brand name in consumer finance or credit card receivables. We actually think there's alpha there in terms of what we're delivering on the asset side.

So there is a really strong symbiotic relationship just from the intellectual capital we're picking up. I think secondarily over time, what we're hoping to get to is a place where we can provide more solutions to borrowers. These are sophisticated capital structures, right? You can see them having warehouse loans, you can see them having actual facilities at the problem, the securitization markets. They may want a forward flow. If you have both of us sitting side by side to be able to create a solution for a company that needs to originate in a lot of different manners, that becomes really, really compelling to them because we're a one-stop shop for that solution. So that is kind of where we're moving towards. I wouldn't say we're quite there yet, but if you can see that vision of having less lenders and better relationships and larger relationships with a few of your finance originators, it just makes a ton of sense for Victory Park Capital and Janus Henderson to sit side by side. 

Stewart: It certainly seems to be the trend. The trend seems to be to larger. So Connell, from your perspective, how does this change things or how does this improve things from your seat?

Connell: I would say three things. First, the Janus team, the people, it was a culture fit, meaning we felt very comfortable with the leadership team, from minute one. And I think the feeling was mutual. So we liked the culture fit. Two is looking at it from our investors’ perspective, Janus plus Victory Park together offers a more fulsome investment solution. So just going back to what we talked about now, we can do liquids and illiquids or publics and privates or however you want to say it. So we can just offer a full suite of services not only from an investment strategy perspective, but also an investment vehicle perspective and Janus allows us to go from traditional closed end commingled funds to other types of funds that investors might need. And three, from our borrowers’ perspective, we noticed that the big investment managers are getting bigger and they're offering solutions to solve the all capital stack needs for a borrower. It could be a senior loan, it could be mezzanine, it could be unitranche, a securitization, loan sales, whatever that company needs. And I think Janus, will allow us to offer those borrowers just a more comprehensive capital solution. And so I think for those three reasons is why Janus buying 55% of us is highly synergistic.

Stewart: So here's the part where I need you guys to dust off your crystal balls and look into the future, right? Connell, you mentioned an expectation of significant growth in this market. By all indications, that's true. There's been banks pull back in this market. There seems to be taking up some of that capacity. But when you look out one to two years, what is your outlook for the asset-backed markets and what key macroeconomic factors should insurers paying attention to?

Connell: I think the growth in the market will continue and bank pullback that's one reason. We've seen in many different interest rate environments that private credit and asset backed lending is growing. And also the types of collateral that our asset backed loan structure can attach to is also growing. And that could be due to AI and GPU chips as kind of the recent flavor for that growth, but you never know what it's going to be. Transportation assets, that could be rail and aviation; FinTech lending to non-bank lenders giving consumer loans or small business loans; embedded finance and different financial products like buy now, pay later. The innovation will continue and technology is reason for that. I see just the market size growing and with commercial banks and regional banks and even bulge bracket banks pulling back on offering those loans, non-bank private credit lenders, just like Victory Park will continue to fulfill that void. Now you still have to stay disciplined, structure loans appropriately, and make sure that your structure can withstand different market dislocations. 

Stewart: This is a question I've been wanting to ask for a long time. You mentioned new collateral types. When investors hear new collateral types, I think a lot of folks go, well, I'll wait and see or whatever, but that's often the time when there's the best opportunities, is when it's relatively new. So is it that the collateral is different, but you can model the cash flows and use the existing structural formats that you currently are doing so that you feel confident in the asset class and that the diversification is actually helping? Can you just talk a little bit about the new kinds of receivables we're hearing, some of which you mentioned?

Connell: It comes down to structure. We always stick to the same structure, senior secured, typically the sole lender. We use data in historical dislocations. It could be the GFC, it could be COVID, whatever the most relevant shock is to the system and make sure that we are attaching at the right loan to cost that can withstand that shock if it happens again. We like our collateral be short in duration. And what I mean by that is, if we ever had to take over our collateral pool—which is usually in a special purpose vehicle—that is all performing on that day we take it over and it winds down quickly because the shorter duration, it's shorter of time for problems to happen.

Now to the other point of, okay, this company is doing a similar product to another type of collateral that's been in the market for a long time. The reason why we like that is you could use historical data and use it to underwrite this new collateral type. You're also doing it at a lower attachment point, and you're getting paid more because it's new. And we like that because if it's around for a while, then it's likely already in the securitization market. We're very comfortable rolling up our sleeves and using real data to form our thesis.

Stewart: That's super helpful, thank you. It was just kind of an out of the blue question. I appreciate you taking it. We've gotten a great education today on private and public asset backed markets. I want to ask you a couple of fun ones on the way out the door. This one's not so much fun as it is serious and it's really meant for people in our audience that are earlier in their careers. And the question goes like this. What are the characteristics, not the skills or major schools, but what are the characteristics that you're looking for when you're adding members to your team? This is a relatively new question for us and we've had some really good answers to it, so if you wouldn't mind, that'd be great.

Connell: What we look for is genuine inquisitiveness and positive energy. This is Sam Zell's rule, which I try to replicate, but he said there's a baseline IQ level needed to work at my firm, but I don't need rocket scientists. After that, what best predicts your success in my world is drive, energy, attitude, judgment, conviction and passion, and the ability to cut to the center of an issue. I would trade 20 points of IQ for those qualities any day. That's what Sam Zell said, and that's what I try to look for in candidates.

Stewart: That's really good insight. How about you Sukh?

Sukh: I don't think I'm going to beat that, but I think for me it's probably where curiosity intersects with understanding. What I don't like is folks who know what to put on a page, but don’t know why that was the outcome. And that's I think the biggest thing that we sometimes see. And it's a little bit of how the American educational system's built around testing. So you optimize for what you know you're solving for and you're not necessarily solving to make sure you actually understand why you got to that problem solve or that solution for that problem. And so when we're looking for people who are really good, what I want to make sure is do you know why that assumption created that outcome? Have you done the work to actually validate that that intuitively makes sense versus that's what the model spit out and that's now what's on the slide. That's where we think you create the best outcomes. I guess people are going to be really successful in their career, which is do they foundationally really understand exactly what they're presenting to someone?

Stewart: Yeah, it's a really good point. And when I taught as a finance prof at three different places, actually, I would ask a question, I would get a numerical answer of 3.578, and then right below it I'd go, why? And it would be blank. And I'm like, I have failed these students. I have failed them. The why is the important part. It's the understanding, the mechanism that makes that answer. 3.5678, whatever it is. So great insights. I've got a different fun one for you today than usual. This is the first, but just bear with me. I'm going to go to you first, Connell. What was the first band you spent your own money on to see or to buy us a song or a CD or whatever? What was the first band? Sukh, you've gotten a little bit of an advantage here because you get a chance to think.

Connell: What's coming to my mind first is a CD, and I think it was Green Day. Dukey.

Stewart: Nice. Mine was REO Speedwagon. Riding the Storm Out, on eight track at Kohler City in Barnhart, Missouri. Long, long, it looked like a place off a hee-haw. I mean it was hilarious, but that was me. For you, it's Green Day. How about you Sukh?

Sukh: It sounds like Connell and I aren't too far apart because mine would've probably been Blink-182. I was thinking it was either Green Day or Blink-182. I think both of them were obviously around and dominating the music scene at that time, so we probably didn't grow up too far apart, then, it sounds like, Connell.

Stewart: Sounds right. That's great. Thanks so much for being on today. I really appreciate it. I got a great education, had some little front and back end, so thanks for joining us and thanks for taking the time to educate our audience.

Connell: Thanks, Stewart. Thanks for having me back.

Sukh: Thanks, Stewart.

Stewart: Our pleasure. We've been joined today by Connell Hasten, with Victory Park Capital, and Sukh Grewal, who's with Janus Henderson. Thanks for listening. If you have ideas for podcast, please shoot me a note at Stewart@insuranceAUM.com. Please rate us like us and review us on Amazon, Spotify, apple, or wherever you listen to your favorite shows. My name's Stewart Foley. We'll see you next time on the InsuranceAUM.com podcast.