Global credit outlook as Ares launches in Australia
Ares Australia Management launched its first local product, the Ares Global Credit Income Fund, on 12 May. The firm is a joint venture between Fidante Partners and Ares Management Corporation – a global alternative asset manager with US$149 billion under management. Teiki Benveniste, head of Ares Australia Management in Sydney, explains how the fund aims to achieve 3-4 per cent absolute return in an ever-lower rates environment.
How do you see a global credit fund fitting into the Australian investment universe?
Australia has entered the low-yield world in a dramatic way in the last three or four years. The outcome is that Australian investors are lacking options for dependable sources of higher income – and this is what our product is trying to address as a first issue. We want to offer a method of targeting income of 3-4 per cent per year in a way that doesn’t add to the risks currently in people’s portfolios, in other words also creating diversification.
There has to be a focus on generating higher income in a way that does not have to sacrifice capital preservation. This is what we are trying to do, and how we do it is by leveraging Ares’ leading investment capability in credit. We are talking about investing in corporate bonds, syndicated loans and alternative credit for this first fund we are launching. It is also global, not Australian. This means there is limited overlap with what investors are likely already to have in their portfolios.
It’s also important to note that as the focus is on securities with higher current income we are generally not reliant on capital gains in the fund to distribute the income. The fund’s objective in distribution terms is 3-4 per cent per year and we are currently generating 4.1 per cent from interest only. On the other hand, while we select securities with higher coupons, most of our investments for this fund are still in the investment-grade space.
To be able to invest in securities that earn higher income, we need to be able to conduct appropriate analysis. That is, focusing on selecting great underlying investments – the right companies that have the track record to perform through the cycle.
Ares has a demonstrated track record of doing so and outperforming the market, especially in times of stress. At the riskier part of the market, where credit-selection skills are most needed, default rates during the global financial crisis were 15 per cent in the high-yield market and close to 10 per cent in syndicated loans. Ares’ investment strategies that focus on investing in those markets only had a maximum 2-3 per cent of defaults during that time.
The Australian investment market has historically struggled with credit in that end-investors want to have credit-type returns but with the liquidity of the rates market. How do you confront the liquidity issue when looking at assets that may not be able to be exited on a daily basis?
Liquidity risk is what gets managers into trouble – if there is a mismatch between the liquidity they are offering investors and the liquidity in the underlying investment. This is clearly a very big focus for us. We are going to adapt the liquidity we offer investors, depending on the underlying investment.
What we are doing in this fund is only accessing what we think are the most liquid markets we can offer in the investment universe Ares covers. It will not have private equity, private direct lending or any of the illiquid investments we could be investing in. The unit trust is focused on securities we believe can provide the daily liquidity investors need and want.
Ares has a huge array of other investments to offer and what we will do is adapt the liquidity we are offering investors through different products. It could be a quarterly liquid product if we had a significant amount of private direct lending or asset-backed lending, for example.
This fund is predominantly invested in the US and Europe. This is a US$4 trillion investable universe across corporate bonds, bank loans and alternative credit markets. The market size also shows the level of liquidity in those markets, with most of these securities traded on a daily basis.
It must be a challenge to launch a fund with an absolute return target in a declining rates environment.
Theoretically, with rates falling, future expected returns become challenged for all asset classes. But the reality is many things are happening at the same time, including credit-spread widening – which offers the potential for better returns or new features making their way into certain instruments.
In any case, we believe we have a diverse enough investment universe of higher-yielding assets to feel confident we can meet our return targets.
For example, within floating-rate credit instruments like loans, we are looking to have LIBOR floors in the assets we invest in. This protects the current income we can generate when rates fall while still exposing our investment to limited interest-rate duration if rates were to start rising. We can also access corporate bonds, which typically have a fixed rate.
In both cases, we will look to find the best relative value on offer to achieve our return targets in the most risk-efficient way. At this stage I think it’s important to highlight that this fund is not going to be focused on generating returns from interest-rate movements – so we will not go from having one-year to five-year duration or go short. The fund will generally hold instruments with 1.5-2.5 years of duration and our allocation will be dictated by the best value on offer between corporate bonds, bank loans and alternative credit investments.
The idea of negative rates appears to be on the cards again in the US and elsewhere. For a credit manager, does the move from low to sub-zero mean anything more than any other headline change in the cash rate?
The clear impact of negative rates is that they push investors further out the risk spectrum. They push investors out of cash and government bonds and into the credit world, where they can still find the level of yield they need to achieve their investment objectives. If anything, we think credit is going to benefit from the investment flows generated by negative rates.
What is Ares’ current view on the risk environment and on pricing for risk?
We think the environment is one in which investors need to exercise caution. On the other hand, we are focused on looking for attractive investments and companies with strong fundamentals as it is possible to find great companies and investments at any point in the cycle. There are price points in the credit market we have seen as an attractive opportunity to invest, where credits have been oversold.
We are cautious about the market more broadly. The action of central banks has helped markets significantly, so we think we are not stretched on risk and are avoiding sectors that have been most affected by the COVID-19 pandemic. We are remaining highly selective in supporting companies with strong liquidity and the opportunity to outperform when the cycle turns.
During the great financial crisis period, defaults continued to rise after the immediate credit crunch. This is a risk we are aware of. But it is usually during these times that our fundamental and capital-preservation focus help us outperform.
What is Ares’ environmental, social and governance (ESG) approach?
Ares sees ESG as core to its strategy and this is evident in a number of ways, starting with where Ares’ head of ESG, Adam Heltzer, sits within the overall organisation. With a direct reporting line to Ares’ CEO, Mike Arougheti, Adam receives full backing from the top in defining and executing Ares’ ESG strategy across the platform.
At Ares, ESG is considered at two levels: responsible investment and corporate sustainability. Responsible investment takes into account the ways in which Ares integrates its ESG principles into the investment process. Corporate sustainability encompasses how Ares manages material ESG factors in day-to-day operations. In both areas, Ares has an established track record of action and impact.
Ares follows seven key principles as outlined in its responsible-investment policy and that guide its approach. Further, Ares is continually seeking to evolve and improve upon these.
The principles include a systematic implementation of ESG factors throughout Ares’ investment process and a tailored approach of adapting platform-wide Ares ESG objectives to the specific dynamics and levels of influence in each investment strategy.
Importantly, Ares is always striving to improve and continually seeking to push the frontier of best practice in ESG integration. This is particularly relevant given Ares’ leadership role in US and European direct lending to small- and medium-size companies.
For Ares Australia Management’s Global Credit Income Fund specifically, we use our research team’s proprietary analysis and third-party ESG ratings to research companies to identify and discuss existing and emerging ESG risks, generate trade ideas using positive and negative outliers on specific ESG issues, and monitor ESG developments affecting key industry drivers.