00:00So I'm going to ask you about loans. Sure. We'll have to hold our breath for that. So I'll get
00:03to that in just a moment. But first I want to ask about this moment we're in. I was talking
00:06with Marion Wheeler earlier who runs leverage finance for Goldman Sachs and said look this is a market that's absorbing
00:11all of this AI related debt. Obviously PIMCO is very active there. But she said at some point this market
00:17is going to start distinguishing between winners and losers especially for data centers. Do you also think that at some
00:23point we won't just wholesale digest all of this debt deluge that's coming. At some point there's going to be
00:28some divergence.
00:30Yeah. I mean there's already been some nervousness when some of the deals have started coming out. I mean if
00:34you think about it a year ago there the size of that part of the market was zero. And now
00:39we're up about 4 percent in the high yield market. And by the next two years the expectations will be
00:44about 10 percent. So a lot of the deals that are coming through some of them are good and some
00:48of them are bad. You have to really make sure you do the correct underwriting of the deals know who's
00:53the offtake from how strong the offtake is what allows them to back out of it. So there will be
00:58some winners and there will definitely be some
00:59losers. Are the bad deals though are they still getting through easily because David it just candidly feels like we're
01:05in this period that it that it's an absolute frenzy that we're short on compute and anybody can get funding
01:11it seems. Yes. Well the hard part is to know what the bad deals are right now because even if
01:16they look bad if you think in the end that they're not going to work out well. Right now the
01:20market is accepting them. They're giving them the benefit of the doubt because of the things that you're just saying.
01:25The idea that you need so much of this compute going forward that no matter how much you're putting through
01:30right now it is just a fraction of what's actually needed. How do the deals look going through your desk
01:35and what you're distinguishing that look good and bad. Yeah. Is there is there a big difference in your mind.
01:39Yeah there is a big difference. So when you're thinking about them these deals are coming out in every market
01:44really if you think about it there are deals that are coming out in the investment grade market the high
01:48yield market the private direct lending market. So there's a lot of deals that are coming out because there's a
01:53lot of funding that needs to take place.
01:54When you're looking at them from the high yield side it's like I said it's really important to know who
01:59has the final signing for the offtake. In other words who that who that company is that's going to be
02:04taking it off for our for us. We like them to be investment grade some of the large investment grade
02:09big companies to have that offtake. We want to make sure that they can't get out of the agreement very
02:14easily. We want to make sure that by the time the agreement ends whether it's five years that is we're
02:19paid back our money and that there is after that after that portion that
02:24there will be some residual value to it. So those are the things you need to make sure you understand.
02:28So on a broader level you had joined the close with Romaine and Katie Greifel shade out to create Katie
02:33and you had talked about this idea that there is some market complacency and that spreads might start to widen.
02:39It still has been a really tight market. David what what finally gets us to that place or maybe you've
02:42changed your mind. Maybe we're forever tight until eternity. Yeah I don't want to say I'm complacent but I would
02:46say the market is pretty complacent. I mean if you think about it right now there's so many unknowns in
02:51the market. I mean oil what's going on in Iran.
02:54And I mean even if you just look at oil prices to decide where those are going to go which
02:58is such a big input to so much of the economy and the market within high yield. There's like a
03:0468 percent chance that the price goes to 65 or 165 over the next three months. So that's what the
03:11that's what the markets are implying. So with that you would think there would be a lot of volatility within
03:16our market. The truth is it's a very bifurcated market in high yield.
03:21There is a lot of it that is sitting at the tighter spread levels. So if high yield in general
03:26is seven and a half percent there's a good portion of that over 50 percent.
03:30It's actually closer to 75 percent that's sitting at a spread level of five and a half six percent. There's
03:36a 25 percent of it that's sitting at over 10 percent.
03:39So if you think about like a seesaw if there was if there was no bifurcation that seesaw would be
03:44flat. But if you've got 25 percent of it that's trading at the super high spread and 75 that are
03:49tighter.
03:49So it's really important to pick out those winners and losers. And that's why the market feels a bit complacent
03:55because they're kind of hiding beneath the surface in that tighter spread product.
03:59There's still losers. Is it all software at this point? What is it?
04:02That is a big portion of it. So if you think about like the big portion of what AI is
04:06disrupting, it is it is it is it is software for for one.
04:12And then it's a lot of servicing that goes in around the software companies. So those are the areas.
04:17Now, most of that is in leverage loans, which has about 15 percent in software.
04:22The high yield market is only about three percent. But in private direct lending, it gets up to about 20,
04:2625 percent.
04:27So that's where the concerns are, less so in the high yield market. But it still feeds through to other
04:33areas of high yield.
04:34Does that mean that there are then attractive opportunities? And maybe this gets us to loads of things that you
04:39can buy out that are kind of being thrown out with some of the concerns that maybe are unjustly so.
04:44Yeah, absolutely. And some of this is the idea that there are always areas or concerns about different sectors.
04:51So right now it's home builders and building suppliers. Right. Because the slowdown in that part of the market.
04:56So you'll see opportunities that at some point pop up there. We're starting to see opportunities now.
05:01Rates are very high. But if you're if you're thinking that rates are coming back down, you'll have an area
05:05like home builders and building suppliers that will actually be the area that should be focused on while the others
05:09have been selling off.
05:10Obviously, energy has been very strong in the market. Being overweight energy has been a big help to any portfolio.
05:17We see that actually continuing for at least through the end of this year. So there are still a lot
05:22of opportunities.
05:23How are you treating interest rate sensitivity right now? There was a hope that we would get cuts. It's a
05:28market that's pricing in a higher likelihood of hikes at this moment.
05:30Yeah. I mean, our view would have been that that there would have been some some cuts at some point
05:35this year. That's moderated now.
05:36I think with many others that it's most likely that there will not be a cut this year. And there's
05:41even the idea, like you said, of a rate rise.
05:44So interest rate sensitive sectors. Now, if you think about loans, loans themselves, higher for longer rates is very helpful
05:52to the loan product because they're floating rate.
05:54So when you think about sectors like that or different areas of the leveraged finance market, that area should do
05:59better as far as just from the idea of having a higher leverage from a higher yield.
06:04So you see these big disruptions in different sectors. And so you're actively managed ETF, L-O-N-Z returns
06:10more than six percent this year.
06:11Yes. That's easily beating out some of your competitors.
06:14Do you think it is an environment where it makes sense to be actively managed just because you are seeing,
06:19again, disruptions in software and otherwise and maybe a passive fund will leave you exposed to?
06:24I would say that product specifically, it's extremely important to be actively managed.
06:29There's about 1,200 loan issuers. So you really need to be able to pick out.
06:33You have to have a team of experts to help you pick out what those best loans are and to
06:38be able to avoid.
06:39Like one of the things we've done very well is avoiding the software sector, not completely, but much of it
06:44during this last downturn.
06:46So it's very important. Otherwise, if you're doing it as a passive, you're really just following whatever the momentum of
06:52the market is,
06:52whichever loans are trading the most, whichever are the biggest loans.
06:56And that is clearly not always the best avenue, which is why active management beats passive management, a product like
07:03this, virtually always.
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