With interest rates at historic low levels and equity markets at concerning valuations, the subtitle of Distinguished Speaker Jimmy Levin’s presentation on October 4th, Finding Value in the Current Investment Environment, was alluring to say the least. Levin is Executive Managing Director and Head of Global Credit at Och-Ziff Capital Management, a manager of alternative asset strategies for institutional investors. The firm focuses on equity, real estate, credit, and—in particular–multi-asset strategies. As of the presentation date Och-Ziff was managing approximately $36 billion in assets with nearly half that falling within the firm’s broad definition of the Credit sector. They separate Credit into two categories: Institutional (primarily Collateralized Loan Obligations—CLOs) and Opportunistic. They further separate Opportunistic Credit into Corporate (meaning any single-payer form of debt including sovereign and municipal debt) and Structured Credit which includes all manner of securitized, or asset-backed pools. Distressed situations are common to both products, and often involve litigation and liquidations. A defining feature of the situations Och-Ziff finds attractive is the opportunity for the firm to exert influence over the resolution of these distressed situations. They prefer to exert this influence in a cooperative manner, but circumstances may require them to play an adversarial role.
Levin asserted that finding value in the current environment requires searching in pockets of the market that are less efficient because institutions, mainly investment banks, are less involved than was the case prior to the financial crisis of 2008-09. Situations involving corporate restructurings were once very big for Och-Ziff but this niche has become very competitive in recent years with more players crowding into the space. Instead Och-Ziff has found success by concentrating their efforts in three areas:
Structured Finance, or working out broken-down, asset-backed products: The securitized market is many times larger than the U.S. High Yield market and the products are more complicated, making for a much less efficient market. The structures were designed to be “bankruptcy- remote” and, therefore, the governing documents do not provide any rules or guidelines for restructuring. That allows a manager able to do its homework and understand the situation to exert a great deal of influence on the resolution.
Market Cycle Trades (essentially market timing): It’s impossible to call turning points perfectly, but a careful manager can make informed judgements on when a market is especially cheap or rich and adjust risk exposures accordingly. Success here requires that the manager take a contrarian approach, maintain enough liquidity to support opportunistic trading, and be ready to take the opposite side of trades when others are either overly fearful or greedy. Equally important is maintaining moderate risk when the market is not at an extreme valuation.
Bank Disintermediation Trades: Opportunities presented by changes in the regulatory environment since 2009 have reduced the number of market makers as well as their level of activity. During a period when the size of the credit markets has approximately doubled, sell side activity by any metric has declined by perhaps as much as 80%. The obvious result has been sharply diminished liquidity in all sectors of the market, especially during times of stress such as the first quarter of 2016. These present attractive risk/reward opportunities for managers who are ready, willing, and able to step in and provide liquidity when others can’t. Success here requires patience and flexibility, characteristics that are now lacking in banks because of tighter capital requirements.
The keys to success in all three of these strategies include smart, incisive analysis; astute trading; thorough understanding of complicated structures; and the discipline to be selective about when to enter or exit positions.