Interview 018_John Fraser
Jun 27, 2014
byInvestment in Japan
Company: 3i Debt Management U.S.
Mr. Fraser joined 3i Debt Management as a result of joint venture between 3i and WCAS Fraser Sullivan, a SEC registered investment advisor founded by Mr. Fraser and Mr. Sullivan in 2005. Prior to founding WCAS Fraser Sullivan, Mr. Fraser was a Managing Director and Partner with Angelo, Gordon & Co., L.P. from 1997-2005. At Angelo, Gordon, Mr. Fraser started the firm’s leveraged loan investment management business and served as portfolio manager of Angelo, Gordon’s five leveraged loan funds since their inception. Before joining the firm, he was a Managing Director with Cypress Tree Investment Management Co., Inc., a company devoted exclusively to the leveraged loan marketplace. Prior to that, Mr. Fraser spent six years as a Vice President and Portfolio Manager with Merrill Lynch Asset Management, where he managed investments in the leveraged loan and high yield bond markets. Mr. Fraser began his career in the Chase Manhattan Bank credit training program, after which he held a number of analytical and lending positions. He holds a B.A. degree from Cornell University.
Q1.Please describe your investment philosophy and how you invest
Our primary objective is capital preservation. Given the asymmetrical return profile of fixed income investing, avoiding realized credit losses has a substantial positive impact on long term performance. Consequently, our primary investing emphasis is on fundamental credit quality. We look for investments in companies that we believe will generate sustainable cash flows throughout a cycle, with long term fundamental value and secondary source of repayment in the event of financial difficulties.
Once satisfied with the fundamental quality of the borrowers we analyze, we use relative value trading to generate outperformance. Although we analyze borrowers assuming we will own their loans to maturity, we are constantly comparing the quality and projected total return of the loans we own with that of other loans available in the new issue and secondary markets.
Q2. Describe today’s current investment opportunities. Why US Bank Loan?
We continue to believe senior secured loans represent one of the best fixed incomes investments available. Loans combine a number of attributes to create this attractive opportunity:
1.Seniority and protection loans are senior in borrowers capital structures and have a security interest in the borrower’s assets. This has historically resulted in low default rates and high recoveries when loans do default.
2.Hedge against rising interest rates loans are indexed to LIBOR and will benefit from rising rates. Fixed rate fixed income assets will experience price deterioration in a rising rate environment as market yield requirements increase.
3.High real return loans are yielding approximately LIBOR plus 465 basis points. Net of expected credit losses of 40bp, loans offer a net real return of approximately LIBOR plus 425 basis points.
4.Attractive relative value loans yielding LIBOR plus 465 basis points equals almost 5%. High yield bonds are yielding slightly more than 5%. Both the yield and credit spread on loans and bonds are roughly the same. Given loans benefit from seniority and protection, a built-in hedge against interest rate risk and expected strong real return, there seems to be little excess return in the high yield bond market to compensate for the additional credit and duration risk associated with bonds.
5.Low correlation to other asset classes loans have historically exhibited low correlation to other asset classes and investment products, making loans a good diversifying investment for many portfolios.
The U.S. loan market remains the largest and most liquid loan market in the world, providing a wide variety of investment options to construct and manage portfolios. Strong new issuance driven by LBO activity, other merger and acquisition transactions and refinancings create constant flow of investment options, while secondary market trading approaching the size of the overall market provide the liquidity to actively manage portfolios to maximize return while minimizing risk.
Q3. Please explain why you have decided to enter this industry
We established the predecessor to 3i Debt Management U.S. in 2005 to provide investment advisory services focused on the U.S. senior secured loan market. We have always believed loans represent an attractive fixed income investment opportunity and deserve a place in investors’ portfolios. Loans offer the benefits noted above, all of which combine to generate a strong risk adjusted return.
Q4. What do you see as the biggest risk(s) in equities in today’s environment? Please elaborate.
Equity valuations are well above historic averages. Investors seem to believe earnings growth will continue unabated well into the future. While we agree the U.S. economy is growing, we also recognize the U.S. is in the fifth year of post-Great Recession expansion, one of the longer expansions in the post World War II period. This growth has been fueled by the massive amounts of liquidity provided by the federal government. We are concerned about the impact of reducing this liquidity on the economy, particularly when the Federal Reserve Board is suggesting the inevitable increase in short term interest rates may be at hand later this year. Slowing growth could cause investors to readjust views on equity valuations and cause a significant pull back in equity prices.
Q5. What is your ultimate investment belief? What do you try to achieve and what would you never do?
We firmly believe the best way to achieve long term outperformance is to focus on fundamental credit quality. Our goal is to preserve investors’ capital by investing in companies whose financial profiles we believe will support our investments in more challenging industry and economic environments. Reaching for yield rarely pays off in the long term, because it generally exposes investors to risks for which they are not compensated. This is particularly true in rising markets where the yield differential between higher and lower quality investments is often compressed. While we cannot predict exactly when the economic picture will change for the worse and default rates will increase, we are firmly convinced lower quality issuers will fare far worse then those with higher quality credit profiles.
Q6. How best would you protect clients’ assets?
We would do exactly what we have been doing since founding the predecessor to 3i Debt Management U.S. in 2005 ? construct portfolios that first and foremost strive to preserve investors’ capital. This requires in-depth fundamental analysis that assumes holding an asset to maturity and factors in a downturn during the holding period. We build appropriately diversified portfolios comprised of such investments and actively manage them to minimize credit risk and take advantage of relative value trading opportunities that can drive outperformance.?
Q7. Please recommend your favorite books on investments, and the reasons you favor them.
The Big Short by Michael Lewis Lewis’s book tells the story of the collapse of the subprime mortgage market that started in 2007 and how a small group of investors had the foresight to take advantage of it. While the thought process of these investors is fascinating, the equally interesting story is of how the vast majority of the market failed to see the warning signs of the collapse. The book offers valuable insight into the herd mentality that often governs investing.
Security Analysis by Benjamin Graham and David Dodd This book explains fundamentals driven investing and is valuable to both equity and debt investors. Often called the bible of value investing, the authors offer insight into how to understand how companies work and the factors that cause their value to increase.
Q8. Please recommend any media source (newspaper, journals and website) you check on a regular basis.
We monitor a wide variety of sources of information, including print and digital news media, market pricing services and market participant commentary. We do so because new information regarding our portfolio investments can come from number of different sources, any of which can signal a possible change in performance that can impact our investment thesis.
This article originally appeared on June 2, 2014. Any views presented in this article are as of such date and are subject to change.
This article and the information provided therein are not a recommendation to purchase or sell any security, nor are they intended to constitute the marketing of, or a solicitation for investment in, any investment product.