A Risk-Aware Approach to Bank Loans
Credit Suisse Floating Rate High Income Fund
John G. Popp
Author: Ticker Magazine
Last Update: Nov 09, 11:46 AM EST
|While bank loans offer a better position in capital structure, which is attractive to those seeking safety of principal, retail investors rarely have access to bank loan portfolios that offer a different risk-reward profile. John G. Popp, Chief Investment Officer and a portfolio manager of the Credit Suisse Floating Rate High Income Fund, and a comprehensive research team of analysts seek lower-volatility returns by constructing an actively managed portfolio of carefully selected bank loans.
“On a relative value basis, we continue to believe loans offer the better risk adjusted return profile, particularly if we think rates will go up.”
Q: How is your research team organized?
Our trading, portfolio management, and research functions sit together in a trading floor environment which provides greater immediacy of information and communication.
The analysts make recommendations to our five-person credit committee, which makes all fundamental issuer decisions. Given the team’s close physical proximity, when analysts make a recommendation and it is executed, the analysts hear it—they are very much a part of the process and see their ideas as actionable.
Q: What is your portfolio construction process?
Ours is a bottom-up fundamental credit research approach. We do not manage explicitly to a benchmark, although our benchmark is the Credit Suisse Leveraged Loan Index (not because it’s Credit Suisse per se, but because of its 25-year history). We buy the names we like as credits and then work with an independent risk team here to do monthly attribution analyses, so we add alpha primarily through security selection.
The portfolio’s overall complexion tends to range from weak BB rated loans to strong B rated loans in terms of the ratings composition from a diversification standpoint. In an asset class with this asymmetric risk profile, diversity is beneficial, and for the loan asset class we are big believers in diversification as a key way to mitigate risk. The asymmetric risk profile means that concentration doesn’t work as well with loans.
Across most of our funds, the top 10 individual names represent somewhere between 10% and 12% of our portfolio. This is a very granular portfolio, with approximately 350 individual issuers at the moment. From an industry standpoint, the top 10 industries would represent about 50% to 55% of this portfolio.
The top two positions are about 1%, the top 10 represent 9%, and the portfolio allocation is a minimum 80% in senior secured bank loans. That said, the other 20% really isn’t out of benchmark, as most other loan funds have cash and high yield.
We have about 8% in high yield bonds, and we manage those separately. We try to buy high-yield bonds with shorter duration and more loan-like characteristics in terms of being senior within that part of the capital structure, and to minimize interest rate risk.
Q: How do you define and manage risk?
Risk assessment goes back to our evaluation of a sustainable business model that can generate free cash flow sufficient to service the debt we assume. We can manage fundamental credit risk at more than just the issuer level, but by making those issuer-level decisions, we also make an industry-level decision in the aggregate.
We use diversification as a way to mitigate event risk in the portfolio, and pay attention to ratings and price volatility, working with a separate risk team.
The front line of our risk management is the portfolio management team working with the analysts on top of these portfolios every day, discussing attribution, looking at our performance volatility, and gauging how it ranks relative to peers.
We use risk metrics and look at the scenario analysis, remaining mindful of the risk around the portfolio in as many ways as possible, including reviewing each name in a macro context.
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