Defensive senior debt strategies in a zero yield environment

With many traditional yield investments providing ever more meagre returns, the hunt for yield has grown ever more intense. Real estate debt can provide a compelling alternative which we believe should be considered more closely in portfolio allocations. Within this space, we think that there are opportunities for margins of around 400bps over LIBOR, whilst retaining the safety associated with an investment grade instrument. Achieving this, however, requires considerable experience and disciplined processes.

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Executive Summary

The low returns world we currently live in has presented significant challenges for institutional investors. As yields on high quality sovereign and corporate bonds stay persistently low, and even negative, pension deficits are increasing, endowments are struggling and sovereign wealth funds are struggling to generate their target returns. We strongly believe that real estate debt may provide a potentially compelling solution for institutional investors looking to make new allocations under these circumstances. As we will outline, Aalto’s conservative approach seeks to mimic the risk profile of conventional investment grade securities, whilst providing a potentially superior return stream to that which investors have become accustomed to from traditional liquid investment grade bonds.

Aalto first entered the real estate debt markets in early 2010, when both the European and US markets were dislocated following the Global Financial Crisis (‘GFC’). Today, these same areas are characterised by a diverse group of lenders, including banks, asset managers and other institutional investors. There is also considerable divergence between opportunities in different geographies, and across different types of real estate assets. Across both the US and Europe, vast changes in financial regulation over the past few years are having a material impact on bank lenders’ lending appetite in the market, thus creating dispersion in certain real estate assets or market segments.

Real estate markets have broadly improved over the last 3-4 years (i.e. assets have become more expensive). At Aalto, we have responded by steadily reducing our risk appetite to help ensure that our real estate debt investments provide our investors with a margin of safety should the market environment change in coming years. In practice, this has meant focusing on defensive direct loans with lower loan-to-value ratios, strong equity sponsors and ongoing maintenance covenants. Our investment focus revolves around sourcing loans backed by quality core and core+ real estate assets, and in targeting a portfolio level average loan margin of 300-400bps over LIBOR with moderate upfront lender fees. Our lending is mainly focused on floating rate and relatively short duration opportunities for our pension fund clients and more weighted towards long-dated fixed rate loans for our insurance clients.

Key Facts

  • We believe real estate loans are attractive in the current market environment:
    • Senior loans, secured by quality real estate assets that can be underwritten in detail
    • Floating rate with short duration
    • Large market with ample potential opportunities – USD 2.9 trillion in the US and EUR 1.1 trillion in Europe1
  • Aalto’s focus is aligned with these areas:
    • Geographic focus on US, Europe and UK
    • In terms of capital structure we look for senior secured debt at 50-60% LTV
    • We lend to institutional borrowers backed by what we perceive to be high quality real estate
    • Our portfolio seeks a material yield pickup to traded corporate debt of comparable credit quality
    • The portfolio’s yield profile is complimentary with direct real estate investment

 

1. CBRE and Morgan Stanley Research.

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Important information

Opinions expressed are those of the author and may not be shared by all personnel of Man Group plc (‘Man’). These opinions are subject to change without notice, are for information purposes only and do not constitute an offer or invitation to make an investment in any financial instrument or in any product to which the Company and/or its affiliates provides investment advisory or any other financial services. Any organisations, financial instrument or products described in this material are mentioned for reference purposes only which should not be considered a recommendation for their purchase or sale. Neither the Company nor the authors shall be liable to any person for any action taken on the basis of the information provided. Some statements contained in this material concerning goals, strategies, outlook or other non-historical matters may be forward-looking statements and are based on current indicators and expectations. These forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update or revise any forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contained in the statements. The Company and/or its affiliates may or may not have a position in any financial instrument mentioned and may or may not be actively trading in any such securities. This material is proprietary information of the Company and its affiliates and may not be reproduced or otherwise disseminated in whole or in part without prior written consent from the Company. The Company believes the content to be accurate. However accuracy is not warranted or guaranteed. The Company does not assume any liability in the case of incorrectly reported or incomplete information. Unless stated otherwise all information is provided by the Company. Past performance is not indicative of future results.

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