In discussion with… Alcentra’s Hiram Hamilton
Can the ‘complexity premium’ of structured credit offer investors uncorrelated returns? Read this Q&A with Alcentra fund manager Hiram Hamilton to find out.
Hiram is co-head of Structured Credit and a portfolio manager for all of Alcentra’s¹ structured credit investment funds. He joined Alcentra in 2008 and founded the structured investment business, launching the first opportunistic fund during the credit crisis in 2009. Previously, Hiram spent eight years at Morgan Stanley, ending his tenure as an executive director and head of its CLO structuring and origination business in London. Hiram graduated cum laude from Bowdoin College in 1997 with a dual major in Philosophy and Neuroscience.
What prompted you to go into asset management?
I was always very interested in the investing side, even in college. Naturally, I felt that going to Wall Street was the best way to learn more and immerse myself in the financial world. Even though none of my degrees were in finance, I realised that firms were looking for problem solvers and communicators. Plus, once I delved deeper, I understood that a big part is just understanding the jargon – the financial industry still has a habit of making things seem a lot more complicated than they really are.
Describe your role at Alcentra?
I’m a portfolio manager that looks after investments in structured credit. Structured credit is essentially the pooling of loans that are governed by central documentation, which then dictates how cash flows will be distributed to the various loan tranches – that’s the ‘structure’ component.
Can you explain the broad appeal of structured credit for investors?
Structured credit is an interesting asset class that offers attractive yields in exchange for giving up some liquidity and taking on additional complexity. You can often get higher yields without necessarily exposing yourself to more risk because these loans are typically first lien to a business, meaning we would get the first claim on any assets in a liquidation. This gives investors some downside protection.
The main trade-off is liquidity, which creates more pricing volatility than other asset classes in the credit space. For instance, in March of 2020, loans and bonds declined by around 20%, while certain tranches in structured credit traded down about double that. Despite that, performance has been pretty good – depending on credit selection, of course. Plus, volatility can also present investment opportunities.
There are also plenty of intricate details that generate additional complexity – what I call the “complexity premium”. It does take a certain level of expertise to understand and analyse these structures.
On a personal level, what appeals to you about structured credit?
I enjoy each investment’s cash flow element, which lends itself to very quantitative model-driven analysis. At the same time, you must be focused when reading through the documentation to spot the details. So, it pulls together an array of skills which I find very appealing. That may be why I’ve been in structured credit my whole career, beginning as an analyst at the asset-backed securities group at Prudential Securities.
My neuroscience background probably made the technical aspect of structured credit appeal to me more. Surprisingly, my philosophy background also played a role! A lot of philosophy has to do with studying the structure of logic. I find there’s some carryover when analysing a collateralised loan obligation (CLO).
What are the strengths of Alcentra in this asset class?
The structured credit investment managers at Alcentra are industry-leading specialists with a global reach in the CLO market, particularly the US and Europe. Our eight-strong team possesses deep CLO structuring expertise and knowledge of how CLOs operate and are documented. Five of our team members are based in London, and three are in New York.
You joined Alcentra at the beginning of the Global Financial Crisis. What was your experience navigating credit markets in the middle of such tumult?
Well, Bear Stearns collapsed in the middle of my first week here, so I immediately knew I was in for an interesting time! CLOs weren’t the centre of the subprime mortgage crisis, but they were a related asset class. And although CLOs are very different from subprime mortgages – being backed by loans to big businesses – they were still “tainted” by their relationship with the broader securitised market.
That turned out to be a great opportunity, as it meant we started at the bottom of the market. It’s partly why we produced some outstanding returns.
Do you see any parallels between then and the current pandemic-related crisis?
I would say the current crisis is the second-best investment opportunity I’ve seen in my career. I think the Global Financial Crisis was scarier because you had big names failing. In contrast, the current crisis is more disruptive terms of human behaviour. Yet, it might not be a “forever disruption”, and we’ve already seen how people have swung from that initial fear of the unknown to optimism that it could be contained.
This dovetails into one of my core investing philosophies, which is to be long-term smart. I think when you manage money, there’s a tendency to try to be short-term smart. So, for instance, in April of 2020, when the market started snapping back, you probably felt the tendency to sell out of the fear it could dip again.
However, I like to focus on the bigger picture. I tell my team, don’t be one-month smart or three-months smart. What we can to do is be one or two-year smart. Of course, it also depends on what type of fund you manage, and you do have to educate investors to encourage them to stick through it for the longer-term.
When you're looking at a CLO, what metric do you value the most?
Since these are pools of corporate credits, the metrics we are tracking here are our exposure to specific industries or sectors. Then we drill down to the leverage of the businesses and study their future revenue trends.
Now, because it’s a pool, there will always be names we don’t like. Of course, we can’t just kick them out of the pool, so what we do is to give these risky names an appropriate haircut. Then, we see if there’s still enough coverage on the entire pool. We systemically do this for all 100 to 150 names in each pool.
By doing this, we can estimate how much losses a pool can take and still deliver par value because of its excess assets. We can compare that to the market price and look for buying opportunities.
What socially responsible factors do you consider when making investment decisions?
Each CLO has a portfolio of loans that collateralise the transaction but are selected by the CLO manager. As such, we don’t choose or control the loans that are included in the portfolio. That said, we do take into account ESG factors when making a new investment. For example, we ask managers for evidence of how ESG factors are incorporated into their credit analysis. Generally speaking, poor ESG ratings lead to higher-risk assets that demand caution or complete avoidance.
What is the outlook for the structured credit market in 2021?
As we know, yield is very hard to come by in the current low interest-rate environment. Yet, despite a big rally from the pandemic lows in March in 2020, CLO tranches still offer higher yields than similarly rated but more liquid credit, such as investment-grade and high-yield bonds. Also, governments worldwide could increase money supply and expand fiscal stimulus this year, which might be problematic for fixed-rate credit investors, as rates could start to rise. CLOs, on the other hand, are floating-rate instruments, which adds to their appeal.
When you're not analysing loan pools, how do you relax?
Happily, I am a very active dad. I have five children – you can thank my wife for that. We have four girls and one boy. It’s super fun to spend time and play around with them. On the personal hobby front, I love playing board games and chess.
¹ Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.
The value of investments can fall. Investors may not get back the amount invested.