Managing risk in credit portfolios

Sharon Greenberg:  Good day, everyone.  I'm Sharon Greenberg, BlackRock’s Global Head of Private Credit Risk Management.  Today, we’re talking about managing risk in credit portfolios.  Today, I'm taking with portfolio managers from our Global Credit business, Howard Levkowitz, Neeraj Seth, and Zach Viders.  I'd like to ask each of them to introduce themselves.

Howard Levkowitz:  Hi.  This is Howard Levkowitz.  Thank you for joining us today.  I'm a Managing Director in the US Private Credit group at BlackRock.  I joined BlackRock two years ago when it acquired my firm, Tennenbaum Capital Partners, of which I'm a co-founder.  At BlackRock, I focus on direct lending and also special situations. 

Sharon Greenberg:  And Neeraj, would you please introduce yourself?

Neeraj Seth:  Sure.  Thanks, Sharon.  Hi.  My name is Neeraj Seth.  I'm based in Singapore and I'm responsible for the Asian credit platform for BlackRock.  I oversee all of the liquid and the private credit strategies in the region.  I’ve been with the firm since 2009.

Sharon Greenberg:  And our third panelist is Zach Viders.

Zach Viders:  Hi, everyone.  Thanks, Sharon.  My name is Zach Viders.  I am a Managing Director in the New York office of our Private Credit business.  I focus on opportunistic credit where I'm a Portfolio Manager of our Global Credit Opportunities Fund.

Sharon Greenberg:  Good day. 

Good day, everyone.  I'm Sharon Greenberg, BlackRock’s Global Head of Private Credit Risk Management.  Today, we’re talking about managing risk in credit portfolios.  I'm talking with Portfolio Managers from our Global Credit business, Howard Levkowitz, Neeraj Seth, and Zach Viders.  Would each of you introduce yourselves, please?

Howard Levkowitz:  Greetings from our Santa Monica office.  Thank you for joining us today.  I'm Howard Levkowitz, a Managing Director in US Private Credit, where we do both direct lending and special situations.  I joined BlackRock two years ago after they acquired a firm I co-founded called Tennenbaum Capital Partners. 

Sharon Greenberg:  Thank you, Howard.  Neeraj?

Neeraj Seth:  Hi.  Thanks, Sharon.  My name is Neeraj Seth.  I'm based in Singapore.  I am the head of Asian credit.  I oversee all of the liquid and the private credit strategies across the region and I joined the firm back in 2009 as a part of an acquisition of a hedge fund called RT Capital Partners.

Sharon Greenberg:  Thank you, Neeraj.  And we’ll turn next to Zach.

Zach Viders:  Thanks, Sharon.  Hello, everybody.  I'm Zach Viders.  I'm a Managing Director in our New York offices.  I focus on opportunistic credit and specifically I’m a Portfolio Manager.

Sharon Greenberg:  Thank you.  Before turning it over to each of you with some questions, I thought I might just give a little bit of a background on risk management at BlackRock.  Risk management has always been foundational to how BlackRock invests capital on behalf of our clients.  At BlackRock, investment professionals are responsible for appropriately managing risk commensurate with clients’ risk and return appetite.  And as an oversight function, BlackRock’s Risk and Quantitative Analysis team, or RQA, works in partnership with investment professionals to help oversee and perform customized analysis.  In this session, I discuss with our credit portfolio managers how they manage risk and work with RQA to drive enhanced performance. 

So, I’ll kick off with some questions.  But, before doing so, I’ll outline the four key themes we’ll talk about today.  First, risk management practices performed across all economic periods and market cycles.  We’ll talk about unique aspects of managing risk in the wake of COVID-19 and how this compares with managing portfolios during previous periods.  Three, the differences and similarities in managing risk of public and private credit assets.  And four, how we evaluate ESG or environmental, social, and governance considerations to assist in identifying and mitigating investment risk.

As I mentioned, BlackRock has always emphasized the importance of risk management in investing our clients’ capital.  In fact, one of my favorite sayings from our Chief Risk Officer, Ben Golub, is that you cannot cram for a crisis.  While we need to be deliberate in managing risk, we also need to be nimble to recognize and adapt to changing market dynamics and dislocations when they arise. 

Howard, I'm going to start with you.  What are some of the key investment considerations you adhere to throughout all types of market conditions?

Howard Levkowitz:  Sharon, thanks for the question.  There are three things we like to think about when it comes to risk management.  The first one is portfolio construction, second one is investment selection and analysis when we’re creating instruments, and the third one is a risk management state of mind. 

With respect to the first one, the type of assets, in our direct lending business this is already a risk management-oriented business in that we are doing typically senior loans.  We get paid first.  We have a security interest to claim on assets and we’re floating rate so that we have taken out issues regarding interest rate sensitivity.  Although, in this environment that issue is – usually revolves around negotiation of interest rate floors.

In our special situations business, the risk management component can be more complex, because we’re not always at the top of the capital structure.  In that business, our predilection is to try and make sure we get a series of contractual rights and seniority that is as strong as it can.  So, when somebody might want us to take a convertible note, we may go for a senior secured instrument with warrants.  If they want us to take common equity, we may try and negotiate preferred.  We are always trying to get the downside protection and maintain the upside optionality.

With respect to the industry, that’s another very important part of portfolio construction.  We always try and maintain diversified portfolios, smaller positions, lots of different types of owners and industries, spreading geographies, and spreading what we think can be correlated risk.  Even more importantly, and we’re seeing that in the current environment, is which industries you’re in. 

Several years ago, we got concerned about the economic environment.  We had no idea that COVID was coming.  But we reoriented our portfolios so that we were focusing on companies with more recurring revenues, long-term contractual streams, strong cash flows, robust hard assets with liquidation values, and moving away from companies that were more commodity-like and competitive in nature. 

So, this helps us build what we believe is a risk managed portfolio.  But, you can have all of the great portfolio construction and if you don’t have good investments, none of it matters, and so having a robust, duplicatable investment process that focuses not just on finding good returns, but on focusing on what can go wrong, stress testing, using historical data, competitor data, and ultimately looking forward. 

Which brings us to the third component, which is the risk management mindset, which I believe is really the most important.  BlackRock has tremendous risk systems and data.  But ultimately, you have to know how to apply them and have the people who have the experience doing that. 

When you see risk factors out there, such as in early January the signs coming out of China, how do you react?  When in ’07 people saw the Bear Stearns hedge fund blow up, how do you react?  And it’s not just managing the downside, because ultimately risk management means making sure you capture the upside.  So, on the flipside of that, when we saw the Fed and other central banks coming into the market with liquidity, how do you react?  This is all a series of things that make up risk management from our perspective. 

Sharon Greenberg:  Thank you, Howard.  That was a very, very helpful overview.  You had mentioned the COVID-19 environment.  And maybe just for some context for our listeners, we saw high yield credit spreads more than double in the US and Europe and nearly double in Asia.  We saw US leveraged loan prices fall by 20 points.  We’ve seen three-month LIBOR fall from 200 basis points immediately to under 100 basis points and then further to where it is now at about 25 basis points.  And we’ve – we saw the VIX spike from 20 to above 80. 

You’ve talked a little bit about how you’ve pivoted, you know, in the face of some of the market dislocations.  I was wondering if you could provide a little bit more detail around how you have focused your investment process in this post-COVID environment.  And I'll also ask if you can share what are some of the risk signs you’re looking out for in private credit markets today?  And I’ll go back to you, Howard, with this question.

Howard Levkowitz:  Thanks, Sharon.  You know, we like to say experience is what you get after you needed it.  And nobody had experience dealing with a global pandemic, at least nobody I know.  There may have been a few infectious disease doctors talking about this.  But certainly, it wasn’t in our risk models and I don’t think any of us had a frame of reference for a cessation of human interaction, normative human interaction on a global basis.

And so, being able to drill down each portfolio company, talk to the management teams, having the relationships with owners, competitors, comparing across businesses and try to assess what was going on as everybody was scrambling in both their personal and professional lives to deal with an unprecedented crisis I think was really a good test of how your risk management systems are.  If you didn’t have the right portfolio construction, you didn’t have the right investments, you were going to have a problem, but then given the portfolio that you have, being able to drill down and figure out where the challenges and opportunities might be, so what’s most important. 

So, as we went through all of our portfolios, what we did was really stress test their cash and their revenues and their assumptions.  And anybody who didn’t think there were changes in their business, we went back and redid our models and recut scenarios on our own, stressing them with other things that we knew were going on at their competitors and other people in the industry. 

Sharon Greenberg:  Thank you, Howard.  Neeraj and Zach, I'd like to hear from you as well if you have, you know, additional steps that you took in the wake of the COVID environment to manage the risk within your respective portfolios. 

Neeraj Seth:  Sure.  I can start, Sharon.  So, from an Asia perspective, obviously not really different than rest of the world.  Asia was obviously first impacted before rest of the regions.  I think the most important thing that, in addition to what Howard touched on, also was a learning which is still evolving to some extent is when you think about the risk factors in the country and the sectors as a unit of risk, they have gained a lot more importance and, in fact, still evolving in terms of how you think about the risk premium.  So, the amount of time that we’ve been spending obviously on looking at the risk factors that various countries, how do you think about risk premium based on where things are, the outlook for growth and macroeconomic stability, I think that has become equally important as looking through the bottom of security selection and understanding the idiosyncratic risk kind of position.  So, this is still an evolving situation, especially given the spread of virus is not uniform and not all the countries are out of it at this point. 

Zach Viders:  Yeah, thanks.

Sharon Greenberg:  Yeah.  That's a very good point, Neeraj.  Go ahead, Zach.

Zach Viders:  Sorry, Sharon.  I guess I would add, and Howard really hit on it earlier in terms of re-underwriting assumptions, but, you know, at GCO we spend, you know, most of our time in the private credit space and we’re doing directly originated deals.  So, I'd say on average we’re already getting better information and access to management certainly than the public markets do. 

I think we, you know, right when COVID was breaking all through March/April, we really redoubled efforts to have nearly weekly calls with management teams, with boards of directors, to make sure liquidity, first and foremost, was okay, but then also to try and, you know, get an assessment for what the, you know, the more medium and longer-term out – outlook was looking like.  Very difficult to tell, but I would say where we’ve really spent our time is just increasing the frequency of touch points with our portfolio companies.

Sharon Greenberg:  Great.  Thank you.  And I think from a risk management perspective, I’ll add that we have certainly been, both from the investor perspective and the RQA perspective, very focused on being careful around our downside cases to make sure that we’re being sufficiently conservative as we underwrite new investments in this environment, because I think as each of you has alluded to, we’re potentially and most likely not out of the worst of the economic effects at this point. 

So, turning to you, Neeraj, you have experience managing both private and public credit investments in Asia.  Can you walk us through with – excuse me.  I’ll – let me try that one again.

Turning to you, Neeraj, you have experience managing both private and public credit investments in Asia.  Can you walk us through the similarities and differences in your investment and risk management processes across these markets?

Neeraj Seth:  Sure.  Before I jump into the similarities and the differences, I would like to make two points I think which are very basic but quite important in my mind.  First, credit as an asset class.  I think this is something which is changing dramatically in terms of the importance of the asset class given the low rate environment, given what the central banks have done, and the need for income, which is very, very profound.

And the second, given the uncertainties that we are living with right now, the importance of risk management in the context of building portfolios is very, very important.  It’s certainly something which is the heart and soul of the portfolio construction and we think about it.

Now, between the public and the private markets, you can think about similarities or differences across a few different dimensions.  So, you can think in terms of the liquidity as a starting point as one of the dimensions, the concentration or diversification of the portfolios, the market and the ideal idiosyncratic risk and how do you make those decisions.  So, if you look through the details, the first one in terms of the liquidity risk, the key here is obviously the underlying fund structures are defined and designed in a way to accommodate the liquidity risk.  I think this is quite important and I do think this is, obviously, very, very basis learning from last number of crises to actually make sure that the liquidity is managed in the right way, especially when you think about our public market funds.  And I think I would view it as a significant amount of work in terms of tiering the liquidity of the portfolio and making sure that we are managing it very closely and especially when times like March where market liquidity gets really impaired, you have to have a way … design and constructed portfolio.  Whereas, on the private credit side a lot of that liquidity is an ongoing assumption of taking that illiquidity risk and getting paid for that risk premium.

The second is from a concentration versus diversification perspective and to some extent, obviously, the ease versus the complexity of implementation.  A public market, obviously, by virtue of what it is, the decisions are made much faster.  The public markets, obviously, the efficiency of the implementation is there and, hence, you do have a much more diversified portfolio and that, obviously, gives you an overall good risk adjusted return and also to some extent protects you from a downside risk in case of market drops or as well as idiosyncratic risk, because a lot of these securities tend to be unsecured in terms of the structure.  Whereas, in the private markets it’s a more concentrated portfolio, much longer time for implementation, and given the amount of time that goes in, you’re taking some more of the concentration risk, which also then varies depending on the strategy within the private credit markets, too.

And the last is obviously the, in some ways the power of liquidity or the importance in our public market portfolio.  It does give you the optionality to think about overall market risk, as well as the idiosyncratic risk and more often than not gives the chance to actually reposition as you view changes, which is not something you would be able to do in a private market portfolio.  And, hence, when I think about how the risk management works, in the private market portfolios or the funds, we have much more of the involvement from the very beginning from our risk being with the head of risk being a part of the investment committee as a non-voting member, providing all the necessary input into the decision making before you actually execute.  Whereas, in the public market portfolios there is much more of an ongoing review scenario, analysis, and adjusting the positions as we go based on the ...

Sharon Greenberg:  Thank you, Neeraj.  That was a very good overview of the differences.  One of the key tenants from a risk management perspective you alluded to that I’ll highlight is that it’s very important to match up the portfolio structure and the ability to provide liquidity and redemption rights to our clients with the liquidity profile of the assets in the portfolio, as well for closed end funds matching the investments’ maturity with the tenor of the portfolios.  So, thank you for that detailed explanation, Neeraj.

Zach, I'm going to turn to you next.  I mentioned that the partnership model that BlackRock’s investment teams and RQA employ is where we jointly manage risk in portfolios.  What are some of the ways you look to independent risk managers to help monitor your portfolios?

Zach Viders:  Thanks, Sharon.  And as you mentioned, the RQA team, your RQA team is embedded in the PM side of our business.  So, in practice what that means is that every name that comes through our pipeline from screening an idea through full blown due diligence to closing a transaction to post-closing monitoring, all of that’s being scrutinized from an RQA perspective.

So, I'd say the primary way to look to independent risk managers, that is your team, is really to bring a different perspective to really everything we do.  So, look, we of course think our opportunistic credit team and the broader global credit platform is pretty terrific in terms of bringing rigorous fundamental credit analysis to all that we do.  But, to have RQA in the room at investment committee, at those meetings or, better yet, having your colleagues sitting, you know, 10-20 feet away from us on the fourth floor, that just brings a myriad of capabilities and data analytics to what we do that, frankly, we would struggle to access, you know, on our own.

So, a few examples, whether it’s running factor analyses or FX and commodity price correlations, taking those analyses and looking at pro forma portfolio construction, if we were to add particular risks to the books.  We benefit from all those capabilities and that’s just to name a few I'd say because, A, we have that dedicated team partnering with us in our investment and risk management processes and, B, and you can certainly speak to this as well, you know, RQA leverages all the unique data that BlackRock has from the public and liquid risks that it owns.  So, in that sense, I'd say being attached to an asset manager of the unparalleled scale of BlackRock and having access to all that data, you know, really sets us apart from a traditional alternatives asset manager. 

And then, one more thing.  I'd certainly be remiss if I didn’t mention the focus that RQA and BlackRock, as a whole, places on reputational risk.  This is all run through a distinct silo with independent reporting lines.  And while it’s certainly not sexy per se, I think our investors clearly benefit from that overlay and extra line of defense to make sure that, you know, we’re not doing business with counterparties that we shouldn’t be.  So, again, I'd say that’s another thing that really sets us apart from other asset managers.  Back to you.

Sharon Greenberg:  Thank you, Zach.  I appreciate your kind words.  I have a question on ESG.  I feel we could do an entire session on ESG and how it relates with our investment process.  But maybe we could just talk very quickly with each of you in terms of how you have incorporated sustainability and ESG considerations into your investment process.  I’ll start with you, Howard.

Howard Levkowitz:  Thanks, Sharon.  Now we have always focused on reputation and governance, the, you know, ultimately who controls the business, where the decision makers are, both the owners and board of directors and also taking the perspective of, you know, how would our investors feel about each of these investments and having their names by them, because ultimately as fiduciaries of our investors’ money, we think it’s very important that they are comfortable with what's in the portfolio.  You know, the ESG framework which BlackRock has helped been a leader in creating and promoting I think gives a tremendous structure and process to that so that each time an investment comes in at the very early stages, we’re asking the questions, going through a list, incorporating the type of dynamic that Zach just described with our colleagues at RQA where we have a separate, well-informed, thoughtful voice in the room looking with us at what is the impact of this company under the various ESG factors that we’re looking at and what does it mean for sustainability?  What is the impact to this business?  It’s is it on a good side of things or is it simply, you know, generating cash flows to exist?  And so, I think it really helps inform an important discussion about the contributions and values of the business and ultimately the incremental risks as well.

Sharon Greenberg:  Thank you, Howard.  Neeraj, can I ask you to address the same question?

Neeraj Seth:  Sure.  Overall, I would say that ESG has become an integral part of the overall investment as well as the risk management process for us in Asia.  We've been working on it for a number of years now in terms of integrating the whole aspect of ESG.  And as much as it sounds obvious, I would say that awareness obviously was not as good as number of years back compared to today.  And this is something which we do strongly believe as a trend is going to keep growing exponentially from here and a lot of the focus from investors will keep going into the ESG focus link strategies.

I think that’s certainly an important aspect.  But one critical element which I do believe is important to highlight is that in addition to having this as thinking about it as from a risk management perspective is also an angle of the investment team is the primary owner of integrating ESG in their investment process, which in a nutshell what it means is that the investment team that is doing the ESG analysis on any investment is also owning the security selection and the portfolio construction.  So, it is overall very close to the investment process and something that I do think becomes very important over time.

Sharon Greenberg:  Thank you.  Thank you.  Perhaps one final question to each of our panelists.  I'd like to ask each of you to leave us with one quick lesson you’ve learned about managing credit risk throughout the course of your careers.  We’ll start with you, Zach.

Zach Viders:  Sure.  Thanks, Sharon.  Look, I think like everything else we're not perfect when it comes to risk management.  And so, I'd say, you know, a learning that I’ve had over the course of my career that I still have, you know, every year is we can get better and I think we strive to get better.  And we’ve covered a lot of the ways that we’re trying to do that at BlackRock and within the credit business, whether that’s, again, heightened efforts on ESG and bringing that into the investment discussion right up front, some of the data analytics we’ve talked about.

But, you know, we just have so many more tools at our fingertips and groups and colleagues like yourself in RQA to just help us get better each and every year.  So, that’s it.  Thanks.

Sharon Greenberg:  Thank you.  Neeraj?

Neeraj Seth:  I think the key is overall understanding the fact that in credit your upside is getting your return and your principal back, whereas, your downside obviously has much more of an asymmetry.  And hence, whenever we think about investing, it’s always a focus on the downside protection. 

Sharon Greenberg:  Thank you.  And Howard, same question to you.

Howard Levkowitz:  Humility.  I’ve been doing this for over two decades and seen a lot.  But, as we’ve learned this spring with COVID, there are always going to be things out there that you didn’t anticipate.  Every crisis is something people didn’t expect.  This was not on anybody’s list of, you know, 10-20 black swans they were expecting to disrupt the markets in the world. 

So, I think you have to recognize that there will be things that you didn't anticipate that you can’t predict.  When you’re building a portfolio and investments, make sure that they have enough resiliency and cushion so that they can withstand even the unexpected.

Sharon Greenberg:  Thank you.  So, I think that resonates with the comments I made earlier, which is you cannot cram for a crisis.  Thank you, Neeraj, Zach, and Howard, for taking the time to discuss the evolution of investing in different credit environments and how each of you risk manages your respective portfolios.

Zach Viders:  Thanks, Sharon.

Howard Levkowitz:  Thank you.

Sharon Greenberg:  This concludes today’s program, but the conversation on credit is ongoing.  We hope that you have found the discussions engaging and insightful and as we all continue to navigate these uncertain, ever-changing times, please consider BlackRock your partner.  Please visit the platform anytime to access all the sessions from today on demand and find additional resources.  We look forward to continuing this dialogue with you.

This concludes today’s program, but the conversation on credit is ongoing.  We hope that you have found the discussions engaging and insightful and as we all continue to navigate these uncertain, ever-changing times, please consider BlackRock your partner.  Please visit the platform anytime to access all the sessions from today on demand and find additional resources.  We look forward to continuing this dialogue with you.

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