This news service talks to US-based New Mountain Capital about the benefits of holding floating-rate credit exposures and how this can work to investors' advantage when rates have been rising, as they have recently.
(An earlier version of this article was published last week in Family Wealth Report, sister news service to this one.)
Investors who hold bonds that pay a fixed interest rate know that returns fade when central banks hike rates as they have recently. And that makes bonds or loans with a floating-rate structure a more compelling option. This logic applies as much for private investments into credit as it does in more conventional bond investing.
New York-based New Mountain Capital favours the floating rate approach, so it has told Family Wealth Report. It has more than $37 billion of assets under management, of which its credit assets account for about $10 billion in assets under management. Its $1.3 billion market cap, publicly traded business development company, New Mountain Finance Corporation, holds around 88 per cent of all assets in such floating-rate paper. NMFC was founded in 2008 and had its IPO in 2011.
NMFC’s net investment income (NII), which many view as the key earnings' metric for BDCs, was $0.39 per share in Q2, representing a 26 per cent increase in year-over-year NII and meaningfully overearning its dividend. In addition to offering a regular quarterly dividend of $0.32 a share, NMFC started a supplemental dividend programme in the first quarter of 2023, showing, it said, a commitment to shareholder-friendly capital allocation. With the programme, 50 per cent of quarterly adjusted NII generated above the regular dividend is paid to shareholders in the following quarter, which means that shareholders will receive a total of $0.36 in distributions in the coming quarter.
“Exposure to loans that float with higher base rates is tremendously valuable to all of our investors, whether institutional or retail,” John Kline, chief executive, told this publication. “Most investor portfolios are over-exposed to credit investments with fixed rates, such as bonds. Fixed rate bonds decrease in value as interest rates increase which has created large losses within investors' portfolios.”
“There are very few asset classes that are positively affected by rising rates; private corporate loans to strong companies with pricing power are one of the few investments that benefit,” Kline continued. “The hallmark of our business is the consistency of our credit selection. We lend to borrowers with strong business models and high free cash flow generation. These borrowers can generally afford higher borrowing and input costs.”
With inflation rising to double digits in recent years, forcing central banks to hike rates after more than a decade of holding them on the floor in the aftermath of the 2008 financial crash, new realities apply. A Bloomberg global aggregate index that tracks bonds (source: Bloomberg, Financial Times, 23 December 2022) showed that fixed income assets fell 15 per cent in 2022. The yield on the index rose as high as 4 per cent in October, rising from 1.3 per cent at the start of the year. When yields rise, prices of bonds fall. As equities also sank in 2022, it meant that conventional “60/40” portfolios (60 per cent equities, 40 per cent debt) gave no protection from the storms.
One of the central ideas behind NMFC's approach is that it gives investors the ability to ride out turbulence, and the floating-rate note holdings reflect that, Kline said.
“A risk is that some companies cannot deal with much higher rates,” he said.
“The firm’s specialty is identifying and evaluating secularly advantaged middle-market companies in a-cyclical industries that have the potential to deliver strong growth irrespective of the economic environment, and then working with them to maximise that potential and drive growth that benefits all stakeholders,” he continued.
“The majority of NMFC’s loans are to private equity-owned companies affiliated with top-tier financial sponsors. NMFC employs the same defensive growth philosophy as New Mountain, and some of the sectors where it has especially deep expertise and often invests in include enterprise software, healthcare services and healthcare IT, technology-enabled business services and financial services,” Kline said.
Another benefit of the listed NMFC structure is that it enables retail investors to tap into the private credit story as it tends to be otherwise restricted to HNW clients and institutions, the firm said.
New Mountain also manages several private credit drawdown funds geared towards family offices, high net worth individuals, and certain institutions.
In addition to New Mountain’s presence in private credit, its credit arm also employs strategies in the syndicated market through funds and collateralised loan obligations.
As regularly reported in these pages, the private credit space has expanded significantly since the 2008 financial crisis, because tighter Basel capital adequacy rules and regulations such as the Dodd-Frank legislation have forced banks to (mostly) pull in their horns. Some of the capital has flowed into private funds instead (an area sometimes described as “shadow banking”).
Kline said that private credit is full of opportunities – although it will not be all plain sailing.
“While private credit has always had advantages for borrowers in terms of certainty, flexibility and ease of execution, these advantages have been magnified as issuance in the syndicated market slowed in 2020 and 2022. The private credit markets are now attracting larger and higher quality financing opportunities than ever before, and on more advantageous terms for lenders. We expect that even as markets reopen, many sponsors and larger, high-quality borrowers will continue to use private credit more heavily, following this positive experience,” he said.
Research firm Preqin predicts that AuM in private credit will reach $2.3 trillion in 2027, although the pace of fundraising will slow. Fundraising is expected to be fastest in North America. In the third quarter of 2022, $172.1 billion was raised by private debt funds globally. Preqin said investors are, even so, expected to be “more discerning.”
The New Mountain Capital firm was founded in 1999 by another Steve – Steve Klinsky. Before he created NMC, he co-founded the Leveraged Buyout Group of Goldman Sachs and served as both an associate partner and general partner at Forstmann Little. NMC has more than 200 staff.