Can you give a brief overview of your strategy in terms of what you are trying to achieve for investors, your investment process and the make-up of the investment team?
Alternatives are increasingly in focus for institutional and high net worth investors and an important growth area for AB. We're committed to building a diverse alternatives platform by expanding our capabilities and attracting top industry talent. Alternatives generally comprise 8% to 10% of our overall assets.
Within alternatives, we have focused on private credit solutions, which account for $45 billion of our AUM. Over the last decade, private credit has evolved from a niche asset class into what we consider an integral component of a diversified investment portfolio. AB's suite of private credit strategies, which spans lending to middle market corporations, US and European real estate properties, consumers and small businesses, complements our $284 billion public fixed income platform. Experienced investment teams with institutional-caliber pedigrees and established track records are based across the US and Europe.
How would your strategy work in an investor's portfolio?
A private credit allocation can play three important roles in an investment portfolio: it increases income potential, diversifies broad public market exposure and can reduce overall volatility.
We seek to achieve this by spreading capital across three independent investment teams. One is focused exclusively on corporate direct lending to private equity backed companies and private equity funds. Another invests in the commercial real estate market, with separate strategies dedicated to the US and Europe. The third focuses on consumer-oriented specialty finance and hard asset lending, including aviation assets and debt and equity in power projects.
We consider all three essential components of a diversified allocation rather than an "either/or" proposition. By allocating across all three, we believe investors can improve current income reduce risk. We can invest with a variety of vehicles, including open-end and closed-end funds, both drawdown and perpetual.
Can you identify a couple of key investment opportunities for your fund you are playing at the moment in the portfolio? This could be a stock, sector or thematic level.
Average new-issue yields in corporate direct lending strategies have continued to benefit from elevated base rates, slightly offset more recently with tighter spreads. Base rates and asset yields are likely to remain above averages from recent years, and higher asset yields result in higher return potential.
At AB Private Credit Investors, our $18.6 billion direct lending platform, we believe our highly selective lending strategy that focuses on companies with recurring revenue streams, clear competitive advantages and diversified business models and avoids those with high loss-given-default profiles gives it the ability to thrive in all market conditions, including those likely to prevail as 2024 goes on.
Liquidity constraints and renewed regulatory scrutiny, meanwhile, are forcing banks to widen their retreat from providing many forms of credit. That has led to opportunities across the commercial real estate market and is helping to drive the remarkable growth of asset-based finance, which helps fuel the global economy through the financing of everything from residential and commercial property to consumer and small business loans.
We see attractive risk-adjusted return potential in this area—and returns have shown little correlation with those generated by direct lending, private equity and a host of public assets, including high-yield bonds and leveraged loans.
Looking ahead to the second half of 2024 and beyond, where are the biggest opportunities and risks for your strategy?
We expect opportunities to persist in specialty finance as the year goes on, particularly as regulatory restrictions force banks to continue to reduce many types of lending.
We also like the long-term return potential of various hard asset-backed lending strategies, including aircraft leasing. Roughly half of the world's commercial aircraft are leased, and the ability to buy planes and lease them to major air carriers—particularly those in select emerging markets were rising income levels provide the means and motivation to travel—offers an attractive risk-return proposition. Like many asset-based strategies, aircraft leasing returns have also exhibited persistently low correlations to a host of other investments, including real estate investment trusts, infrastructure and even listed commercial airlines.
Risks, in our view, are largely tied to the macroeconomic outlook. While major central banks are likely to begin easing policy this year, they're not likely to push them down significantly. A higher-for-longer rate environment will increase risks among weaker borrowers across the public and private credit markets. This underscores the need for private credit investors to maintain strong underwriting standards and risk analysis.
Matthew Bass is Head of Private Alternatives and a member of the Operating Committee at AllianceBernstein
