Fed ‘Not Out of Bullets’ Yet to Control Inflation: Milken Update

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The Milken Institute Global Conference continues in Beverly Hills, California, bringing together investors, dealmakers, power brokers and celebrities to discuss markets and megatrends. Academics, sports stars, entrepreneurs and politicians among the thousands coming to the Beverly Hilton for the event, which runs through Wednesday.

The famed gathering, in its 25th year, has pitched its focus as the power of connection, celebrating “the forces that bring us together while confronting the issues that keep us apart.” It’s a fitting theme for a world jolted by war in Ukraine just as the highest inflation in decades raises the specter of recession and the dregs of a global pandemic refuse to disappear.

The Fed ‘Not Out of Bullets’ Yet With Distressed Debt in Focus (9:30 p.m. ET)

Oak Hill Advisors founder and CEO Glenn August returned to one of the central topics of the Milken conference to help wrap up its second day. August and others pondered what the Federal Reserve will likely do to rein in inflation and how that will affect investment.


In a panel discussion titled “Alternative Opportunities: Stressed, Distressed and Special Situations,” August asserted that the Fed still has options to prevent the country from slipping into a fully distressed environment.

In terms of raising rates, it would take more than just a couple hundred basis points, before the economy reaches a point of deep recession, he said.

“The Fed is not out of bullets,” he said. “The Fed hasn’t even started to shoot.”

He cautioned that doesn’t necessarily mean harsher steps won’t be needed later — and taken.

“If they need to do what Volcker did and choke out markets because inflation is out of control, they’ll do what they have to,” August said, invoking the example of stagflation-busting Fed Chairman Paul Volcker from four decades ago.

Priming Deals Exemplify Document Gamesmanship, Khosla Says (9:30 p.m. ET)

Sticking with distressed debt, the panel moderated by Bloomberg’s Erik Schatzker also delved into some of the mechanics that validate the industry’s bare-knuckles reputation.

So-called priming transactions, in which a minority group of a company’s lenders strike a private deal to provide new financing and seize the company’s best assets for collateral on the new debt, drew mixed opinions from the panelists.

“I learned distressed investing at Apollo, where part of the concept was that it’s fundamentally important when you design debt documents to be able to protect yourself,” said Ben Black, founder of Fortinbras Enterprises. “Sometimes you’re in a bad company with a bad balance sheet, and the only way to get a return there is to write the docs and keep optionality for yourself, because it’s not a growing pie.”

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Victor Khosla, SVPGlobal’s founder and chief investment officer, criticized the trend.

“All this document gamesmanship and the platoons of lawyers, we have very little time for it,” he said. “Our point of view with this stuff is that going out and pounding each other silly is not our way. We’re trying to fix and improve businesses, and if we can do that right we can make a lot of money.” 

August called it a balancing act.

“If you want to provide a company with money to work through a tough situation, you need to be rewarded,” he said. “And the documents in some situations allow for that. When you make mistakes, whether it’s with a bad company or bad documents, you suffer the consequences.”

Elizabeth Burton, the chief investment officer for Hawaii’s employment retirement system, sees such fights from the vantage point of an institutional investor with cash invested in the various funds battling each other. 

“For us, w‘e’re getting hurt no matter what because I’m probably paying that transaction fee,” she said, adding that the intricacies of priming and the related contracts aren’t all that unique. 

“I’ve never met an industry where people aren’t getting screwed over in the docs,” she said. “That’s the nature of the beast.”

Russian Debt Seen as a Too Risky Roulette Game (9:30 p.m. ET)

The distressed investing experts mostly agreed on steering clear of Russian debt.

“We aren’t even investing in companies with Russian exposure,” Khosla said. “We can’t figure out the risk return with it. We don’t play roulette with what we do. We’re not that brave.”

August said his firm was avoiding Russian securities, too, even though they may appear cheap.

“I don’t think our investors give us money to play the roulette wheel,” August said. “I just can’t do it. That’s not why people give us money.”

Burton declined to state whether her fund was or wasn’t invested in Russia. “Dude, I’m not answering that,” she said.

Germany and Italy Headed for Recession ‘Very Quickly,’ Says Khosla (8:03 p.m. ET)

Europe may already be sliding into a distressed investment cycle, said some of the panelists said at the Milken conference.

The region has a “fragile banking system” and economies that are more tightly integrated with Russia than the U.S. is, said Victor Khosla, SVPGlobal’s founder and chief investment officer.

“Germany and Italy are going to be in a recession very quickly,” Khosla said in a discussion titled Alternative Opportunities: Stressed, Distressed and Special Situations. “In the U.S., we have a decent chance to avoid a recession.”

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The energy shock “means a lot more to Europe” than it does to the U.S., said Oak Hill Advisors CEO Glenn August. Lesser growth in wages means the consumer is more exposed, while there are enhanced risks from an escalation of the war in Ukraine.

“Senior executives are buying iodine pills,” August said. “That has to creep into the psyche.”

The U.S. economy is in good shape by comparison, he said. “There is still so much cushion,” with ample rescue capital available, August said.

Andrew Milgram of Marblegate Asset Management said there are also signs of trouble in the U.S., though.

“We’re seeing fast-turn businesses get exposed more quickly,” said Milgram, the firm’s chief investment officer. More and more companies will find themselves in need of restructuring, Milgram said.

Private Equity Seen as Less Risky as Expected Slowdown Hovers (6:50 p.m. ET)

With the Federal Reserve expected to focus on curbing inflation, evaluating investment opportunities will require zooming in on the capital structure of individual companies more than on on how a broader sector will fare, Apollo Global Management Inc. Co-President Scott Kleinman said during a panel discussion at the Milken conference titled “Private Markets: The Opportunity Continuum.”

“We’re talking about a slowdown that is interest rate and debt induced,” Kleinman said. “It’s less about the sector and more about the company.”

One of the biggest shifts that has accelerated during the past year has been what amounts to a role reversal for public and private markets, said Partners Group CEO David Layton.

Previously, the stock market tended to attract investors focused on stable, blue-chip companies, while private investment was for those with a higher tolerance for risk, Layton noted.

“There’s almost been a swap in the roles,” Layton said. “The public markets are becoming increasingly speculative and the private markets are owning larger swaths of the real economy.”

Suyi Kim, senior managing director and global head of private equity at CPP Investments, expects retail investors in search of higher returns to be increasingly drawn to alternative assets. That will likely catch the eye of regulators, she added.

“The more retail investors, the more regulation,” she said.

Not-So Prudent Choices Reflect Enthusiasm: Canyon’s Friedman (6:10 p.m. ET)

Despite equity and debt markets taking a dramatic hit this year, investors are still rushing to take risks, Canyon Partners Co-CEO Josh Friedman said in an interview Tuesday on the sidelines of the Milken conference.

That enthusiasm has caused some investors to make some not-so prudent decisions, he said.

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Looking forward, many investors suspect the market will enter a higher-rates cycle. Friedman predicts the credit market will be here to sustain the challenges.

“I think private credit’s here to stay,” Friedman said. “I think the secondary market with higher rates will also provide some competition. I think there’ll be a lot more opportunities to buy bonds that maybe weren’t that interesting.”

Though a potential recession has dominated recent discussions, Friedman said his worries aren’t with the Federal Reserve alone, but also extend to the burden of debt that’s being funded short-term.

“If short rates go up and burden the budget, it doesn’t leave much room for other things,” he said.

BlackRock’s Conway Says Transition to Net-Zero Economy Is Top of Mind (5:01 p.m. ET)

BlackRock Inc.’s Edwin Conway said environmental considerations are top of mind for many investors in alternative assets, and the world’s largest money manager is seeing much more capital being deployed to support the transition to a net-zero economy.

“You’re really seeing significant demand for private capital to support the transition,” Conway, global head of BlackRock Alternative Investors, said in a Bloomberg TV interview on the sidelines of the Milken conference.

Still, investors aren’t yet contributing the $4 trillion a year that is estimated to be needed for the transition, Conway said.

“There has been a capital shortfall.”

‘Choppy Year’ Ahead With Tough China/ESG Balancing Act (4:35 p.m. ET)

Christopher Ailman, chief investment officer of the California State Teachers Retirement System, said in an interview with Bloomberg Television that he’s finding some opportunity in the market but is remaining neutral. He sees 2020 as a “choppy year” with raising interest rates, war in Ukraine and divisive political issues at home.

While the $324 billion pension fund is knee-deep in ESG investments, it’s complicated, especially in China.

“They are the biggest manufacturer of solar panels on one hand, but they are a huge user of coal,” Ailman said. “But you need them. Everyone loves iPhones. That’s where the minerals and mining is, in China. It is incredibly complex. ESG is not simply three letters.”

Goldman’s Koch Sees Recession, Hopes It’s a Small One (3:08 p.m. ET)

The pending Federal Reserve rate hike isn’t what bothers Katie Koch most. The chief investment officer for public markets equity at Goldman Sachs Asset Management is more concerned about the economy’s slowing growth.

“I don’t want to do any fear-mongering but, of course, essentially this country is going to have a recession,” Koch said in an interview on the sidelines of the Milken conference. “And I hope it’s a shallow one.”

Consumer spending in the next six to 12 months will slow as prices continue to rise, she said. Even with surging inflation and an impending recession, Koch said she is hoping Americans will stay invested.

“Our base case is the Fed is going to be focused on fighting inflation, growth is going to be moderating; returns therefore are going to be more scarce,” she said. “What we are really worried about for our clients is the 60/40 portfolio and its future from here.”

The current landscape is prompting investors to look into other areas of investment. While the firm continues to own “traditional” hydrocarbon companies, it also invests in alternative energy. “We really do believe that we are on the precipice of a major revolution here in climate transition,” Koch said.

Tight Supply Leaves Real Estate Sitting Pretty, Sternlicht Says (2:50 p.m. ET)

Real estate is better-positioned than stocks, bonds and other investments to withstand rising inflation and interest rates, because limited supply and the cost of new construction make existing properties a good bet to hold their value, according to Barry Sternlicht, chairman of Starwood Capital Group, which oversees $120 billion in assets.

“We’re sitting prettier than any other asset class right now,” he said at the Milken conference.

Fed ‘Not Out of Bullets’ Yet to Control Inflation: Milken Update

Well-located resort hotels, class-A office buildings and even co-working spaces are among the property types likely to meet strong demand even as the economy slows, Sternlicht said. Europe, particularly the U.K., is a better place to find value than the U.S., he said.

One of the biggest challenges will be raising money, because portfolio managers will re-balance their holdings by reducing exposure to real estate as other slices of the investment pie shrink, he said.

And there are risky pockets in the property sector, such as office buildings and hotels in San Francisco and New York, he said. Even parts of booming Miami are likely to run into trouble. “It’s going to be ZIP code by ZIP code,” Sternlicht said.

Pretium Sees Home Price Gains Slowed by Affordability (2:45 p.m. ET)

The advance in U.S. housing prices will likely moderate as rising interest rates cut into affordability, but the demand exceeds supply and buying is becoming increasingly unaffordable, putting residential landlords in the driver’s seat, according to Don Mullen, founder of Pretium Partners. The best bets are cities where populations are growing but costs haven’t gotten excessive, such as Provo, Utah, or Jacksonville, Florida, he said during the Milken conference.

“There’s a wild supply-demand imbalance,” said Mullen, whose company owns about 80,000 single-family rental homes.

Mnuchin Says Europe Should Embargo Russian Oil Immediately (1:47 p.m. ET)

Europe should immediately institute an oil embargo against Russia as part of its response to the invasion of Ukraine, former Treasury Secretary Steven Mnuchin said, calling such a move “psychologically important.”

“This is probably the most dangerous situation we’ve been in since World War II,” Mnuchin said during a panel discussion at the Milken conference. “We need to find an exit off of this for both sides,” he said, adding it’s “unlikely” the war would have occurred under the Trump administration.

Exiled Russian oil tycoon Mikhail Khodorkovsky, who also participated on the panel, said the strategy toward Russian President Vladimir Putin should be: “We don’t want to see you in power, but we don’t necessarily need to have you leave power right now, immediately.”

Defaults Are Lurking in Credit’s Unpeeled Onions, CQS Warns (1:44 p.m. ET)

While maturities may be further on the horizon, and interest-coverage ratios are high, defaults are going to come, said Jason Walker, chief investment officer and partner at CQS.

“There aren’t many near-term catalysts for default, but that pressure will build,” he said during a panel about private credit at the Milken conference.

In particular, investors will need to look deeply at borrower profiles to understand risk across their portfolio. As an example, CQS has increased its allocation to bank regulatory capital, which can often have better-quality loans and a higher pool in terms of credit quality, he said.

“There’s going to be a lot of nuance, it’s going to be important to unpeel the onion a little bit,” he said.

Deals Take a Breath After Global Gut Punches (1:33 p.m. ET)

Rising interest rates, the war in Ukraine, inflation and other disruptions are going to stymie M&A and initial offerings — for now. Activity probably will ramp up once companies get used to this new normal.

That’s one takeaway from dealmakers during a panel at the Milken conference, which included forecasts during other sessions for bigger combinations financed by private credit and a potential pickup in bids originating in Japan.

In the meantime, “we’ve seen a slowdown in the immediacy of deals people are looking at,” said Melissa Sawyer, global head of mergers and acquisitions with law firm Sullivan & Cromwell. “People are nervous about doing things in the very near term.”

The numbers back that up. Global dealmaking is off to a soft start this year, despite a handful of blockbusters including Elon Musk’s takeover bid for Twitter and Microsoft’s pact for Activision Blizzard. M&A is down about 9.5% year-over-year, to $1.1 trillion in announced deals through Tuesday, according to data compiled by Bloomberg.

Guggenheim’s Walsh Has Eye on Exit for Floating Rates (1:10 p.m. ET)

Guggenheim Partners will be on guard for more defaults in preparation for a possible move out of floating-rate investments and into more secure credits.

So says Anne Walsh, the firm’s chief investment officer of fixed income, who told a Milken conference panel there’s “quite a bit” of leverage throughout credit markets. “The risk, of course, is that that cost of capital is also going to be rising and could be quite rapid,” Walsh said, and the cost of leverage within the system then may be “unsustainable.”

If defaults rise as a result, Walsh said that’s when portfolio managers would need to quickly pivot from floating-rate assets and the high-yield market and back into higher-quality credit, “where the debt-service coverage ratios are much better.”

Antares Sees Private Credit Handling Bigger Deals (12:55 p.m. ET)

As more money pours into the wider private credit market, firms will have the fire power to underwrite bigger deals and take market share from the leveraged loan market, says Antares Capital Chief Executive Officer Timothy Lyne.  

“Some of the deals in the leveraged loan market in the $1 billion to $1.5 billion range are going to go to the private credit market, and at the same time, private credit managers are raising larger funds that will allow them to finance larger transactions,” Lyne said during a panel discussion at the Milken conference.

The multibillion-dollar unitranche market, which blends elements of loans and unsecured credit, is set to grow unabated, he said. “I absolutely believe the mega-tranche trend will continue and we’re going to see more of them,” he said. Antares itself led a $3.4 billion unitranche financing for Galway Insurance last year to partly fund the takeover of MAI Capital Management. 

Deutsche Bank Expects Japan to Go Shopping for U.S. Deals (12:41 p.m. ET)

Japan could ramp up its deal activity in the U.S. this year, according to Deutsche Bank’s global head of investment banking coverage and advisory.

Drew Goldman told the Milken conference he’s expecting “some surprise investment on a large scale” in the form of mergers and acquisitions. Japanese companies “have a lot of cash and a history of investing in the U.S.,” Goldman said.

Venture Capital Gives Minorities a Slow Welcome  (12:28 p.m. ET)

Venture capitalists are backing more minorities in technology and Silicon Valley, but the changes are “still too slow,” SVB Financial Group Chief Executive Officer Greg Becker said Tuesday.

“You’re not going to see a dramatic change” without limited partners calling on venture capitalists and other sources of funding for early-stage companies to shift their priorities, Becker said during a panel discussion held as part of the Milken conference.

Becker said investors have become more aware of environmental, social and governance issues. In the past year, shareholders have secured surprising victories, including a vote engineered by a small activist investor that landed it two Exxon Mobil Corp. board seats.

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