T. Rowe Price takes big step in alternative investments with acquisition
In a sign of the times,
Price T. Rowe
announced on October 28 that it had acquired Oak Hill Advisors, a manager of high-yield assets and private credit, for $ 4.2 billion.
This move is as unusual as the last time T. Rowe (ticker: TROW) made a note acquisition, in 2000, when he paid $ 780 million for the other half of a joint venture he had. with British asset manager Robert Fleming called Rowe Price. -Fleming International.
In a zero interest rate environment like today, investors are looking for alternatives to traditional bonds. Oak Hill, or OHA, has a lot of experience – over 30 years – and assets – $ 53 billion – in alternative credit, and in particular in illiquid private debt which cannot be traded in the markets of public titles.
“Rowe Price-Fleming International was a very strategic deal in the sense that it was a statement that we were going to try to be a global company, not just a national company,” said Bill Stromberg, CEO of T. Rowe. “It has gone really well over the past 21 years. We think this partnership with OHA is also very strategic, and a statement that says we want to diversify more widely into the world of illiquid alternatives. It’s a big statement.
Debt issued by the private sector has a number of advantages over traditional high yield bonds and syndicated leveraged loans – exchange traded loans often issued by banks. All three types of debt carry significant credit risk, being generally rated below investment grade, or BBB. But a private lender usually has more control over the terms of the debt, and most of these loans have what are called restrictive covenants, protections that give lenders the ability to recoup their investment in the event of financial hardship. . In contrast, the high yield bond and syndicated loan markets have little such protection and are often referred to as “covenant-lite”.
Like syndicated loans, most private debt issues also offer variable rates, offering returns that rise or fall with going interest rates. This should protect that debt from the inflationary environment that many investors fear we are currently experiencing. In contrast, the prices of traditional bonds move in the opposite direction of interest rates, which generally increase with inflation.
T. Rowe Price is already offering the popular $ 3.8 billion
T Rowe Price Floating Rate Fund
(PRFRX) retail mutual fund that invests in publicly traded syndicated loans. But the syndicated loan space is teeming with competitors, some of whom offer exchange-traded index funds like the $ 7 billion.
Invesco Senior Loan
(BKLN), which can track benchmarks at lower fees than active managers.
By its nature, private debt, created and held by individual lenders, cannot be indexed. This allows active managers who are good credit analysts to structure debt transactions that potentially offer higher returns with less risk than government debt issues while earning higher commissions than in the markets with competitors. index funds. It also enables active managers with scale and experience to find the best deals.
“We have invested hundreds of billions of dollars in [debt] transactions, ”said Glenn August, CEO of OHA, who will remain in place to manage OHA as a separate subsidiary after the acquisition. “We have built deep relationships over the years with all the different financial sponsors [of private debt deals], and this gives us the ability to seek exclusive opportunities. There are also very few companies like us that can provide billions of dollars. [credit] solutions. ”
For these reasons, Morningstar analyst Greggory Warren, who covers T. Rowe Price, increased his price target for the company to $ 211 from $ 202 after the deal was announced. “The company’s push towards alternatives was not that surprising, as it highlights the willingness of most traditional active asset managers to find ways to offset the pressures from low-cost index products,” wrote Warren. T. Rowe Price stock rose 5.7% to $ 215.29 at the close on Wednesday.
But such a strategy carries risks. The most obvious is that private debt is illiquid and generally cannot be traded. This means that apart from OHA’s existing investment products, which target high net worth individuals and institutional investors, access to OHA’s new management team’s investments in mutual funds and ETFs from T. Rowe Price’s retail, which offer daily cash, will be limited. .
Yet Rob Sharps of T. Rowe Price, chief investment officer and group CIO, sees a ‘crossover’ in the retail arena with the acquisition: ‘We see opportunities through the type of investor and the customer type. What we are seeing in the market is a democratization of alternatives [investments]. We will therefore partner with OHA in time to develop new vehicles and new products to leverage the benefits of private credit investment portfolios. These types of retail investments will have limited portfolio liquidity, potentially being closed-end funds, interval funds, which only allow quarterly redemptions, or business development companies.
The other risk is credit quality. According to S&P Global, the syndicated loan and high yield bond market recently crossed the $ 3 trillion mark. Meanwhile, the private debt market has grown tenfold to $ 412 billion over the past decade, and especially increased last year.
With so many investors looking for yield in a zero interest rate environment, credit standards have declined while leverage has increased in most companies. The lack of proper covenants caused recovery rates on syndicated loans to drop to 47 cents for every dollar invested, from 70 cents, after a default during the 2020 pandemic, according to Moody’s.
The OHA alone has seen its private debt activity reach $ 20 billion, up from $ 10 billion last year, August said. The good news is that he is negotiating the terms of that debt. He also has a significant activity in the settlement of troubled debt. So even if OHA’s private loans head south, the firm could negotiate a decent recovery for its investors.
It is therefore understandable why T. Rowe’s shares recovered after the announcement.
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