Asia Summit—Global Capital Markets: The Search for Value 

September 19, 2016

There Is a World of Upside If You Know Where to Look

Investors hungry for decent returns in today's financial markets know they may have to move far afield from plain-vanilla stocks and bonds. But where can they invest without taking undue risk?

A group of veteran money managers provided their best ideas at a session titled "Global Capital Markets: The Search for Value" at the Milken Institute Asia Summit. Institute Chairman Michael Milken opened the discussion by noting that many large pension funds require annual returns up to 7.5 percent to meet their benefit obligations—yet interest rates on trillions of dollars' worth of government bonds are at zero or actually negative.

Lawrence Golub, CEO of Golub Capital, said his firm's strategy for generating better fixed-income returns is to concentrate on what some call the “safest emerging market in the world": middle-market American companies.

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From left: Gordon Fyfe, CEO and chief investment officer, British Columbia Investment Management Corp.; Lawrence Golub, CEO of Golub Capital

Golub Capital has become a major nonbank lender to middle-market businesses, which encompass about 200,000 firms with $10 trillion in total revenue. That market has been largely abandoned by risk-restricted commercial banks since the 2008 financial crisis, Golub said.

Yet the middle market is filled with companies that are "growing and resilient," he said. "They really have to be solving market needs to compete with larger companies." He cited two industries as particularly interesting: home health care for the elderly and business-to-business (B2B) software.

Net of fees, Golub said, "typical" returns on senior secured middle-market company loans have been 6.2 percent annually, compared with 4.7 percent on an index of high-yield bonds and just 2.6 percent on syndicated bank loans to large companies.

Larry Post, a partner at Arena Capital Advisors, also has focused on an "undermanaged" market: shorter-term high-yield corporate bonds. In that sector, Post said, "we've been able to produce returns of 5 percent to 7 percent a year with very low volatility." The average life of his portfolios is under three years, which limits the interest-rate risk of the bonds.

On the equity side, veteran emerging-markets investor Omar Lodhi, partner and Asia regional head for Abraaj Group, said success in that sphere requires taking the long view of the positive forces at work. Emerging markets "will bring 1.7 billion people into the middle-income consumption classes in the next 20 years," he said.

Political risks, of course, are ever-present in emerging markets, Lodhi noted. But even the potential for coups d'état doesn't necessarily alter the growth prospects of solid investment ideas. "People don't stop educating themselves, they don't stop feeding themselves," he said.

Lodhi added that winning in emerging markets also requires having "boots on the ground, to be able to see risk through a local lens." Investors also have to allow for the likelihood that over time, emerging-market currencies will decline against major currencies as a function of the smaller nations’ growth, Lodhi said. "You have to be able to factor 6 to 7 percent devaluation per annum into your business plans."

Asked by Milken to pick a great opportunity among emerging markets today, Lodhi named Indonesia as having "tremendous potential." He said the Southeast Asian archipelago’s economy could grow as fast as China did in its boom years.

A fourth panelist, Gordon Fyfe, who oversees $130 billion in pension fund assets as CEO and chief investment officer of British Columbia Investment Management Corp., said his fund owns double the market weighting of Indian equities. He expects the next decade to be "very exciting" for Indian stocks.

Fyfe stressed the need to be opportunistic when markets suddenly swoon. In markets that are fully valued, "there is the risk that you get an overreaction to some bad news." But because his fund has more cash coming in from worker contributions than goes out in benefits, any market decline "is actually good for us," he said.

When the financial collapse forced heavily indebted investors to dump assets in desperation, the pension fund that Fyfe was overseeing at the time bought into Australian port facilities and New York City high-rises at bargain prices, he said. The lesson: "You need to be ready to go" with fresh capital when crisis strikes. "Often you will find yourself walking in the direction that everyone else is running away from."

Watch the Full Discussion