PGIM Lauds ‘Bulletproof’ CLOs as Credit Risks Rise

Hello, and welcome to the Credit Edge, a Wiki markets podcast. My name is James Crumbie. I'm a senior editor at Bloomberg.

And I'm MATC.

Woyner, a credit analyst covering industrials with Bloomberg Intelligence. This week, we're very pleased to welcome Gregory Peters, co, Chief Investment Officer of PGM Fixed Income.

Are you Greg, I'm great, Thanks for having me. PGM is one.

Of the world's largest investment managers, with one point fortullion in asset center management, of which fixed income AUM totals over inn billion, and so Greg is one of the co heads of the multisector team. Before joining PGM in twenty fourteen, he was Morgan Stanley's Global Director of Fixed Income and Economic Research and chief Global cross Asset Strategist, responsible for the firm's macro research and asset allocation strategies. And before that he was at Solomon as well as

James, Yeah, we have tons of questions for Greg, but first we will set the scene. Markets have rallied on hopes of trade deals, but there's still a huge amount of worry, not least about tariffs, but also about the budget deficit, the FED, riots in la and global geopolitical concerns.

Where do we go from here? Boy?

That was a great intro. I found myself nodding to everything that you said. I think it is a valuation story. Heading into this year, we had a more optimistic view of the global economy of the US economy, and we.

Were still cautious.

And the reason why we were simply cautious is because risk reward.

Was quite poor.

You know, spreads are top kind of richest death style that we've seen over the past just call it thirty years. If you just oversimplify, spreads are you know, well below the average. And it feels to me, just based on your intro, that we have above average type of risk environment. So I do think credit spreads are too tight. I think this is a market where you're induced to take less risk. Button down your risk profile, roll and carry, don't go out the curve, don't necessarily go down the

Talking about the risk profile.

So what sort of the house of you at PGM in terms of the big beautiful bill. Is it going to trigger a sort of net reduction to the deficit? I think President Trump has called out one point four one point five trillion lower or do you think it's going to push us further into the red to the tune of two and a half million. I wouldn't exactly call a four trillion dollar delta a small figure. So how do you see that playing out. What's the impact on demand for treasuries.

Well, I have yet to see.

Any think tank or independent study to suggest that this is a deficit reducer, so I'd be curious to see the math on that. So all roads lead to a greater amount of debt, a larger deficit, and I think the markets care a lot about it. This is one of these things. As we entered this year, tax reform, let's just call it.

I'm doing air quotes.

A tax reform was viewed as a market positive, you know, balancing out immigration and tariffs. But I think what you're realizing is that this comes out of cost, and the markets are the bond market is increasingly worried about that cost and the payback. And I think this is a situation where this bill will get passed in one way, shape or form, and I think the bond market is going to dislike it.

So it means high yields at the long end, But it presumably doesn't make or it makes a recession less likely, does it? Because it's very supportive.

It does.

There's a decent amount of fiscal stimulus coming in now. I think that's lost on a lot of folks. So this will can continue to push the fiscal that I believe averts a recession. It's hard to it's hard to forecast the course because there's you know, so much in the way of unknowns and uncertainties. We have yet to see the impact of the tariffing strategy or shall I say, the change in the strategy that makes it really difficult for companies to plan. So the truth is we don't know.

That most of the companies have shown that they can live with these high rates for quite a long time and they've done okay. And then on the other side, you know, there isn't a lot of supply, there's a lot of demand. So the sets up the credit, I mean, at least the consensus shows is pretty bullish, pretty optimistic. You're you're somewhat against that in terms of your well courtious view, but you know you're fighting against some pretty strong technicals there. How do you play that?

I think technicals are ephemeral there, they'll they'll switch when you know, as soon as you count on technicals to save the day, a bad trade is not going to be rescued by bad technicals. I just don't think that as a fundamental analysis, and as an analyst, I'm just not sure that's a real part of the calculus. I'm not a trading desk, right, we are investors. That's different. I mean it helps on the margin, But you know what's different you talked about Obviously companies have.

Been through a lot.

There's a lot more resiliency in corporate America than I think initially perceived. But keep in mind revenues, cash flows, however you want to define it, we're pretty good, right. So, yeah, the cost of capital really jumped up. That cost of capital is not going down, So the delta the operating leverage around future cash flows is really quite high. And what we're seeing in the market is just tremendous differentiation based on that. So these highly levered capital structures haven't

I think going back to sort of maybe a little bit higher levels. So I think when the FED d first institute a QE back in two thousand and eight, if I pull up the HI function on the terminal and sort of regress the Fed's expanding balance, sheeversus returns for the SMP. It's almost a perfect corollary, which I think gave rise to the cloqualism don't fight the FED. Right, So, Treasury Secretary Prestident has said that he wants a ten year at four percent. He says he has tools available

There's a lot to kind of unpack there. You know, each of those are really quite different. I think it's very difficult for the US Treasury Department to have influence on kind of rate levels. I think rates are driven by fundamentals economic activity. You know, obviously growth and inflation.

Can we talk a bit more about the dispersion you mentioned in terms of things all over the mat when you look at the problems you mentioned with high rates and the companies with worse economy, doesn't have to go into recession, but just the earnings start to suffer. I think the assumption broadly is that there is this liver small piece of the market like triple c's, which we

A little too simplistic if you throw in single bees, which is kind of the catch all right, you know a single bee can be two times levered and fourteen times levered, so you know there's a lot there's not a lot of informational content by just looking at kind of the credit rating.

Then that's a big chunk of the market, right it is single bee It is what twenty thirty percent or something like that.

That's the point. So yeah, so it's a big chunk. I think it's fascinating what's going on. So at the top line level, credit spreads are exceedingly tight, but underneath the surface, you're seeing dispersion in the triple C double single bee space.

The widest in decades.

So I use this analogy that always goes over poorly, but I'm going to use it anyway. Which is the high your market is like, or the levered finance market is like a duck. Right on top, it's very placid, but underneath the surface there's a tremendous amount of churn

By the marketplace.

What you're also seeing you mentioned the LME side, is a security price hits eighty and it just is in a vacuum. It just falls because the structure of the market is such where there's not a lot of players who are willing.

To go through that process. Right.

It's a long, arduous, costly process, legal fees, time, you know, you name it. So there's not a lot of willingness or appetite to kind of go through that process.

So are you winning to go through that? Yeah?

I mean we're we're a very big player, but in that space, you know, we think we have a competitive advantage in that space. It's something that we've been very involved in.

What's the advantage of though, is at scale scale you need.

Size and scale. Yep.

You know, a lot of the distress players have been taken out kind of early and they've folded just because you know, the investments didn't go well.

So there's not a lot of players.

But you need size and scale, and we have size and scale at PGM. We have one hundred and fifty six credit analysts, which is enormous. We have the distress capabilities illegal all this stuff. But there's not a lot of players that do it. But if you can do it, the potential is really quite good.

But the problem with these transactions, according to some analysis that we've seen, is that half these deals don't work out. You know, they end up going bankrupt anyway. So you know, how do you kind of look ahead, particularly in these times of very uncertain macro markets, you know, how do you look ahead and see this one's going to make it, this one isn't, and position yourself a quidity.

Yeah, no, that's a good quote.

We were just quoting that yesterday actually, So it's been a coin flip. Yes, you know, whether it works out, but I think it goes to asset value and looking at businesses that are good businesses, good assets that are

You don't be hunded the keys, So how do you avoid that situation? I mean, being the owner, you don't have to run a company.

Well, you know it's about the exit, right, So no, we don't want to run the company. We tried that at Morgan Sally and didn't go so well. No, it's about refitting the capital structure to put this company in a better position to succeed, not taking the keys and running it right. So it's just kind of working through just from a pure.

Capital structure standpoint.

We've retraced back to pre tariff levels on both the IG and High Yield Corporates index, so I think we're eighty five over right now for IG and about three hundred over for high yield which to your point, is

I've been surprised at how comfortable the market's been on the idea of a deal, right, A true trade deal is not a kind of a memoranda of understanding. So I've I've been shocked that the markets have just been this is great, We'll take it and move on. So I don't think this story has ended yet. The devil's into details. I think the market has been too swift and quick to just declare victory.

And then you know, who knows.

You know, maybe the whole point of April second was to make anything after that point, you know, completely consumable and digestible and acceptable. Right, So I don't know, but you have to follow the numbers, and you know, we don't have enough data yet to follow those numbers. But I've been, you know, surprised that the the the acceptance. But I think the tail risk is still quite quite pronounced. Our base case is one of muddling through, but the.

Tails are as fat as.

We've ever seen them. It just makes it really, really difficult. So I don't think you are getting paid for those tail risks. If you look at the pricing of credit just broadly defined, I think it's pricing in a model throw and mortal throw is great for credit, right, that's what you want. But you know, I would submit that the tail risk is higher than normal, and I want to get paid for that too.

Credit also seems to be pricing in the idea that the Trump administration will be more pragmatic ultimately than comforted confrontational, and that you know, things do get very choppy, then that they will be this put taco trade. Ye, things will reverse and you know people are even putting levels on it, let's say one thirty for the IG spread. In terms of that, that's where you you know, stop

The market is in eternal search of free puts, right, so you know the Fed put, now the Trump put. I just don't know enough. I would not bank on that at no point intended. There's definitely this de escalation strategy at place, So I do think there's some element of it for sure. But you know, we haven't yet seen the data around the uncertainty feeding into the economics shet right. You know the economy is going to show some signs of strength because it pulled forward. I think

To allay those fears necessarily.

So, I mean, this all makes absolute sense on a fundamental basis. But I go back to the point about technicals, which just every time there is a widening out, it snaps right back because there's so much cash out there looking to buy, regardless of all the problems that we are facing, and I am often puzzled by it. But again, it just thinks you can't fight the technicals.

No, I think that's right for now. Could it go on?

It's been going on for saving the years.

Well, I've been a different macro environment too, but there's a lot of cash in the system.

Absolutely.

But if your thesis, not yours, but kind of like the generic you thesis, is that I'll be rescued by the technicals, I just have a hard time with that. And if I'm wrong, then I'm okay with that. Actually, things have a tendency of going on longer than I think we you know, anticipate oftentimes. I think this is one of those times. But given the TEL risk and everything else we mentioned, I'm not sure technicals what I

So for the PM's listening today, you know, what's your guys pre election for portfolio positioning? You guys EU over the US, are you short data? There is longer data paper to help temper those fiscal risks relating to those deficits and structure products? What does that what does that bias look like for you guys?

Yeah, so we've been very button up on the risk side. So we love credit, so we have a a natural tendency of playing in credit. We think we're very good at it. But you think about from a scaling standpoint, we have the ability to you know, run one hundred percent of our risk threshold.

E's actually we can go up.

To one twenty if we really like it, you know, kind of spinal tap esque. We're at thirty now, so we're at the lower end of the range, and so how are we getting there? So it's a short maturity roll and carry and high yield fits that built too, So this is not an up and quality trade necessarily.

You know, high yield.

Carry is attractive carry, so we still like that, and then the structure product piece really fits in. So structure product is an area where you know, we feel in a portfolio construct, but it allows you to move up and out the efficient frontier.

And they're the quintessential carry trades.

You look at you know, double A, triple A colos, it's carry safe carry, and so that's that's what we're doing. I mean, Europe has been you know, slightly more cheap than the US. You know, a lot of that has to do with the proximity to what's going on in Ukraine and Russia. But it's it's it's small to this point. It was larger this time last year. That kind of valuation gap has you know, someone closed.

But it's a.

Portfolio that's more defensively positioned, i'd say, And we have more US treasuries in our portfolio than we've had in a long time as a defensive measure, because I want to be front footed, right, so I don't want to be locked in my risk if the markets.

Do blow up, if there's a period of dislocation.

We want to have the cash and the ability to kind of jump in.

So we're biding our time.

I'm laying in wait for that, and US kind of treasuries, you know, allow for that. What's lost on I think a lot of investors on the credit side is the swap spread, right. So the cheapness the yield that credit folks are so excited about really the byproduct of the swap spread more than the credit spread, right, So treasuries are cheap more than credit is cheap.

And treasuries and thank you, by the way for being the first credit edge guest to mention spinal tap. I'm very happy to hear that reference, you'll get the short end of the treasury curve, are you you're not going out long on mean, we've told you talk about the long end being somewhat more Yeah.

Yeah, so we want to be closer to FED policy than further away. The back end of the curve is driven by you know, all these other uncontrollable type of factors, and that manifests itself in that risk turm premium. So yeah, it's uh, it's more kind of ten years and in so it's not taking a duration bet as much much as it is taking a liquidity stance.

I don't see that's you know, leverage loans, repackaged floating rate. Does that mean that you don't expect any rate cuts this year?

Well, so we penciled in from you know, god, it's been forever now kind of two two, maybe three now maybe it's one to two. Uh, you know, our view all along has been kind of higher for longer. I don't see the same scope and capacity for FED cutting rates.

Uh.

You know, if you look at the market reaction for you know, any swoon up until recently, it was the instantaneous rate cuts, right, So you look at kind of what happened when we had the regional bank situation. I think within you know, six hours, eight cuts were priced in. You know, this is a time when I think the

You also got the president and Smett said the treasury sector, you're talking about pushing rates down somehow. We'll see how that goes.

But so obviously the theme is obviously very defensive. So within at least the corporate credit portion of the portfolio, are you guys under overweight any particular sectors? And given the defensive nature of the posturing, and do you guys like single a's like a GI aerospace or defense names or are you guys wanting to go down to something that looks like a Boeing at a sort of low low ig Like how do you guys, how you guys positioning that I.

Love how you snuck in Boeing there very smooth. I like that.

I would say this cycle, if you can call a cycle, is less kind of sector sectorial driven than previous cycles. What we're seeing is just real differentiation by leverage. I think the consumer segment is a fascinating segment to evaluate. So what we're seeing is the you know, the larger public kind of consumer retailers. They're obviously concerned and talking about tariffs, but they are eating that, so to speak, in their margin, and margins are quite skinny to begin

The fact that you.

Have you know, X amount of leverage more than you know this institution. I don't care. I care about the price. And so this case shaped type of experience that we're seeing on the consumer side. So this is a long winded way of saying, I don't know if it's so

Right.

You look at twenty fifteen, it was all about energy. You look at kind of late nineties, two thousand, it was all about tech and telecom. Now it's really about how much leverage do you have, and it's indiscriminate.

Years and years and years of really.

Low rates, it just kind of lifted, you know, across It was indiscriminate, right, didn't matter what segment of the economy you're in. You know, you got cheap costs of capital, and you know that's that's wor it's playing out.

I'd say, so you expect more defaults in the consumers, that's to whether it have been LBOs.

I would expect that to be the case.

Yeah, I think, you know, retail is kind of fickle in the best of times, very exposed to consumer behaviors, you know, of course, and so I would expect, you know, higher than what we've seen before.

Any other sectors that stick out in terms of high leverage and getting penalized by the market.

Well, you know, I think the other sector that we're focused on, well well too, I guess one is the chemical sector. So the chemical sector is you know, under pressure. You know, it's been dominated by China. You know over the past n number of years. There's lots of chatter if it's a structural shift, and you know, will these chemical companies suffer through it like they have in the past. Our view is you know, much more kind of negative around that, you know, just some kind of see the

You know. The other is the hospitality space.

Right if you think about immigration as an example that you know, as a very targeted part of the market where immigration is quite important and as as that turns, not only are they running out of workers, but they have to pass those costs along and once again consumers are very sensitive. Right, So you know, those are you know areas that we're you know, we're quite focused on. But there's you know, there's positives too, right, I mean

Right, that's not.

Going to you know, move lower anytime soon. And just think that's a real opportunity.

Does that include like themes about the energy transition. I think you've had Caterpillars tilted some pretty bullish views for their mining business over the next five to ten years, whether it's copper, li theum, all of these important metals that are needed to facilitate this huge transition. Is that something you guys are expressing in the portfolio or are you not necessarily.

Is not necessarily it's a more complicated story, yeah, right. You know, these are high cyclical type of commodities, So I think that's a very different story. You know, ultimately you're taking cyclical risk there structural things that you mentioned, but I think, you know, the sickle aspect is still quite pronounced.

I'm interested in your Vie's also on private credit because a lot of people we've had on this show have just talked about it endlessly, and you know, it's seemingly this great, very safe, very high return product that everybody's

Yeah, so, I you know, would start out by saying, I think over time it's going to be a single market. You know, this demarcation between public and private will fade. I go back to my experience when I was you know, in lever finance high yield at the time and you know, loans were the new shiny thing, and why were they so popular, Well, they had great sharp ratios because they didn't get marked and they were senior in the cap.

Structure pretty much how private credit is today pretty.

Much and loans, to be fair, loans aren't even considered as security. So it's more complicated, right, just structurally contracts right then, yeah, yeah, yeah, so so so I think over time that that'll just continue to fade. I'll tell you that we get refinanced out of our public deals into privates and privates in the public, so it's already being blurred.

So you have to have a view.

But I think there's been you know, maybe a little too much excitement on the private side. You know, I think there's real value in pockets, but you know, the value that I see is more on the below investment grade side it syncratically, of course, and then on the ass the asset base an ant side, which is where I think there's more opportunities. You know, at this point in time on.

How I mean, you have to wonder that about the sustainability of the capital structure when you know, those borrowers that are going to that market because they have to paying you know, substantially high rates. How much longer can they fold? And it's floating as well, So are we not instead of setting them up for failure?

Well, time will tell.

If you look at leverage in the system, there's a lot more leverage, you know, in the levered loan market and in the private credit market. I think the trap that acid allocators are falling into is that they're looking at the empiricals and the empiricals.

Are way out of date.

Right, So the history around both lever loans and private credit is they have a lower incidence of default and higher recoveries. I'm not convinced that's going to be the case going forward. If you look at kind of distressed activity, default activity, you know, you've been seeing the private space running.

Higher rate than the public space. You know.

The issue on the private side is that it's not until you experience an impairment.

That you have to recognize it.

So it just takes longer kind of inherently to to play out. But you know, we're seeing these companies struggle just based on you know, their higher costs of capital and a little little hit to their cash flows. They can't afford that hit. The cash flows, So you know, we'll see about the wherewithal of the industry to you know, put more money into these you know situations. But you know, not all the sponsors of these different private credits have that wherewithal.

Is there enough of a pickup though to justify the lack of liquidity, lack of transparency, all of the other things you can't see, is that is there enough in private when you when you're shown a deal, could you don't just get a broady syndicated leverage loan that pays you just as much and you know has a transparency. Why wouldn't you just say, say, in the public market.

It depends on your liability and your liquidity needs. So if you have just kind of in theory ten years locked up capital, then you're less worried about the liquidity aspect of it.

If you had, are you getting the pickup over the private even to justify that?

Well, right, if you're not worried about liquidity, then yes. If you are, then maybe not. But you know, there is a trade off when you go into private credit. You know, even with less and inappropriate pickup, there's other things that go away, like acid allocation or relative value. You you're not as front footed, right, You're you're kind of

Is two hundred enough? Is it one fifty is it, you know, so on and so forth.

And when you say convergence that the two will converge, how long does it take and what does it look like? Does it mean that it's just exactly the same as leverage loans on now? Ultimately, I just.

Think they'll they'll there'll be differences, of course, like there's a difference between you know, lever loan, HI you bond. But players think of that as one big sandbox. Right when we look at deals, we look at it versus loans and bonds. Companies issue oftentimes and loans and bonds. So I just think it's it'll be a single leve fin market, not a very separated private credit.

But will the private credit be more broady, syndicated and traded with muks and you know all of that stuff that you get in the leverage loan market.

I think it's going that way. You know, the push tour words ETFs in this space is you know, pushing it along.

Now.

I think this is a good news bad news story as well as any time you get retail involved in a niche market, you know, the emphasis and onus changes. Right when private credit investors are just dealing with institutional savvy investors. The hurdle is different. Once you push it into the retail space. There's a much closer examination, and it'll be curious to see how it holds off upon closer examination.

So all of the stuff you look at, Greg, globally, we probably hadn't hits on it all. But I'm interested in your idea of relative value right now?

Where is the value?

I mean, we've talked about how tight spreads are in US credit, We've talked about a bit of the value proposition in Europe. It's a big weld out there. There are many other products. What do you what do you think whe's the value?

Yeah?

My caveat is there's not a tremendous amount of value. There's no real highly dislocated asset as far as I can tell. So it's all on the margin and marginally what I see is structure products is being dislocated and attractive.

Most clos cnbs less.

So I think you know that's changed unless you go into the single assets single barwer space, which is basically lending on property. There's some you know, interesting opportunities there, but yeah, I would say, you know, clos broadly defined anything structured still trades a little more cheaply because of the time and effort it takes to explain it to someone, right, you know, it's it's true, it's one of these things.

Then people are still still thinking that cl those are the same as CDOs that blew the world.

Four letter words. Yeah, yeah, you know it was. Obviously it's a very different market. And even then, to be fair, the COLO space behave exactly as it was supposed to in the global financial crisis, and now it is even better protected more subordination, and so you know, we think these structures are bold.

But if you're worried about the loans though underlying it, I mean, do you think there's enough diversity in the basket to protect you against that?

I do?

I mean, to put it in perspective, if you own a triple a colo you have, I'll just round up because it doesn't matter forty percent subordination underneath you. So a lot has to go wrong. I mean, the world almost effectively has to end for that to be touched at the top. I think the structure and the subordination is what you're really participating.

In, not the underlying loans itself.

I know it sounds kind of funny to say, but when you're that senior with that much protection, you know, the loan market could really come upon hard times and these structures will be fine as you go down less.

So right, it's just kind of the lost absorption nature of it.

So triple b's not so much, uh, you know, even single a's but you know, definitely triple as you're fine.

Yeah, although we did see a triple A. I think the c NBS that didn't make it. That was recently so no old triple as.

That was a savsby deal, right, so that didn't have the diversification piece to it.

Yeah, But point well taken.

This is why this is why it trades more, chiefly because there's always a you know, you know, a story about it.

Yes, yes, yes, and it sounds you'll edge right, you've been doing this for a long time. We've had a great conversation. You've seen you've seen it all. How do you differentiate your self?

I think there's there's a few ways. One is just discipline. I think being longer term focus is.

A competitive advantage.

You know, we talked about the technical side, and the technical side helps on the margin for sure, But you know, when you're running close to nine hundred billion of assets. You know, you need to be fundamentally focused, and we're

I think.

Give them the new cycle that we have trouble seeing longer than the end of the week. So what does long term mean to you?

It's definitely longer than the news cycle, which is I

Do you worry about anything, particularly Greg, We've had people worry about all sorts of things on the show, and we are credit people, and you know that's over there looking very worried. So what what keeps you up at night?

Well, there's a lot that you know keeps me up. But I think what keeps me up on the credit side is there's not a lot of history recent history of credit issues. Say that differently, you know, it's not a well experienced market. There hasn't been a true credit cycle since honestly, you know, thirty years. So you know, I think there's a tendency for investors to be dismissive around the downside of credit, you know, whether it's the Taco put or the Fed put, whatever you want to

Even in twenty twenty that barely lasted, it was.

We have it was, yeah, it was not even three weeks, right, so we have not seen a sustained downtrade and what words me is when and if that does happen.

I do think the next credit.

Cycle will be a more classic one, whatever that means. But it's not going to be you know, reinflated instantaneously by the FED or by the fiscal. Right you put those two things together. You have a FED that's constrained by inflation. You have the fiscal constrained by you know, the current state of the fiscal which suggests to me that credit is you know, going to drift much lower than what we've seen and when.

If we do hit a patch here.

So I worry about the behaviors of the market in that. And you know, you talked about l E and you know the knives are going to be much sharper in the capacity to absorb the downgrades is going to be much less, And so I worry about credit really becoming dislocated in a meaningful way. The flip side of that, I'm also excited about it.

Well, plussibly could trigger the end of the cycle. I mean, because as we've talked about, it goes on forever and we've thrown everything else it and the bad news just keeps coming, but spreads just keep getting tights of.

No the doorability of the economy, and these companies are real. But the trap is just because it didn't happen doesn't mean it can't happen.

And you know, we'll see.

But these things take time, and it's important to remember that, you know, these companies are financing themselves at a much higher rate than they have in a long time, and and it just takes time to play out, and so that operating leverage piece, I think is missed. That cushion to absorb those cash flows moving lower is not what it once was.

Great stuff. Greg Peters, co, Chief investment Officer at PGM Fixed Income. Many thanks for joining us on the credit edge. Thank you, and of course we're very grateful to Matt Gooyner from Bloomberg Intelligence. Thanks for joining us today. Thanks for having me back for more credit and market analysis and insight. Read all of Matt's great work on the