Animal Spirits Podcast Summary: "Talk Your Book: How Private Credit Works"
Release Date: March 17, 2025
Hosts: Michael Batnick and Ben Carlson
Guest: Phil Bauer, Portfolio Specialist at Calamos Investments
Introduction to Private Credit
In the March 17, 2025 episode of the Animal Spirits Podcast, hosts Michael Batnick and Ben Carlson delve into the increasingly popular investment strategy of private credit. With private credit becoming a hot topic among financial advisors over the past 18 to 24 months, the episode features an insightful conversation with Phil Bauer from Calamos Investments, who provides expert analysis on the mechanics, benefits, and risks associated with private credit.
Understanding Private Credit
Defining Private Credit
Private credit involves lending funds directly to companies without the intermediation of traditional banks. This asset class has gained traction as banks withdraw from certain lending markets, creating opportunities for private credit managers to fill the void.
Phil Bauer on Private Credit’s Evolution
Phil Bauer explains that private credit isn't a new concept but has become more prominent due to regulatory changes post-Global Financial Crisis (GFC). He states:
"None of it is really new. These are all loans that were getting made for a long period of time. They were just sitting on bank balance sheets." [06:35]
Key Components
Private credit encompasses various strategies, including direct lending, asset-based finance, specialty finance, commercial real estate debt, and more. The flexibility and diversification within these areas allow investors to tailor their exposure based on market conditions and risk appetite.
The Rise in Popularity of Private Credit
Proven Performance and Accessibility
Phil Bauer highlights the asset class’s solid performance over the past 15 to 20 years, generating 3-4% net excess returns over traditional bank loans and high-yield markets:
"The asset class has proven itself... you've generated 3 to 4% net of fees, excess return over a long period of time." [03:14]
Regulatory Shifts and Market Demand
Post-GFC regulations forced banks to reduce their lending activities, especially to small and medium-sized enterprises (SMEs) and for private equity buyouts. This regulatory landscape created a "perfect storm" for private credit demand:
"The first is really that the asset class has proven itself... the explosion in funds that have been structured to be more accessible to a wider audience." [03:14]
Impact of 2022 Market Volatility
The volatile year of 2022, characterized by high inflation and fluctuating stock-bond correlations, underscored the need for diversified income-generating assets. Private credit's floating rate nature made it an attractive alternative to traditional fixed-income investments, especially as bonds underperformed:
"Private credit, one of the features of it is the floating rate nature. So there's no duration. You didn't get killed." [04:19]
Components and Strategies within Private Credit
Direct Lending
Direct lending involves providing loans directly to corporations, bypassing traditional banks. Phil Bauer defines it as:
"Direct lending is lending specifically to a corporation... You have certainty of execution." [08:25]
Specialty Finance and Asset-Based Lending
Specialty finance includes lending against specific assets, allowing lenders to take ownership of collateral in case of defaults. This approach provides additional security for investors.
Commercial Real Estate Debt
With approximately $2 trillion in refinancing needs over the next few years and regional banks pulling back from lending, commercial real estate debt presents significant opportunities for private credit investors.
Diversification Across Sectors
The private credit portfolio discussed is highly diversified across various industries, including software, financial services, real estate, professional services, and more, mitigating sector-specific risks:
"Your winners do not make up for your losers... you need to be diversified." [28:55]
Risks and Considerations
Credit Risk and Underwriting
The primary risk in private credit is credit risk, the possibility that borrowers may default on their obligations. Bauer emphasizes the importance of rigorous underwriting:
"Underwriting the credit of the company is first and foremost the most important part." [12:30]
Vintage Year Risk
Phil points out the significance of vintage year risk—the performance of loans based on their origination period. Funds started before the Fed's rate hikes faced higher risks, while newer funds, like Calamos Axia, benefit from loans underwritten in a rising rate environment:
"That's the vintage year risk that we were referring to earlier." [24:32]
Concentration and Diversification
Concentration risk arises when a portfolio is overly exposed to a single borrower or sector. To mitigate this, Bauer discusses the necessity of diversification across different risk factors and loan levels:
"Make sure that you're diversified by GP and at the loan level." [15:28]
Market Dislocation and Liquidity Risks
While private credit funds like Calamos Axia use interval fund structures to provide limited liquidity (up to 5% redemptions quarterly), extreme market dislocations could still pose challenges. However, the fund's structure aims to prevent forced selling during downturns:
"You're never a forced seller... that has to get worked through before you take a dollar of loss." [12:30]
Calamos Axia Alternative Credit and Income Fund
Fund Overview
Phil Bauer introduces Calamos Axia Alternative Credit and Income Fund (ticker: CAPEX) as an interval fund offering diversified private credit exposure. Launched in September 2023, it quickly approached half a billion dollars in assets due to strong investor demand.
Yield and Fee Structure
The fund boasts a net yield of 10.7% from its private credit portfolio, complemented by a liquidity sleeve to bring the all-in yield closer to 10%. Unlike many private credit funds, Calamos Axia operates on a no-fee, no-carry basis, eliminating the typical 80% of funds that charge incentive fees:
"Pick the one with the highest yield... but definitely don't do that." [15:28]
Diversification and Strategy
Calamos Axia employs an open architecture approach, co-investing alongside General Partners (GPs) without additional fees. This strategy ensures broad diversification across risk factors, geographic regions, and industry sectors, reducing idiosyncratic risk:
"You're getting diversification by GP... diversification by loan level." [16:15]
Liquidity and Redemption
Operating as an interval fund, Calamos Axia allows quarterly redemptions up to 5% of the fund’s NAV. This structure ensures that the fund can manage liquidity without disrupting the underlying private credit investments:
"On the liquidity redemption side, we only offer redemptions on a quarterly basis up to 5% of the funds NAV." [17:16]
Performance Metrics
The fund distributes returns monthly, averaging a 9.5% annualized yield, exclusively from cash coupons without any return of capital. Leveraging at 15-20% supports pipeline management, ensuring funds are readily available for new investments:
"We have a liquidity sleeve which is like cash and high-quality bank loans. That would bring the all-in yield to closer to 10%." [21:36]
"Historically we have distributed about nine and a half percent annualized." [33:12]
Managing Risks and Ensuring Stability
Non-for-Selling Structure
One of the key advantages of Calamos Axia is its ability to avoid forced selling during market stress, ensuring the portfolio isn’t liquidated below fundamental values. This feature protects investors from panic-driven market downturns:
"You're never a forced seller... you can work your way through those situations." [14:53]
Diversification Across Credit Factors
By diversifying across multiple credit factors and maintaining a balanced portfolio, the fund minimizes the impact of any single default or sector downturn, striving for consistent performance:
"Diversification is a little bit less at the industry level per se... you need to be diversified." [28:55]
Conclusion and Final Thoughts
The episode concludes with Phil Bauer emphasizing the robust structure and strategic diversification of the Calamos Axia Alternative Credit and Income Fund. He encourages listeners to explore the fund further through Calamos’ website or by reaching out directly for more detailed information.
"So getting a foundation with an open architecture type solution is really the great way to accomplish that." [15:28]
Key Takeaways:
- Private credit has emerged as a reliable income-generating asset class, especially in volatile market conditions.
- Calamos Axia Alternative Credit and Income Fund offers diversified exposure with a competitive yield and a unique fee structure.
- Risk management through diversification, rigorous underwriting, and structured liquidity provisions ensures stability and mitigates potential downturn impacts.
- Investment in private credit requires understanding the underlying strategies, fee structures, and risk factors, making due diligence essential for advisors and investors alike.
For more information, listeners are encouraged to visit Calamos or contact Phil Bauer directly via email.
This summary encapsulates the key discussions, insights, and conclusions from the "Talk Your Book: How Private Credit Works" episode of the Animal Spirits Podcast. It provides a comprehensive overview for those interested in understanding the intricacies of private credit and the strategic positioning of Calamos Axia within this asset class.