Stakeholder activism has traditionally been associated with equity investment, but with investors (and asset managers) seeking ways to protect against the downside risk of the listed equity markets and to access diverse return sources, the use of alternative asset classes has become more attractive. The result of this shift in the market cycle is the emergence of a new wave of stakeholder activism in these alternative asset classes which looks and feels like traditional stakeholder activism but tastes very different.
This article will focus on corporate loans (also referred to as private debt) and does not seek to look wholly at all alternative asset classes.
Background to the rise of a new form of stakeholder activism
For several years, the loan market has predominately been the domain of banks, however, with adoption of the various Basel regulatory standards, banks have been syndicating the loans they originate to third parties to free up capital on their balance sheet to write more business. At the time of drafting the various pieces of South African legislation governing pension funds, collective investment schemes and insurance companies, loans were not included as a type of asset/security that could be part of these entities’ asset allocation by the regulator.
Notwithstanding the above, asset managers, albeit indirectly, gained access to loans from using acceptable investment vehicles/structures such as repack vehicles, credit linked notes and linked policies (“vehicles”).
These vehicles were (and are) often managed by asset managers who also manage the assets of the above-mentioned entities. In some cases, the asset manager will manage loans on behalf of a client on a segregated mandate basis but in all these cases, the commonality is that the entity or clients becomes the lender of record alongside the loan originating bank. This results in the asset manager now sitting alongside the banks (and other financial institutions) in the case of lender decisions.
As assets under management have grown (which are linked to underlying entities’ assets under management), so too has the ability of the asset manager to take a bigger exposure to these types of assets. With this, what we are seeing is that asset managers are starting to have exposures to corporate loans which is significant and requires the banks to take heed of the asset managers as they can affect (or even block) the decisions related to the underlying loans.
The change in tides
As mentioned at the start, asset managers are no strangers to stakeholder activism. Globally there is also an increased focus on Environmental, Social and Governance (“ESG”) elements and it is only expected to increase further in the coming years. With the increase in exposure to corporate loans, asset managers are increasingly assuming a stakeholder activism role in asking the tough ESG questions of potential and existing borrowers.
Inherent in the rise of this new form of stakeholder activism, is a tension between the borrowers, the banks and the asset managers. Asset managers, under FAIS, are fiduciaries and need to act in a fiduciary capacity towards their clients, whereas banks are not under the same legal obligation (albeit they still need to protect depositor’s monies). The banks also often have a wider relationship with the borrower, such as a banking relationship, which may be taken into consideration when considering requests from the borrower. While asset managers may have exposure to the borrower via equity or even exposure to another loan of the borrower, asset managers approach lender requests under the loans with different considerations.
What does this mean going forward?
Alternative assets are here to stay and will become more relevant in investors’ portfolios. This means that asset managers need to ensure that they have an in-depth understanding of these asset classes. Importantly, a thorough upfront due diligence process, taking into account all factors, including ESG, how this (and other considerations) are affected by the buy and hold nature of these assets given the limited liquidity embedded in them, loan portfolio concentration and re-investment risks, is undertaken prior to any investments. This is achieved through strong credit committees and a depth of knowledge in the investment team who are responsible for approving and monitoring the transaction and potentially managing a workout scenario if the company defaults on its loan covenants.
This can and will mean that asset managers can further the call for sustainable investing by taking steps to measure and report on the positions they have taken in holding borrowers to account on ESG issues but at the same time offering their investors further diversification and protection from the risk of the traditional asset classes.