A Fed Hike That Opened the Door to Private Credit

SPEAKER_1 (0:00)

And joining me right now, Mike O'Brien, Portfolio Manager of Hilton BDC, Corporate Bond ETF. So, you're looking at the Fed's decision yesterday, and how it affects the bond ETF space. Tell me first that, and then I want to get to HBDC.

Mike O'Brien (0:18)

Yeah, sure. So, the Fed rate hike was broadly expected by the market. It was priced in about a 90 percent probability of that happening.

So, bonds really reacted quite favorably to that, in the sense that now Fed credibility is somewhat getting restored, and the market got more or less what it wanted. So, we're not surprised by the recent bond movements that's going on in the market, and see some attractive opportunities there.

SPEAKER_1 (0:49)

Then I think about your Hilton BDC corporate bond ETF, right? And I think about here the big picture and how this now maybe gives us some exposure to a corner of credit that's been hard to reach. How so?

Mike O'Brien (1:03)

Yeah, so at Hilton Capital Management, we launch HBDC, which is currently the first and only pure play BDC bond ETF. It's a passive ETF that tracks the largest BDCs out there that issue bonds themselves. So unlike BDC equity that gets a lot of press coverage out there, these are the bonds that HBDCs issue themselves. So this is how they're actually financing the loans that they're making out to small and medium-sized companies. What attracted us to the space is that it's definitely under-followed, but the spread and yield on these bonds are quite juicy. Right now, these bonds are about 170 basis points over like duration treasuries. The duration on these bonds are on the shorter end, so typically between two and three years. Our duration on HBDC is about two six.

There's relatively less interest rate sensitivity, especially in a Fed hiking cycle, that is somewhat attractive. Then the last thing is there are regulatory cap limits on BDCs themselves. BDCs have a max leverage ratio that's assigned by Congress of two to one. That's comparison to a bank that is roughly about eight to one.

These BDCs are significantly under-levered, while their bonds trade at pretty attractive spreads. We view this as a way to get extra yield, extra spread for investors while entering the private credit ecosystem all with the liquidity that comes with an ETF.

SPEAKER_1 (2:30)

It's business development for the companies.

That's what BDC stands for, folks. In the meantime, I like that you're talking about the opportunities, that there are more of them. There are more coming to market, more availability, and that they do actually pay off well when you think about the spreads and such. Is there a lot of risk involved though?

Mike O'Brien (2:52)

There's obviously risk involved in this, but in our minds, the BDC bonds themselves are substantially less risky than the equity. So a lot of investors know BDC is based off the equity, which is on a lower cap structure than the bonds. These bonds are primarily investment grade bonds. So HBDC is in the mid-90s for investment grade bonds in the portfolio, and they're overwhelmingly senior unsecured bonds themselves. Then as I mentioned earlier, you have those leverage two-to-one cap structures in place.

With a lot of these BDCs, like the bigger guys like an Aries, a Blue Owl and so forth, are running their leverage substantially below that max cap. Some of these guys are running 1.2 times leverage. So we view the risk versus the reward here as quite attractive. For anyone that wants a little bit more yield in their portfolio, without having to dabble down to the more riskier high yield fixed income securities out there in the market.

SPEAKER_1 (3:53)

I'm glad you brought in the private credit story and some of those names as well because that was actually my next question. You also manage the Tactical Income Fund and Dividend Yield Strategy. Tell me quickly about that as we talk about income a bit more broadly.

Mike O'Brien (4:07)

Yeah. Our flagship product here at Hilton is our Tactical Income Product, which is really a dynamic income focused product out there. It's a multi-asset story in that we blend equities and fixed income together to get a substantially lower volatility metric for our investors with an attractive yield and a total return profile that investors do like. The volatility on tactical income is somewhat between a five and six percent standard deviation, which is about a third of the volatility of the broader market.

With our yield on the portfolio being around four or five, so somewhat around what a treasury is. But the portfolio does have about 48 percent equities in it, and with the rest being fixed income. We juice the yield a little bit on the equity side with dividend stocks that are lower beta than the broader market, mixed with fixed income. On the fixed income side, as we talked about with the Fed hiking, we have a barbell approach at the moment with some shorter duration, fixed income securities, some floating rate securities, mixed with some longer dated securities out there as well. We view the mid-curve fixed income securities as somewhat unattractive right now, as we're just starting to do a Fed hike cycle. And it's important to remember the Fed rarely hikes once.