Bryan Krug – High Yield Credit Investing

**Patrick O'Shaughnessy** (0:24)
Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management.
My guest today is Bryan Krug, who manages the Artisan Partners Credit Team and oversees more than $3 billion in high-yield credit investments for the firm. This was my first conversation on high-yield, so I took it as an opportunity to get an overview on the investment universe and hone in on the tools used for analysis and security selection. As an equity investor, I think one of the most fruitful areas of research is into ways that companies fail or go wrong, and credit investors focus almost entirely on this potential for impairment. My guess is that all equity investors will learn something useful from this conversation, so please enjoy. Maybe before we get into what opportunities or dangers the credit cycle creates at different points, you could outline, because this is the first time I've had any conversation with anyone specifically about the high-yield universe, and really about fixed income in any level of detail, to be honest, much more of an equity guy. So maybe highlight what that universe of high-yield looks like, how it's defined, and from that definition, we'll kind of get into some of the more particulars.

**Bryan Krug** (1:45)
So let's talk a little bit about the evolution of the markets. And I think that it kind of gives some very good context as to how things have been in the past and how they're going in the future.
So if you look historically, if you go back 20 to 30 years, the high-yield market was a subordinate credit solution for companies that the banks went on to. So in the past, banks used to lend, and they would lend to typically, let's just depend on the business between three to four times debt to EBITDA. And then when companies wanted incremental leverage, the banks wouldn't take that risk. So a public market solution occurred, which was basically the high-yield market. And the high-yield market really started in the early 80s, and it's grown pretty significantly through predominantly the growth of alternatives. So if you think of alternatives, private equity, as an example, private equity uses high-yield to basically leverage their equity returns, and it's also grown through companies that have incurred capital to build out capex. So examples would be MGM or Wynn.
Those casinos were built with high-yield capital. Sprint used high-yield capital to build its network out. So those are examples of businesses that actually have tangible needs for it. So that's how it started out. The banks used to lend, and then high-yield was the more junior capital solution for the fixed income side. Then structured credit happened probably about 15 years ago. It became much more universally accepted, and the loan market moved from a bank-owned market to a syndicated public market.
And what happened is structured credit made it cheaper for syndicated structures such as CLOs to essentially give risk to companies cheaper than banks could do it. And you also had regulatory changes where it was more expensive for banks to hold that capital from a risk-weight capital perspective. So banks moved from an origination model where they used to originate and retain the risk to a syndication model. And the syndication model essentially evolved to where investors such as ourselves, CLOs, and other managers essentially take that risk at a more senior part of the market. And so that started 15 years ago and that market essentially went from nothing to a trillion dollar market in the last 15 years, give or take. So that's been a significant growth on the loan side. The way that the public high yield and the public loan markets work is typically the loan market is your more senior tranche. It's often floating rate.
Its characteristics are that it has limited call protection, which is important because if there's a lot of demand for loans, the spreads will compress. And it's similar to like a mortgage where if you have a rate of 5%, if market rates are in a 4% for your mortgage, you essentially refinance it. It's capital that issuers have the ability to reprice. High-yield market is typically seven to eight-year maturity on average.
It is typically non-call for approximately the first three to four years. And there's a call premium of four to five points at that time. And so if the company wants to address the maturity earlier, there's breakage that the issuer must pay to move on. So that's actually a big benefit to owning a high-yield piece of paper.

**Patrick O'Shaughnessy** (5:04)
Maybe you could talk a little bit about the idea for investors of why to allocate to this specific asset class relative to investment-grade bonds and maybe also compared to equity. So if you think about those two, plus maybe cash as big primary asset classes, what are the behavior points that distinguish this asset class?