A conversation on January 8th, 2021 between Scottie Bevill, Senior Investment Officer – Global Income Strategies, Teachers' Retirement System of the State of Illinois and Sylvia Owens, Managing Director, Kennedy Lewis Investment Management.
A Bond Guy Embraces Private Credit
A lot has changed in the fixed income world in recent years, and Scottie D. Bevill may well be the poster boy for those who have readily adapted to these changes. As Senior Investment Officer of Global Income Strategies at the $57 billion Teachers' Retirement System of Illinois (TRS), Bevill is a self-proclaimed “bond guy” who is now deeply immersed in private markets. Shortly after undergrad, he worked in Houston and Baton Rouge, primarily for a servicer with the Small Business Administration and an internal auditor for over a year. In 1993, he joined TRS, located in Springfield, and has headed up global income, both public and private debt since 2000, after his M.A. in Economics.
Since 2008, TRS has committed over $7.2 billion to private credit markets, currently about 24% of global debt and increasing up to 35% of global income over the coming next few years. What he’s seen happening in the bond world and how he’s responded say much about the rapidly changing role of private debt in the fixed income world.
Left to right: Sylvia Owens, Kennedy Lewis Investment Management; Scottie Bevill, Teachers' Retirement System of the State of Illinois
OWENS: So, Scottie, you’re on your 29th year at TRS. When I ask people about you, they often describe you as humorous, a bond nerd, big heart, animal lover, and number one Sammy Hager fan, but the words that come up most frequently are “unconventional,” “passionate,” “competitive,” and “diligent.” Can you talk a little bit about how you’ve embraced private credit and what you think makes a great private investor?
BEVILL: When we started to tilt a little bit away from public markets and toward different structures was after the WorldCom, Enron, Tyco, and Global Crossing scandals. That made us think about the public markets. And then there was the Great Financial Crisis, where money market portfolios broke the buck and certain collateralized portfolios were significantly written down. That’s when we started taking on some private debt. Originally, private credit was called special situations: We didn’t formally change it to “private debt” until about 2017.
We were large investors in TALF (Term Asset-Backed Securities Loan Facility) and (PPIP Public and Private Investment Program), which the Fed set up in 2009. Everyone saw the benefits of these private structures, and that experience was the genesis of our interest in special situations in the distressed real estate market 2010, 2011, 2012. And then we dipped our toes into other forms of direct lending in 2012 and 2013.
OWENS: One of the debates that’s currently ongoing is whether private credit is a hybrid asset class: It contains elements of private equity-like terms but on the other hand, it’s debt, so what’s important here, a private equity skill set or a fixed income skill set?
BEVILL: It’s a little bit of both, but I think you need more of a debt skill set because, as you said, at the end of the day, it’s still debt. The opportunity set is much more top-down (understanding where we are in the credit cycle, where we are in terms in the different macro factors that come into play) – and not just monetary policy, but fiscal stimulus.
OWENS: A number of your peers from the fixed income side are contemplating how to initiate or expand a private credit allocation. What would you tell them? When you look back, what was the hardest part of transitioning from being a pure traditional fixed income portfolio manager to really embracing private credit as a permanent part of your program?
BEVILL: I’m an old school bond person – bond math, top down macro, and all that – so embracing private debt was initially a struggle for me given my background. But the further we went along, dipping our toes into different strategies, we soon realized that it’s a very similar process to public debt. For example, if you look at it from an alpha and beta standpoint, direct lending would be your beta or passive component, so to speak, your sleep-at-night, senior secure lending.
OWENS: Okay: You’ve identified beta. Now if you had a blank sheet of paper, and you were going to construct a new private credit portfolio from scratch, how would you set it up?
BEVILL: It clearly depends on the size of the pension plan. It’s difficult to have exposures to all kinds of segments within debt because scalability is a real issue in certain sectors. But given a clean piece of paper, as I said, I’d adopt the same mentality on the private side that I do on the public side, where you’re going to start on the beta piece. And then you take kind of a core satellite approach.
OWENS: How much of the portfolio should be core?
BEVIL: That’s debatable, but I’d say a nice 30-ish percent exposure to start, and then you build around that with specialty direct lending. I’m still a firm believer in real estate credit: Just as on the public side, Fannie Mae’s and Ginnie Mae’s are still a big portion of the debt markets. But there’s also more ‘niche-y’ areas, such as shipping, metals and mining, certain healthcare lending facilities, rescue financing, etc. There are niche sectors where you need lots of expertise before you should get involved, but it’s the same thing on the public side.
OWENS: Where does distressed and special situations then fit within this context? Would that be a niche?
BEVILL: We carve out a separate sleeve for stressed and distressed. We haven’t turned on the faucet like a lot of other investors have in stressed and distressed. My view is this is more of a 2022 issue because right now, there’s so much stimulus that has gone into the market. Also, there’s a big difference between stressed and distressed. Distressed often involves corporate control issues. We’re going to deal with that more in private equity. Private credit is designed to not get too much equity exposure; it’s designed to be debt: I prefer to be more stressed as opposed to distressed.
OWENS: Meanwhile, you’ve gotten rid of high yield altogether.
BEVILL: Yes, we decided three or four years ago to no longer have any dedicated high yields in the portfolio: Direct lending has been that replacement. You can get similar exposure: It’s just private.
OWENS: At a recent TRS board meeting when you presented your annual fixed income asset allocation, you said, there is “the right thing to do; the public pension plan thing to do, and then there’s reality.” Can you elaborate on what you meant?
BEVILL: It has to do with the potential returns if you stick to public markets. I think the five-year expected rate of return on public debt – which drives a lot of asset allocation decisions – is roughly between 60 to 80 basis points: That’s all you’re going to earn. That’s pretty darn low.
And if you look at emerging markets, whether it’s local or hard currency, those are currently yielding somewhere between 5.5% to 6%, which is very low to historical terms. Even in high yield, your spreads are still 300 over, so you’re in the 4.5% range, but that isn’t very high returns relative to historical standards.
OWENS: If you combine some intelligent leverage with private debt, what kind of long-term returns are realistic?
BEVILL: I’d say somewhere around 7% net: I think that’s a fair, conservative estimate.
OWENS: Historically, people have thought of fixed income as providing liquidity for the portfolio.
BEVILL: You do lose your liquidity in private markets, but anyway these days when you try to trade in public markets during stressed times, it has become difficult.
OWENS: It can be difficult to get comfortable regarding private market benchmarks. Benchmark are considered very important in public markets, but in private credit, there’s a debate about what is the right benchmark. How did you solve that in your mind? How should people be thinking about benchmarking private credit?
BEVILL: It’s tough. There’s no right or wrong approach to benchmarking private credit. When you look at the public side of debt, there’s the Barclays Agg, even though there are a lot of concerns about it. But in private debt, there’s so many different structures within real estate, and direct lending and specialty finance that aren’t in benchmarks, so it’s extremely difficult. We currently do not have a benchmark for the private debt portfolio. What we do is show multiple benchmarks that other people use: We’re comfortable with that. We don’t know how this is going to evolve going forward. But at the end of the day, we’re trying within private debt to have 200 to 250 basis points over the public benchmarks, and so far, we’ve been successful in that endeavor.
OWENS: What do you think is going to be different in the credit world over the next five to 10years?
BEVILL: I see three things. First and foremost, there will be exponential growth over the next one to three years – and you’re going to see the growth of private credit relative to private equity.
There’s going to be a lot more, new players within private debt, and I suspect large investors are going to create preferential contractual agreements, which will limit access to certain funds that maybe we would like, but we can’t write as large a check as others can.
Second, there’s not a lot of regulation in private debt, and I suspect down the road, there might be some additional regulatory things that come into play: Governments try to fix things with a sledgehammer when all you really need is a screwdriver, and they’re reactive, so as soon as something bad happens in the private debt markets, they’ll come in with a sledgehammer.
And, I think as we go forward, the third thing is consistent change. What I’ve seen in the last 25 or 30 years is that markets consistently change, whether it’s derivatives or CLOs. I don’t know what that may look like, but there’s going to be change, and I’m always excited about what could change.
OWENS: What advice would you give people who are coming out of college or just starting their career in finance? What kinds of things do you think they should think about or take away from your experience?
BEVILL: It still amazes me that folks who are just getting into the industry know so little about the debt markets. The MBA programs are biased toward private equity and the stock markets: They don’t teach enough about the debt market, which is the second-largest market on the planet.
Also, I think you need to spend a lot of time understanding macroeconomics. The central banks have been driving the show for the last few years, and that’s going to continue.
OWENS: Finally, when you think about the strange year we’ve had with COVID-19, what are going to be some of the lasting impacts of the pandemic?
BEVILL: A pandemic is different than a financial crash or – going back to WorldCom, Enron, Tyco, Global Crossing – a flat-out fraud. I think this will have a longer-term psychological impact. Certainly, commercial real estate is going to change. I think everyone has discovered that certain business functions can be accomplished without going to an office or getting on an airplane.
But I keep coming back to central banks more than anything else. We’re approaching 105% stimulus relative to global GDP: That’s going to change things for years, and the outcome of that five years from now or 10 years from now is unknown. As we come out of COVID, once the vaccine kicks in and things kind of come to normal, because of the current savings rates in the U.S., it’s going to be like rocket fuel: There’s going to be a massive growth spurt for a short amount of time. But we’re in unchartered territory, so having flexibility and dry powder and a willingness to look at things that are niche, that don’t fit into the box, is going to be extremely important as the debt markets evolve.
This conversation has been condensed and edited for purposes of clarity.