Through coincidence rather than anything else, my entry into credit markets coincided with the establishment of Challenger Investment Management back in early 2005. And so in many respects the events that shaped the path of the CIM business were the same events that impacted my personal journey.
In early 2005, credit markets were coming to terms with the correlation crisis of 2004, the structured credit boom was still in the middle innings and interest rates were around halfway though a rate hiking cycle that would not end until early 2008. This particular time had a lot in common with the environment we see before us today; spreads were tighter but with no signs they would go wider and interest rates had been held at a very low level for an extended period before a sharp hiking cycle commenced.
It was at this time that I learnt my first lesson of credit investing: always question the narrative. As humans we struggle with complexity. Sometimes simple narratives allow us to simplify a concept and can be hugely beneficial. In fact a common trait of the best investors I have dealt with over the years has been their ability to simplify complex problems. But these investors always asked themselves what would happen if they were wrong. Two of the narratives I recall hearing at this time were, “the GSEs benefit from the implicit support of the US government” and “the US housing market has never had a YoY decline”. Believing the first narrative resulted in the major rating agencies all rating debt issued by Fannie Mae and Freddie Mac receiving a AAA rating, the same rating as the US government. The second narrative resulted in billions of dollars of CDO’s being issued on the false presumption that house prices couldn’t decline in California and New York at the same time. Both of course proved to be false narratives but even prior to 2008 there were investors who questioned the simple narratives. With respect to the GSE’s the truth was in broad daylight; the support was implicit- there was nothing written anywhere that said the government would bail out the GSEs if they ran into trouble. And everyone knew it! The house price narrative was also based on tenuous foundations. In fact, when investors said house prices had never declined on a year on year basis what they meant to say was the FHFA US Housing Index which started in the 1970s has never experienced a year on year decline. So in 2005 there was around 30 years of data that investors and rating agencies relied on to build highly complex models of the default correlations of mortgage backed securities comprising 1000s of underlying mortgages.
Of course while the narratives change, they don’t go away altogether. In 2025 the major banks in Australia are seen as too big to fail. Our major bank ratings benefits from upwards notching as a result of their systemic importance to the domestic economy. Now I’m not saying that this is wrong but I am advocating that investors consider the possibility that the assumption that a major bank could fail without a government bailout.
Now as we moved past the capitulation point in markets in April, 2009 I learnt another important lesson: price matters. As we emerged from the Global Financial Crisis many investors refused to look at certain opportunities at any price. This was especially true of securitised products which were tarred with the same brush as subprime MBS or CDO’s of ABS. Collateral performance improving? Not a buyer. Ratings upgrade? Not a buyer. House prices increasing? Not a buyer. Acronym in the name? Definitely not a buyer. When other investors are telling you that they are not a buyer at any price then that is an indication that the price of the asset may be cheap relative to its intrinsic credit, structural and liquidity risk. In fact when it came to securitised products, these assets remained cheap to their fundamentals for over a decade (unfortunately that ship has now (mostly) sailed with securitised credit generally representing fair value to corporate credit!). Another interpretation of this is that price is a representation of technical factors (i.e. buyers verses sellers) and often investors become overwhelmed by the fundamentals and forget about the technical factors.
Even though the GFC is a distant memory for many with the majority of investors starting their careers after the GFC ended, the lesson is still relevant today. Consider private credit where domestically the sales pitch seems to be centred around the fundamental strength of the asset class (ie there is minimal default risk because of covenants protections and equity coverage) with less regard for the pricing of the risk. This is exacerbated in Australia by the lack of mark to market discipline exhibited by managers. Indeed during COVID we saw listed investment trusts where managers were marking to market pricing at a bigger discount than the listed trusts where managers didn’t mark to market. Price matters!
In the 2010s a re-regulation cycle was fully underway as regulators tried to adapt capital standards to strengthen global banking systems to limit the risk of systemic failures. In Australia we were introduced to the phrase “unquestionably strong” and sorted through the fallout from the Banking Royal Commission. Exploiting the opportunities that were presented was contingent on the third lesson: smarter mandates make smarter investors. Whether credit or equities, listed or unlisted, funds management is a competitive industry. You win flows by outperforming peers which then leads to you bidding up the price of the assets you own and you drive the price so high that you start underperforming. In the 2010s there were very few credit funds that did not allow redemptions on a daily basis. When markets were buoyant, these funds would buy up the most high yielding assets, whether Additional Tier 1 instruments, mezzanine tranches of securitised product or private credit only to be forced to liquidate these positions when markets sold off. Having a mandate that allowed for investing with more than a day by day horizon allowed us to make smarter decisions, especially during selloffs. We weren’t hoarding liquidity in fear of redemption requests but tactically deploying capital during periods of dislocation. A contrarian approach such as this makes a huge amount of sense in credit because in the absence of a default, bond prices ultimately revert to par. While value investments in equity markets can remain cheap for decades, in credit you are repaid at par at maturity.
Today there is a much greater range of product types for investors including closed ended funds, open ended funds, interval funds and listed funds. These different vehicles are suited to different asset classes. Listed funds can allow investors to access less liquid credit but with the risk that the fund trades at a discount to the value of the assets. Interval funds are well suited for performing private and semi liquid credit as they allow for periodic redemption windows ensuring that the liquidity profile of the assets matches that of the liabilities. Closed ended funds work well for higher returning credit such as venture debt or distressed where the return profile is much more equity like and the timing of the repayment of debt is much more uncertain. Each structure has their pros and cons. If care is taken at the product design stage better and more sustainable returns can be generated over the long term.
One of the aspects of my role that I have loved most of all is that markets are constantly evolving requiring us as investors to evolve alongside. At Challenger Investment Management, we have embraced the evolution, striving to learn more about credit markets, investment philosophies, approaches, risks and opportunities. The first 20 years of our journey has seen us grow from investing for a captive insurance company, to assisting our superannuation industry in their journey into private credit, to running public and private credit funds on behalf of institutional, wholesale and retail investors, to managing separate accounts for some of the largest sovereign wealth funds in the world, to originating assets for global banks and insurance companies, and to advising governments on their investment programs. We’ve learnt from all of these clients and appreciate their support of us over the years.
Thank you to all our clients, past, present and prospective. We look forward to the next twenty years of our journey in credit markets with you.