Fixed Income Investing

Posted on
21st August 2020
By Travis Miller

Fixed Income Investing

Simple Formula (By Travis Miller, 21st August 2020)

The hardest part of my job over the years has been simply sifting through an endless supply of companies looking for capital. Good on them I think, as being a business owner myself, I know how tough it is at times to source capital.

To avoid working 24 hours per day, it has been critical to deploy a method of quickly filtering through the investments that we can take through our initial due-diligence (DD) process, and subsequently make it to our Investment Committee for the final sign off.

When I look at Fixed Income investing in the Private Credit space, I have 5 key criteria in order below that drives my decision to consider investing, this filter has no pricing model or complex formula, although works very well;

  1. Personality Test
  2. Alignment of Interest Test
  3. Documentation Test
  4. Structural Test
  5. How do I get out? Money backTest

What does that even mean? I will go through them in detail below, although in short, if the above is not a pass on all 5, I will not even commence more formal DD of the respective risk/return of an asset.

Personality Test

This one is pretty simple (possibly called gut feel). If I do not like or trust the key principals and staff members, I will not invest (benefit of running your own business, you can choose who you deal with). At times I will give the benefit of the doubt and test the individuals reputations on my network for feedback. This one is often required when dealing with hardcore credit people (as they can often be hard to read, good at credit but socially awkward, great to invest with, just do not socialise with them!)

Alignment of Interest Test

There are two aspects to this one;

  1. Who will lose money before me? I want to know that the person I am lending money to will lose money and/or assets before me so that they are strongly incentivised to protect their own interests, and in doing, so protect mine. and/or;
  2. At worst, someone who will lose money at the same time, when looking at co-investing it's important (aside from rating your co-investor) that you rank equal (Parri-passu) on all fronts, to ensure alignment when/if things get tough.

Documentation Test

Who drafted the docs? There are lots of capable lawyers working in cupboards, small offices and building out small business (just like us), which is fine, although I want to know their backgrounds, track record and experience. It is in times of need when you will dive for the docs, the clauses, the security, caveats etc.  It's at this point, you will be happy you went with a good legal team.

Structural Test

If things go bad how can I throw a tantrum? Security, arrears triggers, revolver stoppers, NIM capture, covenants and lots of other big words.  As an investor, you want to have enhanced structural elements that are investor-friendly, and useful when you need them.

How do I get out? Money back Test

I want my money back.  What is my exit?  In Private Credit, it is quite often a refinance, which is fine, although I want terms that incentivise the borrower to execute the refinance and that have a number of theoretically predictable paths to exit.

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