How HPS mitigates risk and drives high returns by being a creative player in an uncompetitive market
Transcript
Mark Rubenstein, I joined HPS in 2008. I oversee the junior capital investing strategy at HPS, which is called Strategic Investment Partners, or SIP.
HPS's investment strategy is to leverage its global sourcing network to invest in and underwrite leading businesses in their industries and high-quality management teams, with a strong focus on capital preservation and downside protection. SIP's strategy is to invest in the junior part of the capital structure - so everything from junior debt, which could be structured as second lien or unsecured debt through PIK notes, convertible preferred, and in a small portion of the portfolio, common equity.
In a capital structure, first-lien debt will have a priority claim on the assets of a company. So in a bankruptcy scenario, those first-lien investments will be repaid first. So the junior capital sits between the first lien debt and the common equity of the company. I think what we found over time is that by selecting these very large companies, you know, we haven't seen those enter periods of distress as extreme as would require a bankruptcy filing. The funds have had a very low default rate, and losses given default have been de minimis. We're picking very large companies that operate in stable, recession-resilient industries. They've been tested through the great financial crisis and COVID. They tend to have very strong free cash flow conversion. So industries that are not capital intensive do not have significant CapEx requirements. They tend to have a strong recurring revenue profile.
Structurally I think the two considerations are one, controlling these tranches. So with our scale, we're typically the controlling holder. The second structural component is just a very strong focus on documentation. So our documentation standards are very high, and you'll see protections in those documents that would be much stronger than in a typical syndicated debt instrument. There's only a handful of providers of capital at this scale with the expertise that we have to negotiate and structure and invest in these large transactions.
In addition, you know, if you look at the total dry powder dedicated to private funds, which is several trillion dollars, a very small percentage of it is dedicated to junior capital solution providers. We've seen on the junior capital side the universe of issuers that are seeking long-term partners that can provide these creative junior capital solutions.
Lastly, I would just note that in volatile market periods, we tend to see that supply-demand situation exacerbated further and that issuers, whether they be sponsors or management-owned companies, are more focused on privately placed solution.
I think investors seeking attractive risk-adjusted returns and credit are well-suited to the HPS funds.