Among the papers piled on my desk over the long weekend was a report from the folks at KKR (KKR) with the ominous title "Outlook for 2016: Adult Swim Only." The opening sentences let you know this is not an upbeat forecast, telling investors, "We approach early 2016 with caution. In our view, valuations are not cheap at a time when central bank policy in the U.S. is changing, global trade is stalling, and corporate margins are peaking."
The report goes on to say that the weakening yuan will lead many nations to consider competitive devaluing and that KKR is projecting lower-than-expected GDP growth and inflation for most of the world.
While I do not put a lot of weight on most forecasts, KKR does have a worldwide presence and its fingers are in many pies around the planet. The private equity firm is active in most industries and asset classes through its buyout, real estate and infrastructure funds.
At a minimum, it's worthwhile to know how KKR is approaching 2016. Private equity forms are the smart, patient money and usually astute at identifying pockets of opportunity and on the sell side where assets and companies may be overvalued.
To put it mildly, KKR is being cautious. The report says, "We are raising substantial Cash, initiating our first underweight position in Public Equities of this cycle, and seeking out more idiosyncratic opportunities across Fixed Income and Alternatives."
KKR also believes a continued slowdown in China may create some distressed and special situation opportunities as the year progresses. Among specific sectors and themes it notes "improving household formation, increased Internet penetration, and an intensifying focus on healthcare, beauty and wellness."
The report also cites the private financing markets, telling readers that "recent gyrations in the financing markets are providing non-bank lenders a significant opportunity to leverage the market's illiquidity premium to earn compelling risk-adjusted returns. In our humble opinion, private financing opportunities across real estate, infrastructure, corporate take-overs, and equipment currently appear to be the most attractive risk-adjusted opportunity in the market today."
This would seem to imply a big opportunity for select business development companies and real estate finance funds. In this area, I favor those offered by KKR's competitor Apollo Global Management (APO):
-- Apollo Investment (AINV) has seen its share price stumble of late because of energy exposure and rate-hike concerns but its relationship with the private equity and alternative asset management should help it grow earnings and payouts over the next several years.
-- Apollo Commercial Real Estate Finance (ARI) originates, acquires, invests in, and manages commercial real estate mortgages and debt securities.
Both AINV and AIR trade at steep discounts to net asset value and have double-digit yields. They are only for long-term owners with a strong stomach for volatility and sharp price swings but I believe those willing to own for five years or longer will be pleased with the results.
KKR is not all that upbeat on anything but offers some advice on where to look for opportunity, telling investors, "Specifically, parts of the U.S. equity market (e.g., risk arbitrage stories and rising ROE stories) and parts of the European equity markets (e.g., dividend yielders with growth) will likely outperform again in 2016, we believe." The rising ROE story makes sense to me and I will be setting up some screens to see if I can find improving companies at attractive prices. I will report back on my findings.
KKR also thinks that debt will be a better investment than equity, pointing to levered loans, in particular, as possible outperformers. This makes me think that we might want to consider a BWW (buy when whacked) senior loan closed-end fund associated with experienced private equity and distressed investing firms.
I like Apollo Senior Floating Rate (AFT) and Blackstone/GSO Senior Floating Rate Term Fund (BSL). Marc Lasry's distressed debt firm Avenue Capital also has a closed-end fund, Avenue Income Credit Strategies (ACP), with levered loan and high-yield bond exposure. These are the ultimate stay small, move slow investments, in my opinion. Buy them on days when fear has markets firmly in its grip and high-yield and loan funds are taking a beating.
I suspect 2016 will give you plenty of opportunities to scale into a position in all the funds I mentioned in this article.
The KKR report has some useful information and ideas to consider as we move further into the year. Most of the major private equity firms have a research and report section on their websites. In addition to always reading the conference call transcripts from KKR, Carlisle Group (CG), Apollo and Blackstone (BX) it is a good idea to check these for updated information that might help you achieve better long-term results.