In conversation with John Fekete, MBA ’99, Managing Director/Portfolio Manager, Crescent Capital Group
Mr. John A. Fekete serves as Managing Director of Capital Markets at Crescent Capital Group, LP and a member of the firm’s Management Committee. Prior to joining the firm, Mr. Fekete served as Senior Vice President of High Yield at The TCW Group, Inc. He joined TCW in 2001 as a Credit Analyst. Prior to this, he was a High Yield Research Analyst at Triton Partners LLC, where he was responsible for covering the gaming, lodging, telecommunications, and cable industries. Mr. Fekete started his investment career at Core States Bank, where he served as a Leveraged Credit Analyst in the media and communications group. He received his B.S. degree in Finance from The College of New Jersey and his M.B.A. degree with distinction from Cornell University.
1. You have had a successful career in asset management for over two decades. Let’s start at the beginning, what shaped your interest in the field and when did you first know you wanted to pursue a career in investment management?
I was introduced to investing by my father. I remember being eight or nine years old and reading the stock tables in the newspaper and watching Louis Rukeyser on Wall $treet Week. What was fascinating to me was that every trade had two sides and was an expression of countervailing views: someone thought the price of a stock or bond would rise, so they were a buyer, and someone else had conviction of equal strength that the price of the security would go down, so they were a seller. But only one side could be proven correct, and success (or failure) was very measureable. You could see every day whether you made the correct or incorrect decision and how your portfolio was doing. That ability to express a view, with near immediate feedback, and watch your portfolio grow if your decision was correct caught my interest. Over time, the passion for picking individual stocks for my personal account translated into a passion for investing in companies on a much larger scale. I majored in Finance in college and knew I wanted to pursue a career in investment management going into Johnson.
2. What attracted you to fixed income investing in particular? How has the business changed from when you first started?
My focus for the past 15 years has primarily been on the US high yield bond market. At $1.3 trillion in size, the US high yield bond market is small compared to US equities or investment grade corporate bonds. Bonds trade on the telephone and are fairly illiquid with one-to-two point bid-ask spreads, making it an inefficient market. That inefficiency made it really interesting for me because it meant there was an opportunity to produce excess return and outshine a group of peers. Those market inefficiencies have allowed active management to produce investment returns that exceed benchmark and passively managed investment strategies. Nearly three quarters of high yield bond fund managers have produced excess return relative to their benchmark and passively-managed ETFs over the past 10 years. That is in stark contrast to large cap equities, where roughly 70% of actively managed strategies either lagged their benchmark or passively-managed, low fee ETFs.
The US high yield market is much larger and more mature than when I first started, and institutional investors these days make a strategic allocation to what is considered an established income generating asset class. Surprisingly though, in terms of day-to-day portfolio management, the business hasn’t really changed all that much from when I first started. It’s still a niche market, trades are generally initiated by telephone and made over-the-counter rather than by automated trading through an exchange. There is still a much greater opportunity to create alpha compared to other asset classes, and for that reason I think it will be one of the last asset classes where passively-managed strategies displace active fund managers.
One significant change that has occurred over the past 15 years has been the withdrawal of banks from lending in the US. In the 1990’s more than 75% of loans made to middle market businesses in the United States were made by commercial banks. As a result of regulatory changes over the years, particularly increased capital requirements following the 2008-2009 financial crisis, banks have pulled back from lending. In the most recent quarter, less than 10% of all loans to middle market businesses were made by banks. Non-bank financial entities like asset management companies, pension funds, insurers, and hedge funds have stepped in to fill the void. These entities are more lightly regulated than commercial banks, so it remains to be seen what long term effects this monumental shift will have.
3. What is your view and outlook on the current unusually low yield environment for corporate issuances, particularly for low grade bonds?
Valuation is not especially compelling for any asset these days. You could make an argument that equities, bonds and real estate are all overdue for some sort of correction. In the current low-yield environment investors (both individual and institutional) needing income have had to reach for yield in lower-rated, more speculative corporate bonds. As yields move inversely to bond prices, that has helped to push the yield of the US high yield bond index down to a little over 6.0% today. That is low on a historical basis, no doubt. But it is worth looking at the potential headwinds for the asset class, which helps to explain why there is support underpinning current valuation. The primary adversaries of US high yield bonds are credit defaults and inflation. Credit defaults occur when the borrower is unable to make interest or principal payments as agreed. Defaults result in realized losses which drag on performance. The current environment for credit defaults is very benign. In fact, the rate of defaults is actually decreasing, meaning the likelihood of incidence of realized credit losses is expected to diminish for the next several quarters. So that headwind is actually a tailwind for investors right now. The second threat is inflation, which can eat into fixed income returns. Well, it has become hard to ignore the deceleration in inflation in this country. Energy prices are lower, food prices are lower, air fares are lower. Taken together, inflation indicators have been stubbornly low for years and continue to undershoot the Fed’s 2% annual target. Why is that relevant for fixed income investors? It’s important because the Fed cannot raise short term interest rates in any sustained way if there is little or no inflation, less they risk pushing the US economy into a recession. For this reason, many investors expect interest rates to remain lower for a longer period of time. Lower rates would continue to create demand for US high yield bonds, extending the current run which has produced a 7.9% annual return for the past 10 years.
4. What business trends will shape the future of fixed income investing?
As the population ages you can expect to see a shift in asset allocation in this country, with increasing dollars flowing into fixed income products, which could lead to job growth in fixed income research and portfolio management. The shift from active to passive management in asset categories like equities is likely to continue to gain momentum, as asset management vehicles like mutual funds lag their benchmarks repeatedly over multiple time periods. Fee compression across asset management has been a trend, as investors demand lower costs and better performance from their managers. As we look into the future we also expect to see the role of technology increasing. It is reasonable to expect technologies like artificial intelligence to begin to play a greater role in identifying investment opportunities, trading anomalies, and mispriced securities. Regulation and capital requirements will also shape the future, creating opportunities and challenges and potentially changing the competitive landscape. As I noted earlier, commercial banks have largely pulled back from lending to small businesses in the US due to regulatory changes and increasing capital requirements. This dislocation has created an opportunity for asset managers, insurance companies and hedge funds to increase market share. Today, there are more than 2,000 private credit funds in the US lending directly to middle market businesses. Recognizing and adapting to these changes is critically important.
5. You’ve covered a number of industries within the fixed income space. What advice can you share with students on how to cultivate strong industry knowledge?
Strong industry knowledge is key to optimal security selection. That knowledge begins with understanding the key drivers and dynamics affecting a particular industry, the industry outlook and relative attractiveness of the sector. Next, researching the financial health of the companies competing in that industry will build a better understanding. Factors like projected revenue and profitability, stability of cash flows, appropriate margins/ratios, ability to service debt and reinvest in the business, financial flexibility and liquidity. Industry knowledge can also be developed by following management teams, their track records, integrity and incentives.
During the early stages of my career as a research analyst I had the benefit of covering many diverse industries, including telecommunications and media, casinos and hotels, restaurants and retail, and aerospace. That experience allowed me to develop deep knowledge of the specific industries, but also provided valuable perspective across multiple industries which is critical to being a successful portfolio manager. As a portfolio manager you need to make decisions each day regarding which industries to overweight and underweight and identification of relative value, and that can only come from having experience covering a broad range of sectors. For that reason, we encourage our research analysts to rotate sector coverage every 5-7 years.
6. You were a Cayuga Fund student in the first graduating class of 1999. What was the experience like for you and how did it help your career?
I feel privileged to have been selected in the inaugural class of Cayuga Fund portfolio managers. It was an experience that well prepared me for a career in investment management. There were fewer student portfolio managers back then, we were both sector analysts and PMs, and we had a very tightly knit class. We worked closely with the faculty advisor, Charles Lee, and helped each other succeed by practicing stock pitches, preparing for job interviews, etc. I learned valuable skills that immediately translated into the workplace, skills I believe enabled me to be more effective contributor in my first job post-MBA. Through my Cayuga Fund experience, I learned to value securities, to make collaborative investment decisions with my peers, and to understand the impact of my investment decisions on a portfolio. All the while having access to a trading studio with professional-grade data feeds and analytical tools that typically were not available on a graduate school campus at the time. The degree of decision making authority combined with academic instruction allowed me to hit the ground running upon graduation. The concept of an academic class, a student-run fund, and a trading studio all rolled into one program was very novel 18 years ago.
7. Is there anything you wished you knew or had focused more on in business school before starting your career?
The academic curriculum at Johnson at the time I was enrolled was mostly equity-centric. The securities valuation, capital markets classes, and career center had deep expertise in equities, so it made sense. In hindsight, it would have been beneficial to have gained more theoretical and practical exposure to fixed income given the secular shift that was underway. Fixed income has taken a front and center role in investors’ portfolios with the aging of baby boomers in the US, and the employment opportunities for fixed income analysts and portfolio managers have grown while equity research has been under some pressure due to the movement toward passive investing.
8. You are a loyal supporter of the school, giving your time and money in support of Johnson. Why is service and philanthropy, and particularly towards Johnson, important to you?
I am grateful for being given the opportunity to attend Johnson. The 2-year MBA program and Cayuga Fund experience well prepared me for my first job post-MBA. I received an incredible education and made close friendships that have now lasted for two decades. I was especially moved by the willingness of Johnson alumni in the investment management field to share knowledge, open doors, and help shape my career. I relied heavily on Johnson’s alumni network and now I am in a position to return the favor by providing financial support to Johnson and career advice to students.
9. What advice would you give current students looking to enter the asset management business?
Do your homework prior to the interview process. Understand which skills are essential in this field and how best to position yourself to break into asset management. As a new analyst you will probably work 50-60 hours per week so you want to be as sure as you can that this is the right career for you.
Be willing to do a lot of legwork on your own. Very few investment managers have formal recruitment programs that come to campus. For many firms they may hire only one or two new research analysts a year. So there are lots of folks looking for only a few open positions. That means students need to be proactive and creative. Use the Johnson alumni network, it is powerful and your best resource. Participate in as many informational interviews as possible to speak with practitioners to learn about the field. Most candidates are looking for jobs in New York, Boston or Los Angeles. If you are willing to consider other cities you may increase your opportunities. Students can also consider roads less travelled. For me, I was attracted to the inefficiencies associated with the high yield bond asset class. Away from equities there are interesting asset classes like mezzanine debt, real estate, and convertibles that employ very similar skills but are a bit under the radar, providing additional paths in asset management.
Finally, remember your career is a marathon, not a race. I can’t tell you how many times I speak with recent graduates with two or three years of investment research experience wondering when they will be promoted to a portfolio manager role. The best analysts are seasoned analysts with experience spanning many years and business cycles with deep knowledge of multiple industries. That knowledge and experience takes time to develop.