By CHRIS SHELDON Apr 15, 2020

V FOR VOLATILITY

We began 2020 recognizing that the persistence of 2019 market trends -- the zealous yearn for yield, spread compression, and continued lack of supply and the deepening bifurcation between high quality and storied credits were poised for a shakeup. Nobody could have foreseen the tragic global pandemic that has now changed the world we once knew forever.

Let us first say, we are all facing an absolutely unprecedented crisis with the emergence and continued spread of COVID-19. This is a significant and grave public health issue that has now evolved into a global market and financial disruption. It has catalyzed lightning speed government responses as we have seen with the historic $2 trillion fiscal stimulus package, The CARES Act, approved by the Senate on March 25th.

This pandemic has truly rocked the markets in a way we have not seen since the Great Financial Crisis (“GFC”). The sudden halting of our movement and business activities has created a ghost that is looming through our economy, daily routines, and for a large array of companies -- uncertain future revenue streams.

While we still cannot fully quantify the depths of the financial aftershocks that will inevitably reverberate through our economy and the consumer, we believe strongly that now is not the time to fear the market’s volatility and wrath. Instead, it is a time to be prudent and take opportunities to reposition, lean into dislocated opportunities, and position for the most upside possible.

We do not think this is the second GFC, but rather, a very unfortunate series of events that have shocked the financial system and will now continue to test investors’ stamina as well as the credit health of many issuers who may have had the luxury of floating in, what we call, a market purgatory during an 11 year bull run.

It was only one quarter ago when we were discussing a record number repricings and refinancings in the credit markets – squeezing spread down to record tights. In a complete reversal in March we hit the widest high yield spread levels in over a decade, +1,000bps, and now worry that there might be a record number of restructurings.

There is no doubt that the velocity and severity of this market sell off has caused enormous whiplash for all investors, and as vicious as it has been on the way down, history has taught us that the snapbacks can be equally fast and furious. We know this market is not a forgiving one, but as we navigate this global crisis together, we will find attractive opportunities to invest in good companies with strong fundamentals and sustainable cash flows at discounted prices.

ANIMAL SPIRITS

John Maynard Keynes used the phrase animal spirits to describe the instincts and behavior (often identified with fear and greed) of the market in his 1936 work The General Theory of Employment, Interest and Money. We saw the many shades of market behavior in Q1 and when we think about the credit markets today, we are actually seeing a lot of the trends we have previously highlighted just in an exacerbated fashion:

  1. No Mercy
    Unrelenting punishment on storied credits and COVID-19 adjacent sectors
  2. High Quality Line Up
    A robust appetite for high quality highly rated credits that are low loan to value ("LTV"), many of which were trading at discounts, and represented a very compelling pull to par opportunity creating an attractive risk-adjusted reward on short-term time basis
  3. Shadow Players
    Issuers who may have already been over levered are now facing the music on their ability to service and pay back their debt loads. Everything works in a growth environment but what happens when that growth stops?
  4. Judgement Day
    Rating agencies will continue to be hyper proactive on downgrades, which will create a CLO technical rebalancing and increased pressure in the leveraged loan market
  5. Perceived Quality
    Don’t always judge a credit by its rating. A growing and fragile BBB market could catalyze a tsunami for the high yield index if and when downgraded
  6. The Fed Flex
    An amplified 2018 replay of the Powell Pivot with rates now at near zero and historic federal stimulus programs shifting risk tolerance across the credit spectrum
  7. Shifting Risk Incentives
    Vehicles like Mutual Funds, ETFs, CLOs, and Insurance capital will have less flexibility to play offense in volatile markets as they need to balance risk parameters and structural constraints. We believe this will create more dispersion and opportunity sets.
  8. Illiquidity & Gap Risk Cocktail
    With thinning liquidity in the credit market – exacerbated gap risk ensues due to widening bid/ask spreads

At the end of 2019, we discussed our belief in the importance of a weatherproof portfolio that can endure the erosion of a severe storm but also be positioned for the spring. Even though spring may come a little later now, we still believe weatherproofing is key for the long term investor. At the end of last year, we also emphasized portfolio construction that could arm against a deep drawdown while also sustaining income given the price appreciation run up in 2019. We acknowledge the reality that few were adequately prepared for the enormity and velocity of this deep market sell-off. We knew winter was upon us, but this storm came in with a burst of lightning and no warning requiring turbo charged waterproof alpha protecting snow boots that most portfolios didn’t have.

The year started with the market firing on all cylinders: Dow Jones Industrial Average (“DJIA”) nearly closing at ~30k (29,551)1 on February 12, the S&P at record highs 3,3861 on February 19, and a gleeful risk-on mode carrying momentum from Q4 2019 – all to come to a screeching standstill followed by a drastic turn on February 21st. In just over a month’s time, to name a few out of many new milestones, we experienced the fastest and sharpest market drop ever seen in history with the S&P and DJIA falling to their lows for the quarter on March 23rd declining -30% and -37%2 respectively; the Fed cut rates twice ultimately down to zero; WTI crude suffer its greatest drop since the Gulf War; spreads enter distressed territory for the first time since the GFC with high yield and loans widening out +1,000bps; and a massive asset liability mismatch materializing in the market, exerting severe liquidity pressure that resulted in mass forced selling. All of which gave rise to a very panicked and uncertain market that continues to seek shelter in the storm. Let's wind back the clock and take a tour through the newest chapter of history.

Q FOR QUALITY

Alongside the greatest economic expansion in U.S. history, the leveraged loan market also evolved to double in size and liquidity from $594.2 billion in 2008 to $1.193 trillion today to become a key player in the capital markets. At the onset of the market sell off at the end of February, we saw that the initial decline of the loan market was not as dramatic as it was in high yield given the fact that the loan market is less exposed to energy. However, over the course of March, we began to see the cracks extend within credit and our previous concern about increased credit risk in loans come to a head. We also began to see the bid/ask spreads in loans widen dramatically, averaging ~400bps4 compared to the three year average of 150bps5, which created even more hurdles for repositioning in the tradable credit market. This pricing opacity created challenges during the March volatility and further contributed to the growing gap risk across the credit spectrum.

As price discovery ensued in the market, so did the pressure on credit ratings. In March alone we saw, 1146 issuers downgraded and the S&P/LSTA Leveraged Loan Index decline by 12.37%7, which was the second steepest monthly decline in the 23 year history of the Index. March also brought the largest daily loan decline on record occurring on March 18th at -3.74%.8 There are only four instances on record where daily losses exceed -3%9, all of which occurred in March 2020. Prior to COVID-19, the top three largest loan losses occurred during the GFC.

Despite liquidity of the loan market improving over the years, the severe volatility coupled with the growing reality that many companies now have uncertain future cash flow potential has catalyzed a spike in downgrades by the rating agencies. As credit investors thinking back to the GFC, we remember the controversial position the rating agencies were in when subprime mortgages were falsely representing a higher quality ratings façade than their true credit risk. Additionally, during the GFC, rating agencies were much more reactive to the market and initiated downgrades after companies had already demonstrated significant stress. As we have already begun to see, the rating agencies are being extremely proactive and will continue to play strong defense in assessing credit risk across the market. We expect the downgrades to continue to pour in, and this will create technical selling pressure in the CLO community which represents ~60%10 of the leveraged loan buyer universe.

As downgrades persist, CLOs will look to preserve their Weighted Average Rating Factor ("WARF"), Over Collateralization ("OC") tests, and manage against a capped CCC exposure bucket. The sheer volume of downgrades across this very large buyer pool of the loan market will add to the continued price pressure in the loan market. For reference, at the end of 2019, 10% of the bank loan market was trading below $90, whereas on March 20th, 95% of the Leveraged Loan Index was under $90.11

We believe this network effect, similar to what we saw in Q3 2019, will result in extended gap risk in the market. At the moment, we have seen the downgrade ripple effect solely at the collateral level, but we could see CLO tranche downgrades increase if the rating agencies continue their aggressive posturing on individual loans. This would be most impactful to the lower mezzanine tranches. This potential dynamic, given the size of the CLO buyer in the market, does give us some caution on the loan market technical, but we do believe as the market continues to reposition there will be an assortment of opportunities, some of which are already here particularly those who have been downgraded.

This phenomenon brings our attention to the expansion of BBB issuers within the Investment Grade (“IG”) market. The IG market has grown by 2.3x12 in the last ten years and BBBs account for ~50%13 of the IG index. Similar to the loan technical forming with CLOs and CCC downgrades, the expansion of BBB debt in the market, leads to an increased probability for a technical headwind to be generated should that debt get downgraded one notch into high yield. In fact, we are currently at 2009 levels in terms of notional debt outstanding downgraded this year which stands at $150bn.14 Current projections estimate that global fallen angels could reach $640bn by the end of the year with US companies accounting for ~75% of the downgrades.15 Contrary to the BBB expansion, the high yield index has actually increased its credit quality with the growth of BB assets post GFC. What does this all mean? If we see a surge in downgrades from investment grade to high yield, a flood of new questionable debt will permeate the high yield space providing another opportunity for the reassessment of that credit risk.

With gap risk back on the rise and increased dispersion among sectors, our focus on new deployment in March within KKR Credit has been on quality with a capital Q. As the volatility increased across the month of March, we saw great companies, with strong fundamentals and large capital structures, who were appropriately wearing heavy duty rain parkas for the storm, abandoned. Why did that happen? The main reason was due to thinning liquidity. Approximately ~45%16 of the high yield market is consumed by daily liquidity vehicles who were seeing investors flee with heightened panic and uncertainty surrounding COVID-19, ultimately seeking liquidity at any dollar price. As liquidity slowly dissipated, investors found shelter in the only spot that could weather the storm – high quality companies. Although high quality companies with good balance sheets did see price depreciation, it was not as drastic as lower rated and or more levered companies – making them the only spot and highest price offer for the “here and now” liquidity seeker.

In addition to daily liquidity vehicles creating waves in the market, we saw a considerable run on dollars catapult a violent swing in the foreign exchange ("FX") markets. Sterling and Aussie dollars in particular were two of the hardest hit currencies. At one point, Sterling touched the lowest exchange rate in 35 years while Aussie Dollar was at a -35% annualized return for the year of 2020 (peaked at -60% annualized return on 3/19).17 The severity of this FX swing was the first domino to fall over in the race to liquidity. As the chasm between GBP-USD and AUD-USD exchange rates extended – foreign denominated accounts experienced heightened margin calls, uncertain cash balances, and the urgent need for liquidity. Unfortunately, this series of events also sent ripples through the credit market and created many forced sellers. At this point, sellers were exclusively bid side price takers. Ultimately, the massive policy intervention and announcement of the Fed’s swap lines helped ease the USD demand.

With this thick tornado swirling through the market, we continue to see value in senior secured first lien loans within COVID-19 resistant sectors, for example telecommunications credits, that are highly rated, have low LTV, and displayed strong credit health and cash flow longevity. With BB loan spreads widening out over ~3.0x18 at the height from January 2020 levels, this high quality, BB basket of loans represented a great investment opportunity with overly punished credits trading at significant dollar discount. These credits are well positioned for a pull to par yielding equity-like double-digit returns plus a coupon, assuming 12-18 month normalization.

In addition, our investment strategies seek to deploy capital into high quality credits that had previously committed financing in place resulting in near-term repayment that were trading at attractive discounts. The concept of investing in credits with a near term pay down secured enables investors to deploy capital into dislocation at a discount and provides the ability to recycle those proceeds back into the market on their own terms and timeline. As we saw in the last week of March, high quality credits within large liquid capital structures were the first group to snap back and rally into month end reiterating that there is appetite for risk – just very specific risk at this time.

O IS FOR OPPORTUNITY

With a large portion of the market incentivized not to lean into risk as a result of their structural constraints and investment parameters (ie: daily liquidity requirements, rating limitations, sector sensitivities), there is a road back into “No Man’s Land". We are a true believer that the more agility an investor has the better the long term return will be. While there may be a short term technical that creates inefficiencies or even exuberance in this market, the pendulum always swings its way back to stability.

Secured debt yields have become more attractive than subordinated debt yields in certain capital structures given the unfavorable secured loan technical developing. Companies with short maturities in COVID-19/OPEC adjacent sectors, for example a gas distributor, present longer term investment opportunities with attractive risk-reward profiles. We saw secured bonds experienced 20+ point mark-to-market (“MTM”) declines during the March volatility but as a group continue to outperform unsecured bonds, reiterating our guidance on high quality credit. Over the last decade, the senior secured market has grown demonstrating its ability to be resilient in bouts of market volatility. This time around and in a mere 21 days, the high yield market moved from an option-adjusted spread (“OAS") of 500bps19 above the U.S. 10 year treasury to a spread of 1,000bps, which is defined as distressed levels. The move from 500-1,000 bps during the GFC took 322 days to reach peak levels – that shows us how ferocious this move is compared to historical peaks.

We believe we will continue to see MTM volatility within the credit markets in the coming months, and that could present an opportunity to build added convexity within a portfolio and the potential to generate double digit returns with carry, assuming a 2-3 year hold period. We are also focusing on credits that have strong asset coverage as we believe companies may need access to capital in the months to come and a strong collateral package is a key lifeline if there is continued stress. We continue to operate in a market that is full of unknowns as we wait to discover what the duration of this pandemic and shelter in place will ultimately be which is why we will continue to walk before we run in this market and why we will be investing in simplicity over complexity at this current time.

When we say simplicity, what we mean is that the restructurings, and complex capital structure workouts will come and there will be a more appropriate time to lean back into those investment opportunities as the market finds its footing. Until then, as we continue to live in a world of uncertainty – we will strive to seek out strong fundamentals and storm resistant capital structures.

F IS FOR FUNDAMENTALS AND C FOR COLLATERAL

Portfolio construction is akin to a house blueprint. One needs a plan from the beginning, from the nails to the roof to craft a structure that is fit for any weather, or unforeseen event, even an earthquake. We just had an unforeseen event in the market, and the aftershocks will continue to roll in for some time until we get more clarity, data and a path to containment. Our guiding principal will continue to be about keen security selection and meticulous portfolio construction. Looking to the broader market, we have watched a stark bifurcation between B loans and CCC loans continue to gain momentum and widen during the March sell-off. To put this into context, single B loans declined -13.18%20 in the month of March compared to CCCs which declined -22.20%20 on a total return basis. On the snapback the market witnessed starting on March 23rd into month end, single B's rallied +7.88%20 and BB's +12.70%20 while CCC's were still down -1.35%20 on a total return basis. This fact pattern demonstrates to us that there was an uptick in risk taking in the market going into month end, albeit, specific and curated risk taking. It also tells us that the tale of dispersion will continue to unfold and is here to stay for some time.

Although the market feels unstable right now, we believe there are still ways to preserve income and generate yield. As we have continued to deploy through the crisis, we have found ways to reposition both defensively and opportunistically, though it has not been easy with the lack of liquidity in the market.

At the moment, we think it is important for investors to focus and stress test credits liquidity and fundamental financial health to arm against further downside and sustain income. On days where there may be more market strength and liquidity, executing agility vis-a-vis swaps across bank loan and high yield asset classes may provide interesting relative value plays. These swaps will most likely be longer term forward thinking investment plays where investors may have the ability to monetize on trades that have seen a healthy bid and snap back in the last week of the quarter while continuing to find opportunities in credits that are still trading at deeper dollar discounts. In other instances, swapping up the capital structure of a particular credit or peer credit, for example, exiting an unsecured to enter a secured position. We believe this could continue to be an interesting relative value strategy across structures and COVID-19 adjacent sectors.

Further, as we have discussed previously, dispersion has been brewing within the credit markets for some time. The bifurcation across sectors continues to deepen in this market and now we are also seeing a flood of issuers who had the luxury of time and a fairly stable market meet a sobering reality of servicing their debt loads. The COVID-19 economic impact is real and will be painful. It is highly likely that this will cause one of the sharpest recessions in US history, and it will take years to for the economy to normalize. Defaults will increase as the reality continues to set in and time passes. We expect the default wave to effect a vast number of businesses, many of which were healthy and sound pre-COVID.

As we write this letter, the Federal Reserve Bank (“FRB”) has made yet another historic and extraordinary move to support the credit markets directly with the announcement on April 9th that it would implement an additional $2.3 trillion in COVID-19 relief programs including Main Street Lending Program (MSLP), Primary Market Corporate Credit Facility (“PMCCF”) and the Secondary Market Corporate Credit Facility (“SMCCF”).21 The announcement came right after jobless claims rose by 6.6mm, bringing the total number of unemployment applicants to more than 16mm in the last three weeks. The MSLP will aim to facilitate lending to small and medium sized businesses in the form of an unsecured term loan. The facility will provide up to $600mm of loans, using $75bn equity from the Treasury. The PMCCF and SMCCF are proposed to be Fed backed Special Purpose Vehicles ("SPVs”) that will provide purchasing backstops and lending for eligible corporate debt. The combined size of the program will range up to $750 billion.22

The Fed's Liquidity Relief Program

  • Main Street Lending Program will have two facilities: 1) Can borrow the lesser of (i) $25 million or (ii) up to a pro forma leverage ratio of 4.0x and 2) Can borrow the lesser of (i) $150 million; (ii) 30% of the outstanding and committed but undrawn bank debt; or (iii) up to a pro forma leverage ratio of 6.0x Primary Market Corporate Credit Facility will provide a funding backstop to the IG issuances by purchasing new issue bonds and making loans through a Treasury backed SPV. Secondary Market Corporate Credit Facility will provide liquidity in the secondary market by purchasing eligible secondary market corporates issued by IG US companies and US listed ETFs that invest broadly in US IG.
  • Primary Market Corporate Credit Facility will provide a funding backstop to the IG issuances by purchasing new issue bonds and making loans through a Treasury backed SPV.
  • Secondary Market Corporate Credit Facility will provide liquidity in the secondary market by purchasing eligible secondary market corporates issued by IG US companies and US listed ETFs that invest broadly in US IG.

-Source: Federal Reserve Bank Board of Governors as of April 9, 2020

The eligibility of individual corporate bonds is defined as those rated BBB-/Baa3 as of March 22, 2020 and if subsequently downgraded then the rating must be at least BB-/Ba3 at the time of purchase by the facility.

This gesture by the FRB will inject significant punching power into the credit markets in addition to opening up a new buyer for the fragile fallen angel population (most recently Ford Motor Co.) which we expect to grow in the coming quarters.

The Fed’s liquidity programs and backstops have provided structural support in the credit markets which can be seen with the Primary IG market picking up in the last week of March and continuing to roll into the first week of April helping to thaw the credit markets. On March 31st, we saw $13bn alone pricing and $259.2bn in total March issuance which was a 46% increase from the previous 2016 record of $177.7bn.23

The first week of April saw 49 issuers pricing ~$117.2bn across 97 tranches.24 Gross new issue volume is on track to be ~66%25 ahead of 2019’s pace. One on hand – investors have a growing concern about the size of the BBB market and inevitable downgrades, while on the other hand we have seen a fury of corporate debt issuance – many of which have been rated BBB. We have seen notable and highly impacted COVID-19 companies tap the IG bond market for fresh debt: Carnival Cruises, CVS, FedEx, and Dollar General Stores to name a few.

There is nowhere to hide in this environment and there will continue to be a misinterpretation of risk taking in this market for some time. We believe it will be judicious to stay cautious going forward, but cautious doesn’t always mean the senior part of the capital structure; it means good fundamentals, strong balance sheets, large capital structures, and access to hard assets. In certain situations it will make sense to step down into the unsecured piece. Every investment will have its own credit story in this market.

TIME TO GET COMFORTABLE BEING UNCOMFORTABLE

The uncertainty will continue to follow the market and economy for the foreseeable future, and we believe this is the time to become comfortable being uncomfortable. We are encouraged that the market is pricing risk as it proves to us that even companies in the eye of the storm have access to capital. As investors, we should consider leaning into those opportunities and taking advantage across the seniority spectrum. While we have no doubt this event will change human behavior and we will all evolve to acclimate to a new normal, we also believe that the asset prices of quality credits and businesses will rebound ahead of the fundamentals and delivery of certainty. We will continue to be credit underwriters with deep conviction and focus on the opportunities that have an extended runway of liquidity and or strong collateral packages to provide us with extra downside protection and comfort while we step in during the persistent uncertainty.

As for the broader market, we know no one can ever call a true bottom and what we believe is most paramount now, and going forward, is proactively managing a portfolio’s risk in conjunction with an ambiguous backdrop. It will take time for the economy to find its new equilibrium and we see that as a way to continue to fine tune our portfolio and reposition for spring. We won’t always get it right but we have true conviction in our ability to be agile in this market and identify compelling opportunity sets as the market continues to evolve. As our Co-Founder George Roberts recently reminded us on a firm wide call, markets tend to be driven by fear and greed, and "we are in the fear part of this market."

At this time, KKR’s key focus remains on the health and safety of our employees across the globe and across our portfolio companies. We have leveraged KKR’s global network and scale to share data and information amongst our teams and investors. We are taking in real time data inputs across our businesses to process the market and the uncertainty.

As the data is constantly evolving – we are also constantly iterating with market and its developments to quantify and analyze in real time. We have connected immensely as a community to navigate these untraveled paths together while utilizing our global platform to provide financial, advisory, and operational support through our cross-platform model. We continue to work with companies across all of our strategies to ensure they are taking appropriate measures to protect employees and manage the impact of this crisis with respect to their business and operating models.

As we look ahead, we also look to the past and to history to guide us and inspire us that this too shall pass. As a firm we have 44 years of experience investing through market cycles, world events, and societal shifts. We must remember that the world has seen so many battles, has evolved so brilliantly, and it is always together, as a – company – and team, that we can overcome any challenge together.

We want to thank our investors for their continued partnership, patience, and resilience throughout this time. As always, we welcome your feedback on our letter and are grateful for the opportunity to discuss these topics and the market with our readers.

We look forward to investing into dislocation and navigating this new world order together.

Christopher A. Sheldon




V FOR VOLATILITY BY TAL REBACK



Be very wary of the twenty first of February

The day we saw the markets stall

They looked around and then they found

A new lethal crown was around us all

From that day on, we continued to see

Many bouts of volatility

Become the new normal which we now find

A market’s dystopia that is far from kind

Although the tempest is now here

A weatherproof portfolio need not have any fears

This uncertainty gives rise to new opportunities

And those seeds we will sow

To grow into a blossoming portfolio we hope to forever like and know

ENDNOTES

1 Historical Bloomberg Data as of 2/12/20 and 2/19/20

2 Historical Bloomberg Data as of 3/31/20

3 KKR Credit Analysis and S&P LSTA LLI as of 3/31/20

4 KKR Credit Analysis, S&P LSTA LLI, and S&P LCD as of 3/31/20

5 KKR Credit Analysis, S&P LSTA LLI, and S&P LCD as of 3/31/20

6 KKR Credit Analysis, S&P Global Ratings, and S&P LSTA LLI as of 3/31/20

7 S&P LSTA LLI Returns as of 3/31/20

8 S&P LCD as of 3/31/20

9 S&P LCD as of 3/31/20

10 KKR Credit Analysis and S&P LCD as of 3/31/20

11 S&P LSTA LLI as of 3/31/20

12 KKR Credit Analysis and ICE BofAML as of 3/31/20

13 KKR Credit Analysis and ICE BofAML as of 3/31/20

14 JPMorgan Research as of 4/9/20

15 S&P Global Ratings as of 3/31/20

16 KKR Credit Analysis and Barclays Research as of December 31, 2019. Data Presented using Median of Barclays Range for each category.

17 Historical Bloomberg Data as of 3/31/20

18 KKR Credit Analysis and S&P LSTA LLI as of 3/31/20

19 S&P LCD as of 3/31/20

20 KKR Credit Analysis and S&P LCD as of 3/31/20

21 Federal Reserve Bank Board of Governors

22 Federal Reserve Bank Board of Governors

23 Bloomberg Data and S&P LCD as of 3/31/20

24 Bloomberg Data and S&P LCD as of 4/6/20

25 Bloomberg Data and S&P LCD as of 4/8/20


DISCLAIMERS

The views expressed in this material are the personal views of Christopher A. Sheldon and the Leveraged Credit Team of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, "KKR") and do not necessarily reflect the views of KKR itself. The views expressed reflect the current views of Mr. Sheldon and the Leveraged Credit Team as of the date hereof and neither Mr. Sheldon and the Leveraged Credit Team nor KKR undertakes to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers. KKR and its affiliates may have positions or engage in securities transactions that are not consistent with the information and views expressed in this material.

This material has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this material has been developed internally and/or obtained from sources believed to be reliable; however, neither KKR nor Mr. Sheldon and the Leveraged Credit Team guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.

There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.

The information in this material may contain projections or other forward‐looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this material, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. The indices do not include any expenses, fees or charges and are unmanaged and should not be considered investments.

The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely.

The information and opinions in this document have been prepared and approved for circulation by KKR Credit Advisors (Ireland), incorporating all its subsidiaries (“KKR Credit Advisors (Ireland)”).

KKR Credit Advisors (Ireland) is involved in investment management activities that may relate to companies or instruments mentioned in this document. These activities include, without limitation, trading in various financial instruments, fund management and investment advisory services. KKR Credit Advisors (Ireland) may trade in the instruments (or related derivatives) that are the subject of this document. KKR Credit Advisors (Ireland), or funds managed by it, may have a position in the debt of the businesses or instruments discussed in this document.

This presentation is furnished on a confidential basis exclusively to its intended recipient (the “Recipient”) and is not for redistribution or public use. The data and information presented are for informational purposes only. The information contained herein should be treated in a confidential manner and may not be transmitted, reproduced or used in whole or in part for any other purpose, nor may it be disclosed without the prior written consent of KKR Credit Advisors (Ireland). By accepting this material, the Recipient agrees not to distribute or provide this information to any other person. The opinions expressed in these materials represent the current, good faith views of the investment professionals of KKR Credit Advisors (Ireland), an affiliate of KKR Credit Advisors (US) LLC, (together “KKR Credit”) and are based on their broad investment knowledge, experience, research and analysis. The information herein has been developed internally and/or obtained from sources believed to be reliable; however, KKR Credit does not guarantee the accuracy, adequacy or completeness of such information. Market conditions, strategic approaches, return projections and other key factors upon which the views presented in these materials are based remain subject to fluctuation and change. Consequently, it should be noted that no one can accurately predict the future of the market with certainty or guarantee future investment performance.

This summary is not an offer to sell or a solicitation of an offer to purchase any securities of the KKR Opportunistic Credit Strategy (the “Strategy”) or any other product managed by KKR Credit. Any offer or solicitation with respect to the Strategy will only be made pursuant to the Strategy’s official offering documents, which qualify in their entirety the information set forth herein. In the United States, this presentation is being distributed by KKR Capital Markets LLC, a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of FINRA and SIPC. An investment in the Strategy will entail a high degree of risk and no assurance can be given that the Strategy’s investment objective will be achieved. The Strategy’s official offering documents must be read carefully in their entirety prior to Investing in the Strategy. The information herein (including any “forward-looking statements”) is subject to change, no assurance can be given that actual events or results will reflect any such information, neither KKR Credit make any representation or warranty, express or implied, with respect to such information, nor have any obligation to update such information.

Investment products implementing the Strategy are speculative Investments and are not suitable for all investors, nor do they represent a complete investment program. The Strategy is only suitable for qualified investors who are comfortable with the substantial risks associated with the Strategy’s investments. An investment in the Strategy includes the risks inherent in an investment in securities as well as specific risks associated with investing in illiquid investments, private companies, companies with little or no operating history; and highly leveraged companies, as well as the other risks described in the Strategy offering documents. There can be no assurance that the Strategy will be successful. This summary is not being distributed in jurisdictions where, and is not directed at persons to whom, such distribution or direction is unlawful-or not authorized.

No investment strategy can guarantee performance results. Past performance is no guarantee of future results. All investments are subject to investment risk, including loss of principal invested.

The target returns are based upon KKR Credit’s view of the potential returns for investments of the Strategy discussed herein, are not meant to predict the returns for any accounts managed by KKR Credit, and are subject to the following assumptions: KKR Credit considers a number of factors, including, for example, concentration risk and position sizing, and the use of leverage. Certain of the assumptions have been made for modeling purposes and are unlikely to be realized. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in achieving the returns have been stated or fully considered. Changes in the assumptions may have a material impact on the projected returns presented. All data is shown before fees, transactions costs and taxes and does not account for the effects of inflation. Management fees, transaction costs, and potential expenses are not considered and would reduce returns. Actual results experienced by clients may vary significantly from the hypothetical illustrations shown. Target Returns May Not Materialize.

KKR & Co. L.P. (together with its affiliates, “KKR”) has adopted internal information-sharing policies and procedures which address both (i) the handling of confidential information; and (ii) the internal information barrier that exists between the public and private sides of KKR. Both KKR Credit and KKR's fixed income, mezzanine, special situations and public equity professionals are on the public side of KKR; while KKR's private equity professionals and other affiliated business activities are on the private side of KKR. KKR has compliance functions to administer KKR's internal information-sharing policies and procedures and monitor potential conflicts of interest. Although the Strategy may leverage KKR's private side executives, KKR's internal information-sharing policies and procedures referenced above, as well as certain legal and contractual constraints, could significantly limit the Strategy’s ability to do so. Accordingly, as a result of such restrictions, the investment activities of KKR's other businesses may differ from, or be inconsistent with, the interests of and activities which are undertaken for an account managed consistent with the Strategy, and there can be no assurance that the any account will be able to fully leverage the resources and industry expertise of KKR's other businesses. Additionally, there may be circumstances in which one or more individuals associated with KKR will be precluded from providing services to an advisory account because of certain confidential information available to those individuals or to other parts of KKR or because of internal policies and procedures.

Risks of investing in the Strategy:

Potential loss of investment – No guarantee or representation is made that the investment program used by KKR will be successful. The Strategy represents a speculative investment and involves a high degree of risk. An investment in the Strategy should be discretionary capital set aside strictly for speculative purposes. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in the Strategy. An investment in the Strategy is not suitable for all investors. An investor could lose or a substantial portion of his/her/its investment. Only qualified eligible investors may invest in the Strategy. Because of the nature of the trading activities, the results of the Strategy’s operations may be volatile from month to month and from period to period. Accordingly, investors should understand that past performance is not indicative of future results.

Use of leverage – The Strategy may utilize leverage and may also invest in forward contracts, options, swaps and over-the-counter derivative instruments, among others. Like other leveraged investments, trading in these securities may result in losses in excess of the amount invested.

Fees and expenses – The Strategy may be subject to substantial charges for management, advisory and brokerage fees. It may be necessary for those pools that are subject to these charges to make substantial trading profits to avoid depletion or exhaustion of their assets. Please refer to the Strategy’s offering documents for a more complete description of risks and a comprehensive description of each expense to be charged the Strategy.

Reliance on key persons – The Strategy’s manager or advisor has total trading authority over the Strategy and may be subject to various conflicts of interest. The death, disability or departure of the manager or advisor may have a material effect on the Strategy.

Counterparty and bankruptcy risk – Although KKR will attempt to limit its transactions to counterparties which are established, well-capitalized and creditworthigh yield, the Strategy will be subject to the risk of the inability of counterparties to perform with respect to transactions, whether due to insolvency, bankruptcy or other causes, which could subject the Strategy to substantial losses.

Volatile markets – Market prices are difficult to predict and are influenced by many factors, including: changes in interest rates, weather conditions, government intervention and changes in national and international political and economic events.

Calculation of Net Performance. The performance shown is for the stated time period only; due to market volatility, each account’s performance may be different. Unless otherwise indicated, returns are shown net of management fees, trading costs, and other direct expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns shown assume the reinvestment of dividends and other income.

Calculation of Gross Performance. Where indicated, Strategy performance is gross of advisory fees and includes the reinvestment of distributions, if any. If the manager’s advisory fees were reflected, the performance shown would be lower. Actual fees are described in Part 2A of KKR Credit Advisors (US) LLC’s Form ADV and will vary depending on, among other things, the applicable fee schedule and account size. For example, if $100,000 were invested and experienced a 10% annual return compounded monthly for 10 years, its ending value, without giving effect to the deduction of advisory fees, would be $270,704 with annualized compounded return of 10.47%. If an advisory fee of 0.95% of the average market value of the account were deducted monthly for the 10-year period, the annualized compounded return would be 9.43% and the ending dollar value would be $246,355. In calculating this performance, KKR relies on information supplied by third-parties, which KKR believes to be reliable, but makes no representations or warranties as to their accuracy or completeness.

Year To Date (“YTD”) Returns Are Preliminary. YTD returns should be viewed as preliminary and used for informational purposes only. YTD returns have the potential to be adjusted until reviewed and finalized following year end and changes to yearly data would be made without any notification to institutional clients, prospects or consultants. The reader should not rely on this information for investment purposes.

Any indices referred to in this presentation are used for purposes of comparison to the performance of certain capital markets. The market index returns assume that on the day a portfolio investment is made, a high yield hypothetical investment in a matching amount is made in the given index. For each date on which either a portion or all of the portfolio investment is sold, a high yield hypothetical index multiple (factor) is calculated by comparing the change in index value between the two dates. The cost of the investment sold (or portion of cost sold) is multiplied by this factor, resulting in a high yield hypothetical index value. The return is calculated using these dates of investment and high yield hypothetical value(s) generated. The return figures for each index do not reflect the deduction of any taxes, expenses, transaction costs or advisory fees. Broad-based securities indices are unmanaged and are not subject to fees and expenses typically associated with the Strategy. It is not possible to invest directly in an unmanaged index. The performance of the indices represents unmanaged, passive buy-and-hold strategies, investment characteristics and risk/return profiles that differ materially from the Strategy, and an investment in the Strategy is not comparable to an investment in such index or in the securities that comprise the index. Further, the indices referred to herein are not used or selected by KKR Credit as an appropriate benchmark to compare relative to the performance of the Strategy, but rather they are included herein solely because they are well-known and widely-recognized indices that embody investments with materially less risk than an investment in the Strategy.

BofA Merrill Lynch US Treasury Index tracks government securities with maturities of 10 years.

The BofA Merrill Lynch US Corporate tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody's, S&P and Fitch) and an investment grade rated country of risk (based on an average of Moody's, S&P and Fitch foreign currency long term sovereign debt ratings). In addition, qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $250 million.

BofA Merrill Lynch US High Yield Index tracks the performance of below investment grade, but not in default, US dollar denominated corporate bonds publicly issued in the US domestic market, and includes issues with a credit rating of BBB or below, as rated by Moody’s and S&P.

JP Morgan EMBI Global Diversified Index tracks total returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities, Brady bonds, loans, and eurobonds.

The Barclays US Aggregate Bond Index is an unmanaged index composed of securities from the Barclays Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization.

In Australia, this presentation is being distributed by KKR Australia Pty Limited (A.C.N 126 516 336 A.F.S.L 336127) and is directed to wholesale clients only as defined by Corporations Act 2001. The distribution of the information in jurisdictions outside Australia may be restricted by law and persons into whose possession the information comes should inform themselves about, and observe, any such restrictions. Any failure to comply with these restrictions may constitute a violation of the laws of an applicable jurisdiction. Kohlberg Kravis Roberts & Co. L.P. (collectively with its affiliates, “KKR”) and its directors or employees advise that they and persons associated with them may have an interest in the financial products discussed and that they may receive brokerage, commissions, fees and other benefits and advantages, whether pecuniary or not and whether direct or indirect, in connection with the Funds and KKR Products.

Any fund or funds mentioned in this document have not been authorized by the Hong Kong Securities and Futures Commission for sale to the public and accordingly this document is intended only for use by persons who are “professional Investors” as defined in the Securities and Futures Ordinance (Cap. 571) of Hong Kong and any rules made under that Ordinance. This document and any information contained herein may not be used other than by the person to whom it is addressed and may not be reproduced in any form or transferred to any person in Hong Kong. This document does not constitute an offer for any fund and any subscription for a fund must be made pursuant to the fund offering document.

For investors being marketed by KKR MENA, this presentation is being made available by KKR MENA Limited on a confidential basis solely to professional clients (as defined by the Dubai Financial Services Authority) on a “one-on-one” basis for the purpose of providing certain information about KKR and certain investment funds and other investment vehicles and products managed by KKR. KKR MENA Limited is a Dubai International Financial Centre company which is regulated by the Dubai Financial Services Authority.

This presentation is only being distributed to and is only directed at (A) persons who are outside of the United Kingdom or (B) persons who are (i) investment professionals falling within both Article 14 of the Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2005 (the “CIS Promotion Order”) and Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Financial Promotions Order”), (ii) high net worth companies and other persons falling within both Article 22 of the CIS Promotion Order and Article 49 of the Financial Promotion Order, (iii) other persons who fall within an exemption both in the CIS Promotion Order and of the Financial Promotion Order or (iv) other persons to whom both an invitation or inducement to engage in investment activity (within the meaning of section 21 Financial Services and Markets Act 2000 (“FSMA”)) and an invitation or inducement to participate in a collective investment scheme (within the meaning of section 238 FSMA) can lawfully be communicated. The persons specified in (B)(i), (ii), (iii) and (iv) above are collectively referred to as “Relevant Persons”. Any person in the United Kingdom who is not a Relevant Person should not act or rely on this presentation or any of its contents.

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