XAI Floating Rate & Alternative Income Trust (XFLT) Earnings Call Transcript

Good morning and welcome. Thank you for joining us today. Today, we plan to address proposed changes to both XFLT and OCTIX that we believe will position the funds for potential improved performance and distributions over time and provide other potential shareholder benefits. These changes do require shareholders to vote. Your vote matters, so we appreciate you joining us today. I'm joined today by my colleague, Kim Flynn, who will discuss each fund's proposal for shareholders to consider. I'm also pleased to introduce Young Choi, who is the proposed portfolio manager from King Street for both of the funds. We are excited to be partnering with King Street as we work to improve the fund's performance going forward. Now for some brief housekeeping matters, I do want to note the following. Shareholders of record as of the record date for the funds' special meetings are expected to receive a proxy statement, notice of special meetings of shareholders and proxy card containing detailed information regarding King Street Sub-Advisor and the King Street Sub-Advisory Agreement. Shareholders are encouraged to read the proxy statement and accompanying materials carefully when they receive them. The proxy statement is available free of charge at SEC's website, www.sec.gov. The report is not a solicitation of any proxy. In order to keep this discussion focused on the matters related to the proxy statements and shareholder meetings, we are not able to take audience questions on this webinar. We want to have an open dialogue like our normally scheduled quarterly webinars, so we're planning another webinar with King Street on August 4, where we do plan to address audience questions. Please contact us by e-mail at info@xainvestments.com at any point if you'd like to speak with members of the XA Investments team. I'd like to begin and bring in my partner, Kim Flynn, to the conversation. Kim, shareholder proxy statements were recently sent by mail. Can you please give us a summary of the proposals and why the funds' Board elected to recommend the proposals to shareholders?

Sure, Kevin. Let's start with why the Board determined based on the factors described in the proxy, that a change in the sub-adviser to the funds was appropriate in seeking to improve performance. That change involves replacing Octagon Credit with Rockford Tower Asset Management LLC, which is a wholly-owned subsidiary of King Street Capital Management. Our independent Board has thoughtfully considered the proposal, and the Board has unanimously approved this change. The Board is recommending that shareholders also approve the change. Rockford Tower Asset Management will serve as investment sub-adviser for the funds. As we discuss proposals today, I want to note that any references to King Street include Rockford Tower Asset Management, which is a wholly-owned subsidiary of King Street, employing the same individuals, the same people, and namely, convention largely identifies the firm's credit and CLO investment business. King Street is a leading global alternative asset manager. They have over 30 years of history. And they manage over $30 billion in assets. Young Choi who we have with us here today on the webinar is a senior leader at King Street and has spent the last 20 years at the firm. Young will speak with you today about King Street and his colleagues and the team that he manages and what makes them prepared to take on the mandate and the portfolio management of these funds. When our fund Board made its decision, it considered, obviously, current market conditions in the economy and specifically in the credit market, but it also factored in a number of important considerations that shareholders should think about. One is each fund's core investment performance on an absolute basis and on a relative basis with respect to the benchmark of that fund. Also, we thought about performance relative to peers while these funds were being managed by Octagon Credit Investors. We also had the Board think about the expanded investment capabilities of King Street as compared to Octagon in making their decision. We mailed proxies to shareholders that outline what we believe will be significant positive changes to the funds that should be considered by shareholders. It's really important that we want to note all costs associated with these shareholder meetings, mailings and the efforts to seek shareholder approval and to seek shareholder vote will be borne by XA Investments and King Street, and importantly, not the funds and not shareholders. The funds are now seeking shareholder approval of the new sub-advisory agreement, and shareholders of the funds at the close of business on the record date, which is June 2, 2026, are entitled to vote at the special meeting. That special meeting is coming up July 30. Your vote is important. As Kevin mentioned, every vote counts. The fund Board has voted for these proposals. Glass Lewis, a leading independent governance and proxy analyst firm recommended a vote for the proposals. The XAI senior leadership team, our shareholders and the funds, and we will also vote for the proposals. We ask that you consider the information in the proxy and that you vote for the proposals as well.

Thank you, Kim. So investors in XFLT and OCTIX have experienced total return underperformance and erosion of NAV. Kim, can you speak to the performance of the funds and why management is now recommending a change to the sub-adviser?

So in the chart here, we show Octagon's historical performance in both XFLT and OCTIX. Let's talk about XFLT first. That fund has a long track record dating back to September of 2017, and the fund has meaningfully underperformed its benchmark in all time periods shown. And if you take a look specifically at the inception-to-date total return of 3.28 on NAV, that compares to the benchmark return of 5.19. Now the benchmark for XFLT is the Morningstar LSTA 100 Index and has been the benchmark for the fund since inception. And so this underperformance in several different time periods has led us to make the change or the proposed change here. Now OCTIX only has about 1.5 years track record. The fund still demonstrated underperformance and relative to its benchmark. Let's look at the inception to date annualized total returns. For the Class I, that represented 3.15%; for Class A, it represented 2.19%, relative to the benchmark, which is a blended benchmark selected by the portfolio managers at 5.40, resulting in significant negative relative return to the benchmark. If we can move to the next slide, this illustrates the NAV for the funds. And since inception, September of 2017, XFLT has seen a 54.4% decrease in the NAV over the reported period. Now some of this NAV erosion is realized losses. Some of it is unrealized losses due to marks down in the portfolio. And the Board considered NAV erosion in XFLT in deciding to take proactive measures in working to create a better experience for shareholders. We also wanted to share with you the same NAV analysis for OCTIX, while over a shorter period of time, from December 2024, and the NAV decline over this period was about 6.99% decrease in NAV. And OCTIX, this fund is focused on the CLO debt part of the market. And so this was a significant NAV decline that the Board also considered in their determinations.

So Kim, what is the timetable that shareholders should be aware of for the proposed changes?

Sure. So the upcoming special meetings will be held beginning at 10:00 a.m. on July 30 at the XA Investments office in Chicago. At that time, King Street will become the new sub-adviser of the funds and take over portfolio manager responsibilities on the 30th.

And what would you say are the main benefits that the Board believes the funds will receive via these proposed changes?

Sure. I mean, I think there's a number of different benefits, but I'll focus on what the Board considered. And we're really happy to talk about the potential positive benefits resulting from a change. Our XA Investment management team and the fund Board believes that King Street will benefit the fund in 3 main ways. First, it's a potential increase in distributions and a potential for improved performance over time. Second, King Street, their institutional quality investment management track record is significant, and King Street's rigorous research and credit analysis, tactical trading capabilities, adaptive approach so that they can tailor their management to meet each of the funds' investment objectives is what we thought was important in terms of improving the outcomes for shareholders.

So today, we plan to cover most of the key questions outlined in the proxy statements. We encourage you to review the proxy statements for more information. What I would like to do next is bring in Young Choi to the conversation. Young, thank you so much for joining us. Mr. Choi is a partner and the Global Head of Trading at King Street and the Portfolio Manager of Rockford Tower Management. He's based in New York and he's a member of the Management Committee, the Global Investment Committee, U.S. and European CLO Investment Committees, Risk Committee and the Pricing Committee. Prior to joining King Street in 2006, Mr. Choi worked at Citadel Investment Group as a credit analyst in the distressed high-yield group and was a portfolio manager of the firm's $2 billion U.S. leveraged loan and CLO portfolio. Prior to that, Mr. Choi consulted at Bain. He received his BA summa cum laude in Economics and B.S.E. in Electrical Engineering from Duke University. Young, thank you so much for joining us.

Well, thank you, Kevin. I'm very excited to be here today.

So we're happy to introduce you to the XFLT and OCTIX shareholders. We're looking forward to working closely in the years to come. Could you give us a brief introduction to King Street and your role specifically in the leadership at the firm?

Sure. So King Street is a global alternative asset management firm that was founded in 1995. We manage approximately $30 billion in AUM. And we invest opportunistically across both the public and the private markets in corporate credit, so investment grade, high yield, leveraged loans, structured credit and real estate. And across our $30 billion in AUM, we manage roughly $12 billion of CLO AUM across 20 U.S. CLOs as well as 9 European CLOs. However, we just printed our 10th European deal last month. And we also have one CBO transaction. We have approximately 270 employees with 99 on the investment professional side, with 8 offices globally. In terms of my role on the leadership team. So as mentioned previously, I joined King Street in 2006. So this is my 20th year at the firm. And while I started as a credit analyst, today, I am one of the firm's 7 partners and serve as a portfolio manager on our global CLO management platform, Rockford Tower, as well as our opportunistic credit strategy. I also serve on several investment committees, including the firm's Global Investment Committee, the Management Committee and our CLO committees as well as our risk and pricing committees.

Young, you mentioned Rockford Tower. Rockford Tower is a division of King Street. Can you describe your focus at Rockford Tower, please?

Sure. So I am the portfolio management -- portfolio manager for our CLO management business, Rockford Tower Capital Management. As mentioned earlier, Rockford Tower manages approximately $12 billion in CLO AUM. We launched Rockford Tower in 2017, given that King Street has a long history of investing in CLOs and structured credit, going back to 2008. In addition to investing in leveraged loans since the founding of our firm, so over 30 years of investing in leveraged loans. Now we like the idea of creating CLO equity exposure that we managed for our firm's flagship hedge funds and we've retained all of the equity in a number of our first outstanding U.S. and European CLO transactions. And as we have expanded the platform and built up our track record, we have been able to syndicate third-party equity in a number of our transactions going back to 2021. However, we also have the ability to opportunistically take exposure in the equity of our CLOs as we see opportunities in the market. As far as my focus at Rockford Tower, I am on the CLO Investment Committee for both our U.S. and our European platforms, where we are focused on credit selection. So proving and declining assets and assessing relative value opportunities across both the primary and secondary loan markets. From a portfolio management perspective, we strive to maintain active trading across our deals as we believe that there is always a trade that can be done that can improve the credit quality and the risk portfolio -- the risk of a portfolio, maintain or improve the portfolio ratings, maintain or improve the portfolio spread, and hopefully, maintain and build portfolio value over time. We'll likely cover this later on, but we think one of the benefits that we can bring to XFLT and OCTIX will be dynamically allocating within the funds' investment strategy. So between both the U.S. and European leveraged loan and CLO mezz and equity tranches as the opportunity set and relative value between the 2 markets evolve over time.

So let's drill down further on the funds themselves. Can you please describe your role specifically for both XFLT and for OCTIX?

Sure. So for XFLT and OCTIX, I will serve as the portfolio manager and will be supported by Terry Ing. And for the audience's benefit, I would like to provide some additional information on Terry. So Terry is a partner at King Street and the portfolio manager for Rockford Tower's long-only credit SMA platform and the Head of U.S. Research at King Street. And so while Terry joined King Street in 2024, he has been a portfolio manager and leveraged credit research and investor for over 20 years across a number of very well-respected firms, including KKR and PIMCO. So Terry also serves on the firm's Management Committee, the Conflicts Committee and Responsible Investment Committee. Now we believe that our firm has the potential to enhance return profile for both XFLT and OCTIX given a larger opportunity set to invest across both the U.S. and European markets up and down the capital structure. And two, as we look to apply rigorous research and credit analysis, tactical trading and an adaptive investment approach across these various markets.

Thank you. So everyone loves an origin story, Young. Could you please describe King Street's firm history, the unique aspects to your business? Maybe touch on the people and the ownership structure, the expertise, et cetera?

Right. While I provided some brief background earlier, given that everyone loves an origin story, I'll share some more details around the firm's history and unique aspects of our business. So as mentioned, King Street was founded in 1995, but it was founded in a windowless office in Midtown Manhattan with roughly $4 million of AUM. So relatively modest beginnings. But if you fast-forward the clock 31 years, King Street is now a global alternative asset management firm, managing $30 billion across a number of funds and strategies, from our flagship hedge fund, opportunistic credit strategies, our stressed/distressed focused global drawdown funds, real estate and then our Rockford Tower CLO management business. So the firm has remained 100% partner-owned since the firm's inception, and we've strived to maintain an alignment of interest with our investors as the firm's partners are one of the largest investors across the funds and strategies that we manage. We have 270 employees, 99 of which are on the investment side, with 8 offices globally from the U.S., Europe and Asia. We are highly research-intensive -- we are a highly research-intensive organization where we look to marry rigorous research with tactical trading and an active presence across the global capital markets. While many investors may think of King Street as a stressed and distressed investor across the firm's history and multiple cycles, we also invest opportunistically across both the public and private credit markets across all of corporate credit. So again, investment grade, high yield, leveraged loans, structured credit and real estate. And from an investment perspective, we are generally agnostic with regards to geography, sector and part of the company's capital structure. We are opportunistic in that we look to dynamically shift capital to find the best risk/reward investment across the global credit markets. We are also objective in that we evaluate every investment to determine if it is a good long investment, a good short investment or if we need to maintain price discipline and monitor instead of actively investing at that time. We're also -- we also look directionally, meaning in certain funds such as the firm's flagship funds, we have the ability to go both long and short. And so when you tie in a 30-plus year track record, a large global team that can invest opportunistically with expertise across the global credit markets, I think this is one of the most unique aspects of the firm.

King Street has offices in New York, London, Singapore, Tokyo and others. Can you describe for us the benefits of being a global firm?

Absolutely. I mean we think that being a global firm has been one of our competitive advantages over our history, particularly in light of some of the recent market environments that we've experienced. So if you think about how the markets have evolved over the past 20 years from a global perspective, we had the global financial crisis, which was primarily a U.S. phenomenon, but then quickly spilled over into global markets, followed by the European sovereign debt crisis, we had Brexit, we had COVID-19, then you had global inflationary pressures in a coordinated hiking cycle across the developed markets. In 2022, you had the liability-driven investment crisis in the U.K. You had Russia-Ukraine. You had Japan raising rates for the first time in nearly 3 decades. And now you have artificial intelligence and corresponding disruptions across several industries and sectors. And I'm sure I missed several global events in there, but the point is having a global footprint provides several distinct advantages. Specifically, the ability to leverage any underwriting and credit analysis done on certain sectors and names in one region to quickly react to opportunities that may come across the globe for various reasons. Example of this may be investing in companies disrupted by COVID-19. We were very active in the U.S. and then applying this to certain sectors and companies within Europe, whether it was in the leisure space, the rental car space or cruise -- the cruise space, being able to quickly deploy capital into other areas. Another phenomenon where this has been particularly relevant has been within the leveraged loan space, given the prevalence of weak loan documentation and liability management exercises and distressed debt exchanges. What initially started out and has been largely isolated to the U.S. leveraged loan market started to make its way across the Atlantic to the European markets in 2023. And that institutional knowledge of how this has evolved in the U.S., we believe, has positioned us well for future restructurings and LMEs within the European space. And so our global research and investment team are in regular dialogue and communication to ensure that we are coordinated on these types of opportunities. And having that type of scale and reach is certainly a benefit of being a global firm.

That's great. So Young, can you please describe some of the different areas of the credit market that you do invest in at the firm?

Sure. And we covered some of this earlier, but to go into greater detail, we operate across the global credit markets, both public and private, generally with an opportunistic investment approach as the market opportunity set evolves. And we have -- we may invest in investment-grade, high-yield leveraged loans, structured credit from CLO tranches, ABS and CMBS and real estate, with a global focus. Specifically within CLOs, we have been a third-party CLO tranche investor since 2008, with an opportunistic focus from senior mezz and equity in both the U.S. and the European markets. Given the firm's funds and strategy return profile, in general, this has led us to invest in CLO mezz and equity. However, there have been times we've been opportunistic in purchasing senior tranches as well. And this will include the 2008 GFC, the U.K. LDI in 2022, and in the fourth quarter of '22 to the second quarter of '23 when CLO AAAs for instance were trading north of 200 basis points.