A magical bag: The private credit asset classes

Mary Poppins’ magical bag truly is a thing of wonder. From it she managed to pull a lamp, mirrors, a hat stand and, of course, that tape measure…

In a similar vein, although not “practically perfect in every way”, private debt markets provide almost endless variety – from asset class, sector and borrower through credit quality and jurisdiction to structural features such as lending format, covenants, security, maturity profile and currency.

Here, I consider some traits of the asset classes in which we, a private credit manager running various asset strategies, invest to construct resilient portfolios against the backdrop of dynamic markets.

The private credit toolkit

Our business invests across four principal private debt asset classes – corporate, infrastructure, real estate and alternatives:

1) Corporates

Financing to companies seeking non-public market borrowing. A well-established, sizeable investment universe spanning the gamut of industries (e.g., consumer non-cyclical, industrial, services, etc), housing associations, higher education institutions, utilities and financials. From the biggest multinationals to medium-sized enterprises.

• Maturities range from one to 50+ years
• Pricing tends to be linked to broader fixed income market trends
• Structural protections via covenants (depending on issuer type and quality)
• Coupons may be linked to inflation e.g., utilities

Examples: Mars, British Land, NFL, Bunzl, Halma, Bromford Housing, Anglian Water, Lidl*

2) Infrastructure

Debt financing for infrastructure assets across four sectors: transport (trains, tunnels, bridges), energy (wind farms, solar, energy storage), digital (data centres, fibre) and social (healthcare).

• Often ‘essential’ and can have natural inflation linkage
• Maturities range from three to 30+ years, often with amortising cashflow profiles in project form
• Lower historical default and higher recovery rates than comparable public corporate bonds

Examples: US toll road, London Gateway port, Thames Tideway Tunnel, Cross London Trains, Hornsea offshore wind*

3) Real estate

Lending secured against all manner of property sub-sector types (office, light industrial / logistics, retail, residential (incl. BTR / PRS), student accommodation, mixed use and alternative). Rental income supports interest payments with property providing security.

• Targets stable, income-driven returns, with a roughly five-year tenor (range three to 30 years)
• We focus on the senior portion of the capital structure
• Debt sized to an appropriate loan-to-value (LTV) and quality of tenant(s)

Examples: Ares student accommodation, London build-to-rent, Glasgow City Council mixed-used portfolio, Amazon HQ*

4) Alternatives

Alternative debt is distinct from the traditional loan and bond financing. Like alternative comedy it is defined more by what it isn't than by what it is! Any credit risk in a non-standard format could fit the definition – often bringing enhanced security, additional credit support or priority debt ranking.

• We focus across six strategic sectors: short-dated credit (trade finance, capital call facilities), derivative investments, asset-backed financing, financial risk, insurance- or guarantee-backed, and classic structured finance
• Can be anything from one month to 50 years
• In various cases super seniority to other creditors

Examples: ‘Blue’ bond (protecting marine life), repackaged water company loan (super senior status), short-dated fund financing, government department receivables financing

 Different asset classes provide varying ways to manage inflation (e.g., a borrower’s income profile or investment return structure) and there’s an increasing linkage to sustainable goals (a future blog!).

Managing markets

Asset classes rarely move in tandem. Consequently, we believe there is always likely to be investment opportunity somewhere. Although single-asset strategies can work well, multi-asset and multi-jurisdictional strategies can help investors traverse economic and market cycles, while continuing to deliver on fund needs.

The fact private markets are not ‘window’ markets also means financings continue throughout the year and through macro ‘events’, when other markets might be shut. When COVID hit, for example, corporate markets remained active. Real estate markets then gained huge momentum. Presently, infrastructure is modest-to-quiet, but the tidal wave of funding need could create a period of opportunity, in our view.

With great opportunity comes great diversification potential

Inevitably, I fell short in expounding all asset class virtues, but hopefully I’ve shown how investors can avoid putting all their eggs in one basket.

We believe private markets provide an incredibly flexible investment toolkit that we aim to use for clients’ benefit, in both single and multi-asset strategies.

Optionality allows us to take our foot off the gas if we see deterioration in opportunity e.g., credit quality, structural protections and/or pricing. Hence, managers can think in short-, medium- and longer-term horizons, and direct an acceptable amount of portfolio tilting at different times.

*For illustrative purposes only. Reference to this and any other security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. Such references do not constitute a recommendation to buy or sell any security.