Private Credit: There is another (asset class)

“You must unlearn what you have learned”, said a wise Yoda to Luke Skywalker in The Empire Strikes Back. The advice could not be more apt.

As the dust settles on what one can only describe as a volatile year for the debt capital markets, one in which inflation (amongst other things) has reset the ‘lower-for-longer’ rate environment, it strikes me that some refresher thoughts on the private credit (debt) markets are timely.

In this blog series I aim to do just that. First, I’ll be focusing on some fundamentals, to underline both the importance and potential benefits of private credit to the investment markets and portfolios alike.

Many references to private credit are directed at the low sub-investment grade private fund space, such as direct lending and leveraged debt strategies. Although strategies have existed for some time, their growth has been a phenomenon over recent years, as investors sought ‘higher yield’ in an historically low interest rate environment.

I think we need to define things a little better and acknowledge that there is a trillion dollar-plus higher quality market that has existed for decades – one that institutions globally, whether borrower or investor, know and love.

• By ‘private’, we refer to debt investments that are not typically listed on a public exchange
• By ‘higher quality’, we mean investment grade (AAA to BBB- equivalent ratings) and crossover (BB space) investments, typically in loan or note formats, which typically benefit from structural protections (e.g. covenants and/or security). The ‘market’ refers to various asset classes in which issuers raise finance on an unlisted basis

These are not homogenous markets, and cover everything from the very largest multinational and publicly-rated corporates, through to infrastructure assets backed by contracted cashflows, to prime real estate that benefits from long-term contracted tenancies, and alternative investments such as environmentally and socially-directed bonds.

The recent volatility in inflation and rates markets shone a light on liquidity, particularly for UK investors. One should remember that private investments are negotiated financings that offer an opportunity to structure cashflows (e.g. maturity, income profile) for the benefit of better liability matching – cashflow driven investment.

To my mind, they could form a core portion of an insurance- or pension-based portfolio if the portfolio objective allows, and they provide an opportunity to satisfy a core aim of many portfolios, namely, diversification by sector, borrower, structure and jurisdiction. It’s worth noting that the debt strategy can be more liquid than it is commonly given credit for, with a growing secondary market e.g. more than 10% of our portfolio assets are purchased on the secondary market.

Structural protections afford investors comfort around maintenance of an investment’s credit profile, and in a situation of performance deterioration, an ability to influence borrower actions and/or achieve payback. Over my two-plus decades in the market, I cannot underline how valuable these protections can be, with historically superior recovery relative to other asset classes.

Oh, and privates are typically priced at a premium to public comparable bonds! (I’m sure the return argument won’t go unnoticed).

It is also worth noting the rise of ESG in private credit. The seismic investments required to deliver various sustainable and other initiatives simply aren’t suitable for many other markets in our view, potentially due to borrowing size requirements and/or the more crafted nature of the repayment profile. It’s no coincidence that private markets are the main home of wind and solar, electric transportation, and building environmental retrofit to name but a few.

As the aforementioned Yoda once told Obi-Wan Kenobi, “there is another…” We believe there is indeed another asset class, one complementary to public investments, and offering investors a potential opportunity to diversify portfolios and gain access to credit across a vast array of borrower and issuer types at a premium to the returns of comparable public market opportunities.

Look out for future blogs on these key facets.