Beyond Britain

Most parts of the UK private debt market have not yet been badly hit by Brexit, but caution about its prospects may encourage the creation of more rounded portfolios.

Nicholls: smaller companies, better security

Amid the polarised “leave” and “remain” positions, the rather more nuanced perspective that Brexit might turn out to be a blessing in disguise is rarely made. But for limited partners keen on European private debt, but wary of being overly concentrated in the dominant UK market, Brexit may offer an opportunity to branch out.

“We’ve urged our clients to develop a globally diversified portfolio of private credit, which recognises that the UK is just one part of the global piece,” says Sanjay Mistry, director of private debt and private equity fund of funds at Mercer Investment Consulting.

“We’ve seen GPs taking a more cautious look at the UK due to Brexit risk,” he adds. “In some cases, it means that deals that might have happened are not being undertaken.” However, he goes onto say that he does not think Brexit has caused a “material issue” as yet and the UK is still likely to be a large part of any portfolio.

Indeed, Mistry’s view chimes with the majority. Few see any signs that Brexit is about to cause a serious decline in the UK private debt market. But, on the other hand, a healthy dose of caution might encourage investors to allocate a larger slice of their allocation to up-and-coming European private debt markets taking advantage of improving economic prospects in the Eurozone.

Recent data from Deloitte’s Alternative Lender Deal Tracker showed deal activity bearing up remarkably well in the UK but also made clear that smaller markets such as Spain and the Netherlands were showing significantly higher levels of activity than previously while private debt is also becoming increasingly accepted in the potentially
large markets of France and Germany.

Signs of distress

It may also be that Brexit will have the effect of producing a sharper strategic focus from managers. Given the political volatility and its possible knock-on effects, there will be close examination of which approaches appear best-placed. Following well-publicised woes at retail businesses such as Toys ‘R Us and Maplin, is it time for distressed investors to get excited?

“There have been steps towards distress in certain sectors exposed to the consumer,” acknowledges Mistry, “and there are certainly issues which could generate opportunities for those prepared to take the risk. But there has not been a material move in that direction so far and with interest rates where they are, there’s a bit of a buffer.”

At RM Funds, the firm’s investment trust RMDL – which listed on the UK stock market in December 2016 – recently announced a new fundraise of around £40 million due to what it sees as a £150 million pipeline of opportunity at the lower end of the mid-market and higher end of the SME spectrum.

“We decided to attack a different part of the market from the upper mid-market corporates,” says Pietro Nicholls, principal – investment management at RM Funds. “These are businesses of a good size but they are somewhat domestically focused, not global. It’s an area unloved by institutions as ticket sizes are only around £10 million and, for them, it takes up too much time and resource.”

One advantage of this part of the market, according to Nicholls, is that “investor protections are much better than you’ll find in the leveraged loan space. We actually have financial covenants in our deals, which is something of a rarity post-2012”.

Nicholls’ colleague James Robson, chief investment officer at RM Funds, says the firm targets the type of businesses which offer good security. “We look to isolate security where we can – property and equipment but also more intangible things such as cash flows,” he says.

Adds Robson: “We have all seen the negative headlines around certain restaurant chains and high street retailers and we don’t find those areas attractive. We want good asset coverage and visible cash flows in areas like healthcare and energy. They offer a level of immunity against downturns because people still need medicine and power supplies.”

Solid foundations

One area still attracting a lot of interest is real estate debt, due partly to a continuing investor thirst for yield, but also as preference increasingly switches from higher-risk equity to the downside protection offered by lending.

Lockhart: shift to affordable residential market

Rod Lockhart, managing director of property investment specialist LendInvest Capital, is sanguine about market conditions. “Our personal perspective is that there is not much of a Brexit impact,” he says, “partly because there is more capital coming in from other parts of the world. But would we have raised more capital in the absence of Brexit? My instinct would be yes, but it hasn’t stopped us from doing what we want to do.”

There has, however, been an increasing polarisation between the prime and affordable ends of the market. “The prime market continues to be under pressure, which has been the reality ever since stamp duty was increased,” says Lockhart. Indeed, he says the difficulties in the prime market have now spread out nationally from their London roots.

By contrast, “the strongest liquidity and most deals are at the lower end of the private market assisted by Help to Buy, the government scheme to assist first-time buyers. That area has seen good demand and more recently we have been funding more affordable schemes.”

But while there are few signs of Brexit – or any other political dramas – having a major impact on most of the UK private debt market, there is a corner of the universe where those involved are seeking to draw attention to a major problem. “In the micro-business space, you find a contraction of lending, which is contrary to all other parts of the lending market,” Christoph Rieche, chief executive officer and co-founder of fintech lending platform Iwoca, told PDI.

“I think the problem has got worse [since Iwoca was founded in 2011] and that’s despite a lot of government initiatives,” says Rieche. Targeting businesses with turnover of less than €2 million, Rieche has become acquainted with a part of the market where retreating bank finance has not yet been effectively replaced by anything else. “There is a huge opportunity for us to grow, but it’s troubling to see our customer base not being served better,” he says.

As noted in PDI and elsewhere, the rise of fintech lending has been a notable evolution in the private debt arena in recent years. However, it still has a long way to go to compensate for the loss of many small businesses’ traditional banking relationships. Without the finance to grow effectively, the UK economy’s ‘growth engine’ may be in danger of stalling. Long term, that could be a much bigger disaster than the short-term perambulations around Brexit.

UK-focused private debt fundraising
Capital raised ($bn) Number of funds closed
2012 1.42 5
2013 5.45 10
2014 4.03 11
2015 3.25 7
2016 3.29 6
2017 2.83 5
YTD 2018 1.03 2
Total 21.30 46

Source: PDI