Capital Four: Opportunities in the Nordics

The Nordic region provides a huge market for private debt investors, says Capital Four CEO Sandro Näf.

This article is sponsored by Capital Four

As winter approaches, Europe faces a grave economic crisis – but the Nordic region looks better placed to weather the storm than most of the continent. Sandro Näf, CEO of Capital Four, a Copenhagen-based fund manager, says that the structural resilience of the Nordic economies, combined with the maturity of the private equity market, makes the region ideally suited to private debt investment. With traditional sources of finance less willing to lend, Näf says that private debt is poised to expand its role, providing much-needed diversity in the supply of capital.

Why do the Nordics present an attractive environment for private debt lenders?

Sandro Näf
Sandro Näf

The Nordics have a rich tradition of private equity, dating back to the 1980s. The type of business model that requires relatively high amounts of debt to support concentrated ownership is well established in the region. The direct lending market has been evolving at a good pace, and it has a lot of potential to attract investors that have previously invested in private debt in the US or the broader European market.

On top of this, Nordic economies provide a very resilient economic environment. We saw that during the pandemic, when GDP contracted much less than in other parts of Europe. Scandinavian countries have low debt-to-GDP ratios, so there is more fiscal headroom.

These countries also tend to rely less on industries that are capex-intensive or cyclical, and the sectors where we like to deploy, such as healthcare, technology and business services, are very resilient. Then there are very strong legal protections for property rights and creditors’ rights – similar to the UK, and much better than countries such as France or Italy.

How is macroeconomic and geopolitical volatility affecting private debt lenders in the Nordics?

We are, of course, facing a global slowdown. That means we’re more selective and more conservative on leverage. The changes in pricing in the liquid market have a knock-on impact on the pricing of private debt deals, and the somewhat greater risk backdrop is reflected in the higher spreads in our deals.

The private equity sponsors understand that financing will become more expensive. Many sponsors say they will put less leverage in deals because the interest rate costs are higher and they don’t want to overburden the portfolio companies. But, partly because of interest rates increasing, multiples have come down somewhat. So, private equity sponsors can get the same IRRs on less levered companies because entry multiples are lower.

The Nordic economies are generally less vulnerable to the energy supply crisis because they produce energy domestically and are leaders in renewables. When it comes to labour imbalances, the region is in a better situation than the US because we have more surplus labour and a flexible workforce. Inflation has increased, but we think it is close to peaking. Interest rates are not going to explode, and it could be quite positive if they stabilise at a slightly higher but still relatively low level.

Are private debt lenders well positioned to take advantage of the reluctance of banks and other traditional sources of debt finance to lend in the current environment?

Yes. We have been very reliant on banks to supply capital or debt funding in Europe, and perhaps for a longer period in the Nordics. To rely on one source of funding puts companies in a difficult position – much like relying on one source of energy makes a country vulnerable. So, we should not have a narrative around banks versus the private debt market. We are not doing ‘shadow banking’ – we are enabling our economy to benefit from having richer sources of capital. Having alternative sources of funding for companies is fantastic for the economy.

A lower-middle-market company is not going to be able to access the public bond market or the leveraged loan market. It probably cannot access private debt provided by the biggest players. So, we think there is a particular opportunity for us to support these lower-middle-market companies, of around €10 million to €20 million EBITDA. That’s a very interesting sweet spot.

To what extent will demand for private debt come from private equity sponsors in the coming years?

There’s obviously a lot of dry powder in the private equity community and that will continue to be a driver for private debt. But we don’t invest in sponsored deals because we like sponsors. We like to do deals with sponsor-related transactions because of all the ingredients that come with it. The concentrated ownership model, where you have highly incentivised employees, very focused boards, investment horizons of four to five years, and heavy use of consultants, has been extremely successful.

But there is no reason why this model can only be applied by private equity. We could see that playbook being used even in family-owned businesses. We think that direct lending will spread more and more to non-sponsored transactions. Lenders will push down the things they like about the private equity market – good governance, strong business plans – to the owners of other businesses.

We can’t just hop onto all the sponsored deals because certain types of sponsors look for high volatility to maximise potential returns. That’s something we avoid. We look for companies with high cash conversion and lots of resilience to a recession. Our approach has remained consistent because no matter at what point in the cycle we invest, we have to make recession-proof investments.

How can private debt lenders integrate ESG considerations into their investment decisions?

It helps us that Nordic companies have been taking ESG very seriously for a long time. Our own approach is heavily influenced by our exposure to liquid bonds and loans; the approach we’ve developed in the liquid markets has filtered through to the private debt side.

We’ve developed a scorecard to assess our investments against ESG criteria. The single most important thing is our fiduciary duty – we believe a strong ESG profile is good business. So, we want to avoid having companies in our portfolio that operate in harmful industries and don’t address the problems. Scoring is just the start – it provides a basis for us to enter into dialogue with the borrowers. We find they are very open to that.

The challenging part is implementing Article 8 of the EU’s Sustainable Finance Disclosure Regulation in our private debt portfolio. We’ve spent a lot of time with regulators and legal advisers, and we’ve developed a solution where we price coupons in relation to KPIs on sustainability. We want companies to be aware of what we want and to collaborate with us. I think that works very well – our next fund will be Article 8 with relevant sustainability linked KPIs on the individual deals.