Senior debt seems to be accounting for a greater share of fundraising. What accounts for this?
The returns in traditional fixed-income have become unacceptably low for many institutional investors. The risk profile of senior private debt in high-quality businesses is not dramatically different to that in traditional corporate credit fixed-income securities. As a result, investors are increasing their allocations to senior private credit.
Historically, these investments mainly came from alternative investment buckets. However, the landscape is changing, with many institutional investors now also allocating from their fixed-income buckets, thereby providing an influx of additional capital.
Is there a danger that LPs sometimes invest in what they think is senior debt, but actually isn’t?
Not all senior debt is created equal. Although it in theory provides investors with a higher level of comfort due to its perceived priority position in the capital structure, the important issue is whether the underlying company is high-quality and whether the risk-adjusted returns are appropriate. Manager selection is critical, given the disparity in performance. LPs should look for managers that have a disciplined and cycle-tested approach to investing combined with demonstrably strong credit-picking skills.
What kind of return is it reasonable to expect?
There are a variety of strategies. For larger, more liquid senior private credit, the target returns are 5-6 percent net on an unlevered basis and 8-10 percent for levered fund structures. For mid-market direct lending, investors should expect unlevered fund returns of around 7 percent net.
Could you describe today’s deal-doing environment, in terms of deal terms and level of competition?
Due to the health of our portfolio, we were front-footed during the crisis when there was reduced competition for deals, which allowed for better returns and documentation. There were fewer deals, but they were attractively priced and structured. Following monetary and fiscal stimulus, markets have returned to pre-crisis levels in terms of returns and pricing. However, documentation and structures remain stronger and deal activity has picked up. There is more competition, but far more deals to choose from as well.
What are the key lessons from the pandemic?
One of the key lessons is the importance of fundamental credit-picking skills. At Park Square we focus on high-quality, stable and predictable businesses in defensive sectors we know well. Having an experienced team with workout experience has also been a differentiating factor over the past 12 months, as nearly every credit manager has had to deal with issues in their portfolio. Those managers with experience from prior crises can better assess and put in place the necessary measures that will help ensure strong fund performance.
Robin Doumar is founder and managing partner of Park Square Capital, a London-based fund manager