One of the overriding conclusions from Capital Structure 2014, PDI’s second annual conference in London, is that LPs are increasingly interested in private debt and what it can provide in terms of yield or “enhanced returns.”
Relative to the public fixed-income markets private debt is “an attractive opportunity” offering good risk adjusted returns. John Bohill, senior advisor at LP advisor StepStone Global, said on an investor panel discussion that he was “compelled” to present this option for investment to LPs.
LPs have been cautious about the private debt asset class, particularly in Europe, after capital was committed to distressed and mezzanine funds in the wake of the global financial crisis in expectation of an abundance of opportunities, he said. The expected capital deployment and returns hadn’t borne fruit as that ‘distressed’ opportunity never really materialised in Europe.
And according to Mathieu Chabran, co-founder of private investment group Tikehau Capital, in a discussion on the opportunities, the ‘distressed’ ship has sailed. Banks did sell some assets but he didn’t see them selling very many more apart from perhaps some of their operating companies. The way now, he said, was to work with banks to source opportunities.
Direct lending to corporates, or lending which bypasses private equity-led companies or sponsors in his view, is where the current opportunity set is. It’s where enhanced returns in the corporate lending market reside. This opportunity was also highlighted by a banker during a discussion at the end of the conference.
Paul Shea, partner at mezz lender Beechbrook, emphasised how little competition there was in the lower mid-market. Opportunity to invest in sound businesses in that pocket was one of the positives which existed in the market today. Above loan sizes of $10 million, there is much more competition and this could be an area to watch in terms of a deterioration in lending standards if past practice has been anything to go by. Too much capital, as is said to pervade in the world of private equity, is resulting in pricing bubbles in certain sectors, PDI understands. LPs expressed concern about pricing in general with one saying that “everything is really expensive” and another saying that now is the time to sell if you have a good asset.
That isn’t a concern for the private debt world yet, one industry expert has said in a discussion since the conference. 97 percent of corporates in Europe are non-sponsored representing a big opportunity for investment and those companies which do not want to dilute equity yet. It is an opportunity drawing the attention of investors from all over the world, he said, particularly the US. Origination will be key and local networks across Europe.
The corporate market has been underserved by the banking community because it has been restricted from making the type of loans fund managers can – in the region of five to seven years long. Regulation is one of the barriers, and one which the alternative lending community doesn’t have to contend with as much. Banks are publicly listed entities, surviving on much more liquid and short-term capital. Fund managers and the institutional investors they get their capital from like pension funds, and the longer duration of their investment, are much more suited to make the financing needs of smaller companies for this reason, he said.
Also up for discussion during the two day event were the opportunities available in real estate and infrastructure. John Atkin, director of fixed income at M&G Investments, the asset manager of insurer Prudential, said that it depends on the asset and in particular the cash flows it generates when he decides whether to invest via debt or equity. It further highlighted the flexible approach many managers are taking in the way they approach investing.
Deborah Zurkow, managing director head of infrastructure debt at Allianz Global Investors, renamed the ‘illiquidity premium’ the ‘complexity premium,’ when describing the amount of work that needs to go into assessing an asset in private infrastructure debt investing. However, the long-duration nature of the asset certainly matches what a lot of institutional investors are looking for.
It’s just getting the head around that ‘illiquid’ bit.
According to many, LPs are increasingly looking to allocate to private debt from their fixed income bucket. One question raised was in times of crisis, is a fixed-income instrument always that liquid anyway?
Peter Schwanitz, managing director at Portfolio Advisors, had some suggestions for improvement. He called for more transparency in reporting by managers in a way which could help develop a private debt benchmarking database. And he suggested that more liquid debt structures, such as the Business Development Companies which operate in the US, would be a much needed boost for institutional investment in Europe. He said the key to cracking it was the “fixed-income” barrier. “[Investors] would like to see more rated products. A BDC would be great here in Europe and could enable smaller institutional investors to invest as well.”
Craig Snider, head of risk and due diligence at Crowd2Fund, online lending platform and described how it makes all deal terms available for investors to see, underlining the plethora of data that could be at this industry’s fingertips, which is no doubt useful when making investment decisions, in terms of due diligence and risk.
Peer-to-peer lending is an area that is generating a lot of interest in terms of its potential and the seemingly passive approach to investing it takes relative to other credit intensive approaches in the industry, according to James Newsome, managing partner at Arbour Partners and conference chairman. It’s certainly an area that PDI will continue to watch with interest.