Fund managers which hold on to capital for too long and huge asset-liability mismatches are among the factors which prompt the UK’s Blu Family Office to proceed with caution. However, it has found that shorter-duration strategies have much to recommend them – and is now also considering longer-duration and high-risk strategies such as distressed. The firm’s Tom Tardif answered our questions below.
When it comes to the outlook for the private debt market, would you describe yourself as an optimist or a pessimist – and why?
Generally, we are optimistic but there are some good reasons to be pessimistic too. As such, we continue to invest in the private debt market but with considerable caution. Currently, we invest in short-duration private lending funds, e.g. trade finance or real estate-backed lending. These strategies performed very consistently through the financial crisis but over time the yields have come down – most notably in 2017 and 2018. Despite this, the yield is still far more attractive versus the public debt markets and, as a result, we believe this is the best value ‘fixed income’ we can get.
Consequently, but pessimistically speaking, these attractive returns have resulted in a lot of investors wanting exposure to the asset class, particularly institutional money. Some lending funds have grown so rapidly in AUM that they can’t lend it all. As such, we try to avoid greedy fund managers who take in money they can’t deploy, as we certainly don’t want to pay a management fee to a fund holding a significant amount of cash. On the other hand, we don’t want a fund to relax their lending standards in order to have a low cash utilisation rate. Therefore, it’s important to do thorough due diligence on a strategy prior to investing and to monitor it regularly post investing.
What do you see as the biggest challenges facing private debt at the current time?
Anything that grows rapidly, like the private debt market, will experience a lot of big challenges. As I mentioned above, we invest in short-duration private lending strategies which are often structured as open-ended funds. One of the biggest challenges with an open-ended fund is the redemption terms. A lot of the funds we see offer their investors great liquidity yet originate long-duration loans. For example, one fund we reviewed offered investors monthly liquidity but extended loans with tenors of up to four years. That’s a huge ‘asset-liability mismatch’, and a fund won’t be able to provide the liquidity it has promised investors in an event where a large proportion of them want their money back at the same time.
Sadly, the funds offering this false liquidity are popular with investors. We do not invest in these funds and, unfortunately, that limits our universe of funds considerably. It also means we have to spend significant time educating our clients about the differences between private and public debt liquidity. However, we take comfort in investing in funds with no ‘asset-liability mismatch’, meaning if our clients wanted to liquidate their entire holdings, we could do this in line with the redemption terms.
Following from the previous question, which areas of the market are you most comfortable having exposure to – and which areas might be the wrong ones in today’s climate?
As investors, we are relatively agnostic to which areas of the market we have exposure to. We would like to achieve a diversified portfolio of private debt strategies, in terms of geography and type of collateral we lend against. We use private debt to provide our clients with an alternative source of fixed income, so we are not looking to invest in high-risk lending opportunities. We typically choose fund managers that lend using developed country currencies and use English-based law for the basis of their legal loan contracts, in order to mitigate local jurisdictional and political risks. With regards to which areas might be the wrong ones in today’s climate, we have decided to reduce our exposure to Latam lending opportunities, as we feel that the returns offer poor value relative to the risks being taken (i.e. there is little in the way of premium for lending into this ‘developing’ region).
How is your approach shaped by being a family office? Do you think we can expect more family office involvement in private debt as time goes on?
Our (current) approach to investing in private debt is on the low risk side, in order to achieve a reliable and consistent fixed income for our clients. This approach came about as a result of our clients commenting on the near zero interest rates the public markets were achieving. So, when we were introduced to short-duration private debt, we were very impressed. Consequently, in 2016, we launched our Blu Income Fund, that invests in private debt strategies, providing our clients (and outside investors) with diversified exposure to the asset class and a fixed income yielding 5-6 percent.
As a family office, we are investing both for the long term and on behalf of families with children through to great grandparents. As such, each family member has a different risk preference when it comes to investing. Our first step with private debt was investing in short-duration opportunities and to use the asset class to achieve a low-risk fixed income. However, now we are looking into what private debt can offer us in terms of longer duration and higher risk, such as distressed. We certainly expect more family office involvement in private debt as time goes on – in fact, it already has a huge following as, unlike other investors that are obsessed over liquidity and the likes of UCITS structures, family offices are investing for the long term and can lock up (some of) their wealth for a long time.
Tom Tardif is an associate at Blu Family Office, a family asset manager based in Richmond, London