Safety first

As investor allocations increasingly come from fixed income pools, YIELCO thinks providing yield will become a bigger focus for funds.

Munich-based YIELCO Investments was founded in 2011 as an alternative assets specialist, aiming to connect German institutional investors with opportunities in special situations, private debt and infrastructure investment.

The firm focuses on achieving an attractive total return for investors over time, including through generating yield as well as IRR in its private debt investments.unich-based YIELCO Investments was founded in 2011 as an alternative assets specialist, aiming to connect German institutional investors with opportunities in special situations, private debt and infrastructure investment.

Matthias Unser sits on YIELCO’s executive board and has held senior management positions at a number of European fund-of-funds managers, including DB Private Equity, Sal Oppenheim Private Equity Partners and VCM Capital Management. At each organisation he focused on private debt investments covering mezzanine, distressed debt, credit opportunities and infrastructure.

Speaking to PDI, Unser says the focus on yield has been an important change in investor attitudes in recent years.

“In the past few years we’ve seen a change in the way investors allocate to private debt. They used to access the asset class by re-allocating some of their private equity investments into debt funds, but increasingly they are instead switching their fixed income allocation into private debt strategies,” he explains.

Following this change of allocation sources, limited partners are now looking at yield generation, rather than IRR, as the main goal of their private debt allocation in an attempt to give it some of the characteristics of their other fixed income commitments.

CHANGING RATIONALE

These different allocation sources have resulted in a fundamental change in investor rationale, according to Unser, and the demand for yield changes the types of strategies LPs are looking for. High-risk, high-return strategies with a late-investment payoff are out of vogue in favour of safer and more dependable investments that can regularly return money to investors.

“The primary focus now is on senior lending strategies and some unitranche, while subordinated debt is now less acceptable and pure mezzanine is a much harder sell,” Unser says.

To service yield investors, YIELCO will typically look at slightly lower overall net IRR in the range of 6-7 percent. However, investors want 5-6 percent of this delivered as yield, with only the remaining 1 percent in IRR.

PDI fundraising data also point to the increasing role of senior debt strategies across the private debt asset class. The number of senior debt funds raised has been rising since the global financial crisis, with 57 such funds closed in 2017, compared with nine in 2009.

The amount of capital raised has also boomed, with $62.4 billion raised for senior debt strategies globally last year, well above the $42.3 billion of junior debt capital accumulated. While junior debt has also bounced back from the global financial crisis, senior debt has overtaken it.

Unser believes fixed income allocations will continue to provide capital for private debt, and says: “It is hard to see a reason for this preference for yield changing any time soon as fixed income allocations to private debt are likely to keep growing, and this will increase demand for more senior debt strategies.”

But as the credit cycle changes, Unser expects there will be some strategic reallocation of fixed income portfolios to try and adapt.

“When investors think the market is over-priced and over-leveraged, and we start to see leverage of 4-4.5x, then there will be a shift back towards the subordinated debt strategies, as concerns about higher risk will be mitigated by the need to seek diverse returns.”