Safe and steady may not suffice as inflation bites

At a Private Debt Investor event, a family office shared its experiences of pursuing private equity-like returns from a private debt strategy.

It may have come as something of a shock to a German audience: an LP discussing the prospect of private equity-like returns from private debt. After all, the German investor community has largely migrated to the asset class from fixed income rather than private equity and has typically sought refuge in safer, lower returning areas such as infrastructure debt.

But, at our PDI Debt Week in Munich last week, Evgeny Denisenko, managing principal at Apolis, the Monaco-based family office and regular co-investor in deals, made the point that safe may equate to sorry in today’s environment. He said that, with inflation currently topping 5 percent in the US, senior secured asset-backed loans delivering returns of typically between 5 to 7 percent will barely break even.

As with other LPs – and GPs for that matter – Apolis is finding that some of the sectors that have performed well during the pandemic are also high growth in nature. Thus, private debt – not up to now seen as the sexiest of asset classes – finds itself dabbling in territory more familiar to venture capitalists. With technology-related businesses increasingly on the radar, Denisenko referred to a 55 percent internal rate of return that Apolis had witnessed on an e-commerce deal it was involved with.

How can these sorts of returns be achieved, came a question from an audience member whose interest was unsurprisingly piqued? One answer was fairly prosaic and simply involves introducing some preferred equity to the mix, even if the latter is only around 10 or 15 percent of the total financing. A racier option may be to take a gamble on some future event, such as a refinancing or M&A transaction “which if it kicks in can give you an outsized return”.

Apolis said it had not had defaults in its portfolio but did admit to a couple of difficult situations, one where another lender was identified to refinance the deal and another where an equity raise gave the borrower more breathing room. “So, there is some risk, but it’s not unresolvable,” said Apolis’ Ilya Gertsberg, managing director and chief investment officer.

Exactly what the audience made of this went unrecorded, but the discussion certainly provided food for thought around the topic of LP risk appetite.

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