Institutional investors are not short of options these days. In addition to a greater choice of managers, strategies and fund vehicles, many are finding lower-cost options to traditional investment products.
Fees on actively managed offerings have been trending downwards and investors looking for low-cost access to equities can do so via exchange-traded funds. Even hedge fund strategies, today often bemoaned for high fees and uninspiring returns, can be accessed in cheaper vehicles under the moniker of liquid alts, for which liquidity is held up as a bonus – a feature granting greater flexibility to investors.
So, is it likely private debt funds will eventually have to face cheaper, more liquid products able to attract investors with lower fees and added flexibility? And would investors opt for them?
Private debt funds and alternative credit strategies might both be seen as ways to counter a floundering bond market, but their return profiles make them unlikely to be chasing the same money.
Both “private debt” and “alternative credit” are catch-all, far-reaching terms. A comparison of performance should always come with the proviso that one fund’s composition can be distinct from the next.
Still, private debt as an asset class has return characteristics that should be more stable and smoother than opportunistic fund products looking outside of long-only allocations to publicly traded bonds.
A report this week from bFinance put the internal rate of return for European senior secured private debt products at an average of 6 percent. At the other end of the spectrum, the average IRR for junior debt funds, according to the study, is approximately 15 percent.
Depending on when an LP makes its commitment to a private debt vehicle, it should experience relatively consistent levels of income and returns. The returns of some liquid alternative debt strategies are more volatile.
Take long/short credit – a strategy investors can find outside of hedge fund and private fund wrappers and in more liquid fund vehicles. According to figures from Morningstar, European liquid offerings following the strategy have returned 6.09 percent, 1.39 percent, 0.79 percent, -1.14 percent and 2.30 percent for the years 2012 to 2016, respectively.
That equates to an average return of approximately 1.86 percent over the whole period – clearly ranking behind the expected returns even in the lower-risk portion of private debt.
As long as managers find investors with liabilities matching the return and liquidity profile of their funds, then the risk of such investors turning their attention to liquid alternative credit strategies at the expense of private credit appears limited, assuming these managers deliver more or less to expectation.