Private credit – Feature
“And we also continue to see attractive opportunities to finance, buy and build platforms in sectors ripe for consolidation, par- ticularly in Europe,” Caron says. Moreover, yields are attractive relative to the historical average, thanks to rising base rates. But Sun says: “The macro uncer- tainty means that investors are increasingly cautious and selec- tive, and rightly so in our view. For the time being we are main- taining our up-in-quality stance, favouring higher credit quality and defensive issuers.” Interestingly, the cherry picking by investors has led to grow- ing divergence between defensive issuers and weaker, more cyclical issuers that need to offer better terms to attract inter- est. “This is somewhat different to the public bond market where spread dispersion across sectors is low within invest- ment grade, with the exception of financials versus non-finan- cials,” Sun says.
Diversified and stable Jo Waldron goes further, saying that with interest rate rises and ongoing volatility defining the new normal, private credit should be seen as an attractive source of diversified, stable income and uncorrelated returns. “Recent dislocation and dispersion across credit markets pro- vide an attractive entry point for investors, especially as lenders need flexibility and are willing to compensate lenders for this, leading to increased yields on offer for essentially the same credit risk,” she says. Furthermore, private credit’s often floating rate nature embeds a level of inflation hedging in the return stream. “In the cur- rent environment it is able to offer real yield in comparison to traditional credit classes which struggle to generate real income returns above high single-digit inflation,” Waldron adds.
The attraction of private credit is therefore impressively wide ranging. “We now see a broader client base outside of purely institutional clients, such as wholesale and individual inves- tors, looking to these more flexible structures to access assets which were historically only available through closed-ended funds, as they seek stable, long-term diversified portfolios,” Waldron says. How, therefore, should pension funds respond? “Bearing in mind that portfolio managers always tend to be biased towards their own asset classes, I would comment that pension funds should have a good level of exposure to private credit,” Des- forges says. “And any that are under-exposed should be looking to increase their allocation.”
Defined contribution schemes could consider short-term alter- native finance for its flexibility as part of a portfolio as mem- bers approach retirement, Sun says. “The short-term nature of the underlying loans you can target, coupled with maturity diversification, means that cash could be returned to the inves- tor over a short period, with regular liquidity being generated,” she adds.
The illiquidity premium available to investors from private credit makes the asset class compelling for
pension funds. Linda Desforges, Border to Coast
Come on Rishi! Going forward, the asset class is expected to deliver a good real return after inflation – assuming Rishi Sunak’s ambition on inflation is successful – and here direct lending offers strong downside protection and low volatility. “The illiquidity premium available to investors from private credit makes the asset class compelling for pension funds,” Desforges says. Investor opportunities are, therefore, abound. “Riskier private credit strategies that offer credit solutions to companies that are facing distress are also offering good returns, but the lower risk part of the private credit spectrum perhaps offers the best risk-reward opportunity currently,” she adds. Not stopping there, Desforges also notes that asset-backed strategies are also attractive, albeit within commercial real estate debt their focus is on managers lending to the highest quality assets across the globe and have little exposure to office or retail. “Asset-backed strategies are also looking attractive, such as those focused on mortgage lending, SME lending, intellectual property, etc,” she says. Sun offers another insight given that interest rate rises have peaked. “As we approach the end of the hiking cycle, we believe duration looks more attractive and we will continue to seek opportunities to lock in long-term fixed-rate assets,” she says. “The refinancing pressured faced by real estate debt borrowers may also present a window for investors to step in and provide financing on attractive terms, and we prefer resilient sectors such as residential and industrials.”
This all adds up to private credit not just being talk, but an investment zeitgeist with substance.
Issue 126 | September 2023 | portfolio institutional | 23
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