Private debt – Feature So where does this leave those with exposure to private debt?
PRIVATE DEBT: DIRECT RETURNS
Despite the risks and economic uncertainty, asset owners are bullish on private debt. Mona Dohle finds out why.
Rise of the shadow bankers Perhaps the most significant change in the global financial system following 2008’s crisis was the retreat of banks from private lending. This was to de-risk their balance sheets while new regulation forced them to hold more capital in reserve. Non-bank lenders were quick to step in and fill the void. But gone are the days when these lenders, colloquially known as shadow bankers, were considered niche. Indeed, by January this year, the non-bank financial interme- diation market was worth $50.9trn (£39.2trn), accounting for 13.6% of the world’s financial assets, according to the Finan- cial Stability Board, a watchdog.
This is the result of more players entering the market, with the number of private credit fund providers doubling in the past five years to more than 1,700, Prequin’s latest private debt report shows. Pension funds might not see themselves as part of the shadow banking sector, but by issuing private debt mandates they have become the biggest direct lender to private markets. Pub- lic and private sector pension funds issued 27% of all private debt mandates in 2017, compared to 12% by family offices and 10% by insurers. Meanwhile, private debt assets under man- agement have reached $812bn (£625.8bn) and could hit $1trn (£770.7bn) this year, according to Prequin.
If investors were pressed to point a finger to one of the riski- est parts of the financial markets, private debt is likely to be high on their list. Yet, paradoxically, institutional investors still seek exposure to the asset class. If anything, the recent Covid-induced market volatility appears to have increased their appetite for private debt. Examples include the $227bn (£175bn) California State Teachers Retire- ment System (Calstrs) and the $215bn (£165.8bn) New York State Common Retirement Fund, which are planning to increase their exposure to the asset class.
Closer to home, defined benefit (DB) pension schemes, such as the schemes sponsored by Centrica and Border to Coast, which manages £45bn, are also targeting private credit. But many investors fear that the semblance of business as usual across markets might just be the calm before the storm.
In doing so, they have fulfilled an important role of funding small and medium-sized businesses, many of which do not have the scale to issue public debt and would struggle to strike a deal with the retreating mainstream banks. This is also a trend that Rohit Kapur, pensions investment research manager at Centrica, has observed. “This is an asset class that over the past 10 years has grown, especially in Europe. “Bank disintermediation has been a big driver of this growth and that creates some interesting opportunities for investors.
“Borrowers, especially in the SME space, still need capital and banks stepping away has created this opportunity for private lenders,” he adds.
Silver bullet The trend towards private debt was further accelerated by a combination of two factors: low yields on public debt and a rise in mature defined benefit schemes across the developed world. Private credit offered itself as a silver bullet in that it helps to manage cash-flows, offers higher returns and pro- vides liquidity to small and medium-sized firms. Most defined benefit schemes in the UK are far from fully funded and with a growing number of retired members, sta- ble cash-flows have become a key concern. With yields in pub-
Issue 95 | August 2020 | portfolio institutional | 39
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