Portfolio Insight – Secure income
ARE SECURE INCOME ASSETS BEING OVERLOOKED?
Stuart Hitchcock, head of portfolio management, private credit Amie Stow, senior investment specialist, private credit Samuel Jones, private credit fund manager
As activity in public credit markets has oscillated across our screens, private credit markets have been largely overlooked. In our view, this is an oversight for investors as we believe the attributes associated with private debt become more valuable during periods of uncertainty. We advocate that a portfolio of secure income assets – real estate debt, private (unlisted) cor- porate debt and infrastructure debt, collectively referred to as private credit – can deliver better downside protection, attrac- tive valuations and a depth of universe that is not available in the public market. We also outline where we see opportunities to generate a positive return and a positive outcome for society as the economy starts to heal from Covid-19.
Better downside protection Seniority in the capital structure, security and stringent cove- nants enables private credit to demonstrate higher recovery rates, on average, than public credit¹. With market uncertainty
For Professional Clients only.
due to the global pandemic we believe these features have grown more valuable to investors. For example, the majority of secure income assets are senior in the capital structure and the documentation ensures that we preserve that position, mean- ing that if the borrower falls into distress and even bankruptcy, we should have an advantageous position relative to other investors. Security can also be beneficial. For example, having tangible claims on physical assets, such as property, will typi- cally provide higher recovery values than debt secured against intangible assets. Covenants are obligations to maintain certain credit metrics or restrictions on incurring further debt and are designed to pro- tect end investors. As private investors, these enable us to engage and work with the borrower towards a positive outcome for our investors and themselves. Over the short term, we expect some borrowers to breach covenants prompting them to ask for an amendment or a waiver of the restrictions for a cer- tain length of time. The benefit of the private market in these situations is that we should be able to take earlier action without having to make it public knowledge, preventing other stake- holders getting involved and allowing us to maintain value. A study by the Society of Actuaries demonstrated that on aver- age, recoveries are twice as good1 for superscript private credit compared to rated public credit. Given the disruption to most
1) Society of Actuaries 2003-15 Credit Loss Experience Study: Private Placement Bonds. Recovery reported on an unadjusted basis 2) Bloomberg, sterling investment grade credit spreads. 11th May 2020. 3) Average value premium at purchase versus a basket of comparable bonds for all deals conducted by LGIM Real Assets 2015-2019. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
28 | portfolio institutional May 2020 | issue 93
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