Portfolio Insight – Secure income
company’s business models as a result of Covid-19, structural protections should provide investors an additional layer of comfort relative to publicly-traded debt securities and are like- ly to be more valuable during such periods of uncertainty.
Attractive valuations At the time of writing, investment grade public credit spreads are roughly 70bps² wider since the start of the year. As a result of data limitations in private credit, the re-pricing is not as transparent and will vary considerably by sector and underly- ing asset quality. What we believe will hold true is the roughly 55bps³ long-run average premium that private credit com- mands over public credit. This premium is not static and can range anywhere from 30bps to 120bps depending on the fea- tures of the transaction as well as the market environment. Typically, this premium is associated with the illiquidity of the asset class and the corresponding lack of transparency. However, as we have seen in recent weeks, liquidity has been challenging for public credit and has not always been there when investors have needed it. We argue that, over the life of the asset, the premium also reflects the value added by the structural protections as discussed above. As a result, when pricing a private security, we take a public credit spread, add an illiquidity premium and adjust for the lower expected loss given default, or add a ‘structural premium’. In our view, rates will remain ‘lower for longer’ over the medium term as the global economy recovers from Covid-19, which should cause investors to continue to favour income producing assets. While we expect the private and public mar- kets to move in the same direction, we will be looking to take advantage of any dislocations in long-run premium to selec- tively increase exposure in this asset class.
Depth of universe
While the US private and public credit markets have been very active over the past couple of months, hitting record bond issu- ance, the UK market has been more muted. We expect it to fol- low suit once some market confidence returns and this will mean that there are substantial financing needs in the private markets, especially as banks may not be as willing or able to
lend. For example, in private corporate debt, we have already received calls from large public companies that would not tra- ditionally issue in the private space. In our view, this gives investors an opportunity to increase diversification in their portfolios, taking advantage of the breadth of private sectors versus publics. In addition, we believe investors will be able to access scarce high-quality assets such as higher education institutions, which are likely to issue debt in the short to medium term. Looking further ahead, we also expect opportunities in BB-rated credits. Here, struc- tural protections may provide a safer entry point into credits where fundamentals are weaker. Greater access to manage- ment means we are often better able to diligence the recovery plan the borrowing entity is seeking to put in place and create value for our clients as a result.
Opportunities post Covid-19 Private (unlisted) corporate debt
Private markets remain open, offering funding without the same execution risk that can exist in public markets. Our focus will remain on companies which we believe have a defensive business model, robust capital structure and access to suffi- cient liquidity to see them through short term disruption. We expect opportunities from utilities, housing associations and higher education institutions. Infrastructure debt Transport has been in the spotlight as rating agencies have been quick to react (for example, airports) due to the significant impact on passenger movements. More broadly, most opera- tional assets have strong liquidity positions, particularly those providing essential services to the economy. We expect oppor- tunities from renewables (wind and solar) and digital (fibre and data centres). Real estate debt Due to Covid-19 large transactions have either been pulled or suspended dampening the debt pipeline. Retail and leisure will see opportunities in the distressed space, but this is not an area of focus for us. In our view, opportunities will be greatest in industrials (distribution and logistics), offices in core locations and the private rented sector.
Past performance is no guarantee of future results. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. The Information in this document (a) is for in- formation purposes only and we are not soliciting any action based on it, and (b) is not a recommendation to buy or sell securities or pursue a particular investment strategy; and (c) is not investment, legal, regulatory or tax advice. Legal & General Investment Management Limited. Registered in England and Wales No. 02091894. Registered Office: One Coleman Street, London, EC2R 5AA. Authorised and regulated by the Financial Conduct Authority, No. 119272.
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