Portfolio Insight – Secure income A SECURE WAY TO GENERATE STABLE CASHFLOWS
With pension schemes increasingly turning cashflow negative and interest rates sit- ting at record lows, could secure income assets provide the returns they need? port- folio institutional spoke to a panel of experts in Legal & General Investment Manage- ment’s private credit team to find out.
How would you define a secure income asset? Stuart Hitchcock: The Alternative Invest- ment Management Association defines “private credit” as debt that is “not publicly traded such as many corporate bonds and is originated or held by lenders other than banks. It takes various legal forms includ- ing loans, bonds, notes or private securiti- sation issues”. At LGIM, our
secure
income proposition is driven by private credit, and we have expanded the above definition to all non-public transactions. The opportunity within private credit is very broad and can be characterised by either return maximising or capital pres- ervation strategies through debt invest- ment that generates long-term secure cashflows.
A key attraction of the asset class is the provision of (and ability to negotiate) agreed protections. This differentiator from public credit often leads to better experience in default cycles, where recov- ery rates for private credit tend to be much higher.
Private corporate debt encompasses
financing to companies borrowing out- side public markets. Examples of particu- larly vibrant sectors issuing private corpo- rate debt at present include housing associations, higher education institu- tions and utilities. Infrastructure debt is the debt financing of infrastructure assets such as energy (including renewables such as wind farms and solar), transportation and social infrastructure (e.g. education and healthcare). Real estate debt involves lending secured against all manner of property sub-sector types (office, industrial, retail, residential (including build-to-rent, mixed use and
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alternative) where the rental income sup- ports interest payments and the property provides security.
What impact has Covid-19 had on these assets? Hitchcock: Private markets have operated as we anticipated. There are two principle ways to look at impact – new issuance and existing asset performance. Generally speaking, private debt markets are not “window” markets in the way that the public markets tend to
be, partly
because of the breadth of borrowers across the private asset classes and the covenant and structural protections, which investors truly value.
Overall, private markets have remained open, a dynamic we also witnessed dur- ing other major economic events, includ- ing the global financial crisis. Inevitably, markets were quieter during the latter part of March, with issuance principally driven by less-cyclical sectors such as util- ities and consumer non-cyclicals – these receive very positive interest when mar- kets are more volatile. Momentum has quickly increased. Some fantastic invest- ment opportunities are coming through and we have been deploying for our cli- ents to take advantage of credit quality and returns offered. Our focus remains on the companies that we believe have a defensive business model, robust capital structure and access to sufficient liquidity to see them through the short-term dis- ruption. In the UK, this notably includes current opportunities in utilities, housing associations, higher education, transpor- tation (backed by committed lease pay- ments for essential assets) and major city real estate (office) spaces. From an asset class perspective, private
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corporate markets remained open throughout, offering funding without the execution risk that can exist in other markets. New issuance in infrastructure has been impacted by Covid-19. Transport has been in the spotlight as rating agencies have been quick to react, particularly on air- ports and related assets. More broadly, most operational assets have strong liquidity positions, specifically those pro- viding essential services to the economy. Opportunities in the near term include renewables and we expect to begin to see activity in the digital/data centre space. It is interesting how Covid-19 has highlight- ed certain dynamics (e.g. working from home) that are likely to create an array of opportunities for institutional investors. Arguably, the real estate space has been the most affected over the short term but the pipeline of high-quality opportunities remains strong. Some sizeable transac- tions have been put on hold because financing is often related to purchases of large assets by sponsors and there is cur- rently a level of valuation opacity. Not- withstanding, we have been able to com- mit to financings during the period, notably for existing borrowers, which underlines the advantage of an estab- lished investment base.
In the context of asset management, Cov- id-19 has intensified focus but also rein- forced our selective investment approach over the past few years. We have been focused on stability of income and the robustness of companies over cycles. There has been a benefit, of investing in good credits, supported by structural pro- tections that give us early warning signs of performance trending and, important- ly, an ability to “get to the table” and engage early with borrowers.
Overall, the portfolio has performed in line with expectations. Whilst recognising that economic volatility can lead to sudden and significant movements in business profile, it is very pleasing to confirm that there has been no interruption to income
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