British Business Bank – Industry view


Alice Hu Wagner is managing director of strategy, economics and business develop- ment at British Business Bank


INVESTORS SHOULD EXPLORE THE POSSIBILITIES AROUND PRIVATE DEBT


In recent years, private debt has become an important and valuable form of fi- nance in the UK for firms seeking to grow or looking to make a step-change. In the period following the global financial crisis in 2008, private debt funds picked up some of the slack left by high street banks that pulled back from lending to the riski- est smaller business owners.


Although private debt funds occupy a less visible corner of high finance, the busi- nesses that use their tailored funding solutions are real – some support thou- sands, or even tens of thousands, of jobs. Many may need the repayment flexibility and fresh capital private debt can provide as the UK emerges from its current eco- nomic downturn. As these businesses and the nation shift from stabilisation to recovery, ensuring that they can access the finance they need to grow will be the key to a thriving post-pandemic economy. For investors, commercial investment opportunities abound, but continuing re- cord low interest rates have created chal-


lenging conditions in the hunt for yield and high returns. A recovery-driven rise in demand for private debt could be an at- tractive chance for institutional investors to boost portfolio performance by entering a historically under-exposed asset class. The British Business Bank’s UK Private Debt Research Report – a first-of-its-kind analysis of the smaller end of the UK mar- ket, based on transaction data collected di- rectly from 37 fund managers – suggests that private debt could be attractive to institutional investors in a number of ways, which include: – More diversification, as a higher num- ber and broader range of private debt fund managers provide investors with multiple opportunities for investment. This can help mitigate potential event and concentration risk issues, for e xample, where an unforeseen incident or occasion impacts the performance of a single fund manager


– Greater variety of risk-return composi- tions, as, due to the larger variety of product structures used, private debt offers a wide range of return profiles. For example, fund managers with a higher risk appetite will generally seek a higher yield through more junior, subordinated debt structures, mezza- nine products and quasi-equity or con- vertibles, while those pursuing a more risk-averse strategy tend to focus more on senior/first lien structures


– Attractive low correlation returns, as, from a portfolio performance perspec- tive, private debt offer superior returns relative to certain equity and fixed in- come indices, while being less volatile through economic cycles. British Busi-


ness Bank analysis also shows smaller private debt funds focus on growth-ori- ented transactions in SMEs and mid- caps, which can yield higher returns for investors, although such businesses, being smaller and less established, are also at higher risk of default.


Investors must balance these features against


whether the greater volatility


around expected returns fits their man- dates, of course, given that the inherent capped upside potential in debt does not mitigate the risks of defaults as well as equity does. Although this risk can be mitigated by experienced fund managers through the incorporation of warrants in the loan structure, investors will need to weigh up their own capabilities for judg- ing fund manager capabilities in this spe- cialist area. The current economic climate presents challenges and opportunities for UK busi- nesses and investors. Considering lesser- known choices such as private debt could be a way to maximise the growth potential for both as we all recover.


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ISSN: 2045-3833 Issue 101 | March 2021 | portfolio institutional | 13


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