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Selectivity and the importance of diversification At this late stage of the cycle, there is greater importance on investment selection within and across asset classes as well as the ability to manage credit risk in portfolios to minimise expected credit losses and ensure credit rating downgrades and defaults remain low.
Structural protections such as security and/or covenants tend to be a common defining feature of most forms of private debt and serve to provide the investor with downside protection and early warning signals. Covenants allow an investor the opportunity to intervene early before a significant credit dete- rioration occurs, while first lien security means that an investor is first in line for pay-out in the event of a default.
Together with seniority and security, managers can also buffer in sufficient downside protection and ensure that portfolios are constructed from a wide range of opportunities. Since debt is an asymmetric asset class, an important investment discipline is ‘avoiding the loser’. Therefore, it is essential that a manager has a full choice of investments from which to select only the most robust and fitting. Diversifi- cation is also important to minimise concentration risk.
Taking the long view Private debt is a broad and diverse asset class in its own right, but having the flexibility within a portfolio to consider income-generating opportunities from public and private markets, on an asset-by-asset basis, can also can help to achieve the required risk-adjusted returns and provide sufficient downside protection for investors.
Private debt can provide pension schemes with assets that range between everything from long-dated investment grade opportunities to help fund cash-flows to higher-returning high yield opportunities that can help to reduce funding gaps over time.
For Investment Professionals only. This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. Past performance is not a guide to future performance. The distribution of this guide does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority’s Handbook.
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October 2019 portfolio institutional roundtable: Private debt 25
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