Private debt: all-weather investment solution

04 October 2019

4 minute read

By Gerald Moser, London UK, Chief Market Strategist

After a decade of strong rises in assets under management, can private debt still be attractive for investment portfolios?

The rise of private debt

Since the global financial crisis in 2008, the environment for private debt has been favourable. Assets under management in the area rocketed to $760bn in 2018 from $240bn ten years’ earlier.

Banks were overleveraged in the aftermath of the crisis and spent the following years rebuilding their balance sheets. Furthermore, tighter regulations also limited banks’ appetite to grow their book loans, especially for long-term loans. So there was a need for fresh loans supply and private debt partially filled the gap banks left.

Among investors, there was also an appetite for financing those loans as public markets were offering ever lower yields in the wake of central banks’ quantitative easing policies globally.

Different strategies to fit the economic cycle

Private debt’s attractive risk-return profile is achieved thanks to different sub-strategies offering different exposures to the economic cycle. Senior loans are the most secure part of the capital structure for private debt. They are normally issued for buyout financing as well as growth investing. For this reason, they tend to be popular during the mid-cycle, once the economic environment looks stable and the cycle durable. The purpose of those investments is to minimise risks.

At the other extreme, mezzanine debt is typically unsecured and only senior to equity in the capital structure. In that case, the strategy is less focused on risk reduction and more about return maximisation. Considering the close tie to equity, mezzanine debt usually performs best in the early part of the cycle when the risky assets recover.

Finally, distressed debt is a strategy that requires the economic cycle to enter into a recession or a slowdown for opportunities to arise. With high leverage and defaults on the rise, distressed debt funds are able to buy assets at a discount from companies on the verge of bankruptcy. They create value through a debt-restructuring process. Distressed debt funds tend to be negatively correlated with risky assets such as equities.

Opportunistic credit funds

Opportunistic credit funds offer various exposure to the above three private debt sub-strategies. Managers of those funds have a broader mandate and adjust their main strategy throughout the economic cycle.

Opportunistic credit funds can be used with the aim of yield enhancement or capital appreciation, while also adding a counter-cycle profile to a portfolio.

Attractive outlook and rate hedge

With the stock of negative-yielding fixed income assets close to a record high, private debt still seems to be an attractive addition to a portfolio.

History suggests that the asset class offers an equity-like return, thanks partly to the illiquidity premium, while volatility remains closer to a fixed-income instrument. In addition, private debt offers a hedge against higher rates as private debt is mostly based on floating-rate notes.

History suggests that the asset class offers an equity-like return...while volatility remains closer to a fixed income instrument.


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