Private Debt: The Solution for Low Yield Investors?
Investing in private debt has become one of the largest and fastest growing alternative asset classes in the world and private debt has secured a place at the heart of bond portfolios in today’s environment. low interest rates, according to a UK fund manager specializing in alternative assets. .
Westbrooke Alternative Asset Management believes this growth is fueled by current low interest rates and high equity valuations that leave little margin over current levels.
Dino Zuccollo, head of distribution at Westbrooke, says governments around the world have reduced interest rates to zero to help economic recovery from the Covid-19 pandemic. âAt the same time, stock valuations have been tough as free money has become available.
âIn this environment, private debt offers historical returns similar to equity investments, but can be structured to provide additional security to the investor,â Zuccollo explains.
âThis security can take the form of a direct security interest in tangible property. ”
He says investors can get a higher return by investing in private debt, resulting in an asymmetric risk / return profile.
Private debt explained
Simply put, private debt is a loan from a non-bank lender and therefore falls under the broader category of âalternative debtâ or âalternative creditâ.
The term private debt is used interchangeably with “direct loan”, “private loan” and “private credit”.
Private debt investments are typically used as bridging finance for real estate transactions, finance real estate development, finance business growth, provide working capital, and finance infrastructure.
Westbrooke says private investors such as high net worth individuals, family funds and institutions view private debt investments as an opportunity to improve returns within a fixed income portfolio.
âIt generates predictable, protected and hard currency monetary returns,â says Richard Asherson, director of Westbrooke Alternative Asset Management UK.
There are several reasons for the higher returns generated by private debt investments, including:
- An illiquidity premium, because borrowers have to offer higher rates to compensate lenders who are required to invest for a prescribed period of time (since the debt is not publicly traded and investors cannot easily liquidate their investments);
- A structure or complexity premium, because transactions are often tailor-made and require specific structuring;
- A non-market premium (disinformation) due to the absence of an efficient market that effectively rates debt; and
- Small loan size demands a premium, as banks prefer to lend larger amounts to large companies, resulting in a shortage of capital available for medium-sized loans to small and medium-sized businesses.
Asherson says that compared to listed debt securities, private loans generally benefit from more robust security packages because they hold direct asset security as opposed to a general claim against the cash issuer of the listed debt.
âPrivate debt is often able to generate higher returns due to its inherent complexity and unlisted nature. However, private loans are illiquid and require investors to invest capital for a period of time during which they cannot access their money, whereas listed debt securities can be bought and sold on listed exchanges, âsays Asherson. .
He says UK small and medium-sized business lending activity has grown by more than 15% in the first half of 2020. âWhile part of that increase was funded by the Coronavirus Business Interruption Loan Scheme played a central role in funding this demand.
To date, Westbrooke has invested over Â£ 100million (R 2.1 billion) in 35 private loans in the UK and Europe.
Westbrooke was founded in 2004 and invests and manages investments in alternative assets in multiple geographies on behalf of its shareholders and investors. This includes investments in private equity, venture capital, private debt, hybrid capital, and real estate.
Since establishing its UK office, Westbrooke has provided debt financing to companies across multiple industries in the UK and the EU, with a focus on the lower middle market, a traditionally segment of the market. underserved who have seen an increased appetite for funding in recent months after the Covid-19 outbreak.
Transactions to date include credit facilities to support the UK’s second-largest independent provider of mobile device protection solutions, an independent London-based incubator group that spans the south-east of the UK. England, as well as a number of real estate-backed transactions, mostly focused on shorter-term acquisitions and bridges, Asherson said.
Although private debt investments are available to South African investors, they should comply with the regulations of the South African Reserve Bank (Sarb).
Thus, a local investor should outsource its liquidity using its discretionary annual exchange control allocations and invest directly in hard currencies abroad. The approval of Sarb would be required beyond a certain threshold.
Alternatively, one can invest locally in rand through a local feed vehicle, such as a corporation or endowment trust that has the capacity to invest overseas.
To read: Private assets in 2020: and after?
Zuccollo says Westbrooke expects further growth in private debt as an asset class, but says it’s not for everyone.
âThe rise of private debt as an asset class is still in its infancy. Sophisticated investors around the world have steadily increased their allocation to this fixed income alternative as part of a well-balanced and diversified investment portfolio.
âHowever, quality private debt funds can be difficult to access, especially when South Africans are looking to invest in offshore markets.
“We suggest investors look for well-established asset managers who have in-depth local networks and infrastructure and a track record to help clients gain exposure to the asset class.”