The many flavours of private credit
With different strategies to suit the variety of investor needs, learn the latest trends within a few of them
Direct lending may have grabbed all the attention as the private credit market developed over the past decade or so, but there are many different strategies out there to suit a variety of investor needs and objectives. We outline the trends in just a few of them.
As LPs become more comfortable with investing in private credit, many are now looking beyond the plain vanilla flavour of sponsor-backed direct lending. Indeed, the asset class offers investors a range of options and parts of the economy to target, all with differing risk-return profiles. “The beauty of private debt,” says Hans-Jörg Baumann, Partner at StepStone, “is the different styles investors can choose from. You can opt for defence strategies, where you have exposure to non-cyclical cash flow returns that provide stable income. Yet you can also go for offensive varieties that capitalise on market dislocations and cyclical phenomena. These different styles offer investors the opportunity to replicate cycles in their portfolios.”
So what are the trends in four of private debt’s other flavours?
Sponsorless lending
“We’re seeing increasing opportunities in sponsorless lending,” says Kirsten Bode, Co-Head of Private Debt, Pan-Europe at Muzinich & Co. “We’ve set up teams to capture these and we’re also working with banks to arrange parallel lending – that way we can build diverse portfolios and the banks can source the deals while also retaining their relationships with companies.”
Special situations
Covering a whole range of potential strategies, funds offering access to special situations may be particularly busy in months to come as they mop up more difficult deals. Triton Debt Opportunities had an active 2022, according to the fund’s Head, Amyn Pesnani. “We took advantage of dislocations in public markets last year and saw a lot of opportunity in buying debt from bank balance sheets.”And while special situations in the US may be well served, the picture in Europe is quite different, adds Pesnani. “The competitive intensity of special situations has reduced in Europe below the large deal sizes,” he says. “US funds that operate here have grown in scale and they have had plenty of opportunity in their home market because the US market has seen bigger dislocations. Meanwhile, many European special situations funds switched to direct lending, where the strategy is easier to scale and where LPs have specific allocations to the strategy. The lack of competition makes it an interesting space.”
Real estate debt
This is a growing area as alternative lenders continue to take market share from banks. And, according to Carrie Hartle, Investment Manager, Real Estate Debt at Schroders Capital, there are some strong opportunities in Europe currently. “We’re now seeing repricing in Europe in response to the macro challenges of the past 12 months,” she says. “That means there is the opportunity to enter the debt market at sensible valuations and sustainable yields. It’s a good time to be committing capital for the next three to five years.”It’s a moot point as to where real estate debt should sit in an LP portfolio. Yet for Dadong Yan, Head of Alternative Investment Solutions at MassMutual, the answer is clear. “Real estate debt is a standalone asset class,” he says. “It doesn’t have the same dynamics as private debt – cashflow lending is very different from lending against a building. Some put it in with real estate, but the considerations for a lender are very different from those for an equity investor. Some put it in with real assets.”
NAV finance
Otherwise known as fund finance, this offers funding for private equity fund portfolios as a way of offering interim distributions to LPs, to management companies as a way of funding growth (as an alternative to selling a stake in the management company), and in some instances, it provides LPs with funding to finance their commitments. “We’ve seen a big increase in the number of GPs looking at this,” says Georgina McCreadie, Assistant Director at Deloitte. “This is for a variety of factors and this is particularly so since the end of last year as volatility has picked up in the fund finance market.”As a relatively niche area of investment for LPs, it’s less clear where this should fit in their investment portfolios – for now. “Currently, this tends to go into the opportunistic credit bucket,” says Michael Hacker, Managing Director, AlpInvest. “But investors are starting to see, and be attracted by, the way in which the cross-collateralisation that this strategy offers can reduce risk. They are starting to think about creating other homes for these investments.”Since NAV finance can be either debt or preferred equity or a blend of both, Joe Abrams, European Head of Private Debt at Mercer, suggests it should firmly sit within private credit allocations. “Lower return, higher current cash coupon lending fits into core-style private debt portfolios and blends nicely with the direct lending bucket, while preferred equity is more core-plus, offering a greater tolerance for other forms of contractual returns,” he says. “There will be more to come in allocations here because NAV loans can offer strong alignment – if you’re lending through the fund, for example, the GP lives or dies by the whole portfolio.”
