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PODCAST | – 4 Min

Market weekly – Private debt stands out amid the uncertainty (read or listen)


In this article:

    Uncertainty over the macroeconomic landscape and the outlook for monetary policy currently combine with an awareness among investors that by many measures, valuations in public markets are on the high side. David Bouchoucha, head of our private debt and real assets team, talks about the characteristics that make private debt an attractive alternative.   

    Listen to the podcast or read the article below:

    Private debt – Standing out in uncertain times

    Historically, private debt has delivered diversification, stable income streams and consistent premium returns over liquid and traditional debt, with modest drawdowns over the long term.

    These are uncertain times, so we believe it makes a lot of sense to think about what we know to be certain. What is certain today is that with conventional asset classes either offering next-to-no yield (bonds) or priced close to perfection (equities), the search for yield remains the main challenge for investors.

    In this environment, private debt offers an attractive liquidity premium over public markets. In addition, most of the assets we invest in offer floating rather than fixed interest rates. As investors, we are therefore primarily taking credit risk rather than interest rate risk. Floating interest rates offer protection against rising interest rates.  

    This is not to say that our asset class is without risk. Currently, the reflationary environment leads us to look closely at the business risks of companies in our investment universe. For example, we look particularly closely at exposure to commodity prices.

    Our investment process for selecting the companies in which we invest requires us to make sure a business is not overly exposed to commodity markets in this climate. We are looking for those segments that are the most resilient.

    Innovation in private debt

    The Covid-19 pandemic has had a profound impact on many of the companies in our investment universe and for many it has long-term consequences.

    Innovation occurs at different levels. Our investment process has not changed substantially. We continue to look closely at the risk to which an individual company is exposed and the strength of its balance sheet.

    Innovation comes into play in other areas. For example, when we invest in loans, we can invest in different parts of a company’s structure. In the past, we focused on senior debt financing. Today, we are looking more at junior debt when we finance a corporate or an infrastructure project.

    This is because we increasingly see transactions where the sponsors are not looking at financing at senior debt or equity, but at junior debt. In our view, this part of the capital structure offers attractive yields at a level of risk that we see as compelling on a relative value basis for our investors.

    Relative value is important to us. When we consider financing a particular company or infrastructure project, one of the most important questions is which part of the capital structure is most attractive on a risk/return basis. We are developing our capabilities for financing junior debt because this segment is growing fast and we see a lot of relative value for investors in this part of the capital structure.

    Integrating ESG criteria into our processes  

    Since the launch of the private debt and real asset team in 2017, the integration of environmental, social and governance (ESG) criteria has been a central element of our investment process.

    The SFDR [1] regulation is something of game changer. It forces all managers to structure their approach and ensure they comply with the regulation whose criteria become part of the rules in the prospectus governing a fund. That means the force of contractual law backs the regulation. We see this as a positive development because it ensures a manager adheres to the investment approach laid out in the prospectus.

    Let me give you a concrete example. When we manage infrastructure, we do so with a specific measurement from an external service provider who calculates the net environmental contribution of each investment. This enables us to compare the environmental profile of a particular project with whatever is possible in the universe. With this metric, we can even verify whether a particular project is aligned with the Paris agreement in terms of carbon emissions.    

    The dispositions of SFDR are another step on a journey, which will enhance and legally provide for our commitment to sustainable investing.

    Selective exposures in commercial real estate  

    Real estate market activity was hit significantly in 2020, although capital values held up relatively well. This market offers a deep and broad opportunity set. Commercial real estate offers depth that means we as investors can identify resilient assets at attractive valuations.

    For example, logistics real estate is a fast-developing sector offering investors good value. It is a strong sector compared to others that are more vulnerable to the changes wrought by the pandemic. Hotels and retail assets have suffered in particular.

    We also see prime office space as resilient. There has been a repricing of prime office space. This translates into an improvement in the security and relative value of the assets.

    Commercial real estate represents the characteristics of private debt well in that there are risks, but also attractive opportunities for experienced investors who can identify the best borrowers and keep credit risk at manageable levels. Our teams are able to identify the opportunities through their knowledge of the factors affecting each sub-sector.

    [1] For more on this topic, read An introduction to the Sustainable Finance Disclosure Regulation

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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