With the Bank of England predicting inflation will reach over 7% a year by Spring 2022, it is more important than ever for investors to find a secure return without excessive risks. The recent collapse in fast-growing tech stocks and bitcoin served as a reminder that investors need to look at the benefits of a stable investment, such as private debt.
Private debt has consistently provided solid returns for investors. The first reason for this is the liquidity premium that is built into the pricing due to the illiquid nature of the investment. Secondly, borrowers typically pay a premium for a bespoke structure and for the speed of execution. Finally, as the name “private” suggests, it allows funds to find opportunities as there is less transparency in the market for borrowers.
The clearest example of this can be seen in the real estate market, which has seen an influx of cheap money from investors. As an example, at an institutional level, JP Morgan provided £200m to a bridge lender for the first time in 2020. This has led to significant pressure on pricing, where lenders compete for market share by offering rates that previously simply would not have been available.
Other large institutional investors are concentrating on direct lending to individual companies. This type of lending has attracted a flood of investor money from pension funds and sovereign wealth funds seeking higher returns than those available in the public markets. Ares raised €11bn this year for a European direct lending fund.
Direct lenders are free to take risks that banks would not take, often charging higher interest rates. In the privately arranged loans, they are also able to negotiate more bespoke financing arrangements with individual companies.
There are still opportunities for nimbler funds. They can act quickly and are willing to invest the time to find and execute investments where they can charge a premium, without taking additional risks. This is often called specialty finance, which at a high-level consists of financing activity that takes place outside the traditional banking system.
There are several similarities regardless of what sector of specialty finance you are investing in. As with all private debt investments, there is generally very little correlation with economic cycles. In addition, investments are typically secured by underlying pools of hundreds or even thousands of individual loans. This granularity further diversifies the risk, as overall performance is not tied to a single event or credit outcome.
Specialty Finance can be roughly broken down into three different categories. The first two are the largest two segments and as such are the most well-known: consumer lending, and commercial lending, which covers loans to businesses and invoice financing. Investments in both these sectors are usually made via onward lenders who have the access to and relationship with the end borrowers.
The final sector, and the most interesting sector for us growth wise, is esoteric or niche financial assets. There is usually less competition in these areas due to the time needed to understand the risk and often the bespoke structuring needed. This doesn’t mean the opportunities are inherently riskier, but rather that the lender is able to charge a premium for the structuring without increasing their credit risk.
Over the last few years there has been a big increase in the number of platforms offering direct investments in private debt for sophisticated investors. However, despite the attractive returns, this is a risky venture as this is a very specialist area. It pays to invest via a fund that has the required skills in origination and execution.
From an origination perspective, there is a different ecosystem of borrowers, intermediaries and providers. Deal flow is often generated through direct contact with the underlying finance platforms. Having an established network and deep relationships with key players is therefore crucial.
From an execution point, there is essential knowledge needed to underwrite the risk of these opportunities adequately and successfully. There is often a need for bespoke documentation and structuring.
Fintex Capital has been involved in the private debt market since 2015 and has a proven track record in that space. We would be delighted to speak to you in more detail about investing with us in the private debt market.
Press Coverage | 23 Jan 2024 | Oliver Smith at altfi.com
Press Coverage | 22 Jan 2024 | JD Alois at crowdfundinsider.com