Over the past two years, private assets have become a firm fixture on the investment scene as institutional investors search for yield. Opportunities have abounded and generating enhanced returns was relatively easy. Today, spread compression and the threat of rising rates are taking their toll and the pickings are slimmer than in the past.
“There has been a significant interest in private debt such as real estate, direct lending to corporates via uni-tranche structures (a combination of senior and subordinated debt) and various other types of credit strategies,” says Bob White, portfolio manager in the global multi-asset group at JP Morgan Asset Management.
“The biggest driver in Europe has been the de-leveraging of banks and four years ago it was a great time to lend capital. However, as the economy is healing, the size of the opportunities and returns are in decline. The return premium is not necessarily a function of illiquidity – it is a function of the types of strategies that can be executed within a less liquid vehicle. We generally think of these additional sources of value as including more flexibility in active management, greater use of manager skill and wider access to niche strategies.”
White notes that one of the questions investors should ask when assessing an illiquid commitment, is whether it provides something materially different than can be obtained through a more liquid, cheaper structure. Investments today could include, for example, the purchase of a small €2m block of partially or wholly-defaulted loans that could be packaged, restructured and sold off. This is a far cry though from three years ago when the asset manager would put hundreds of millions to work on some form of non-agency residential mortgage-backed security and reap a double digit return.
Being selective
Susan Kasser, head of private debt at Neuberger Berman, also believes the environment has become tougher. “In Europe, the main theme has been the banks recapitalising and retreating from lending. While this is an interesting trend, I am not sure it is an interesting opportunity,” she says.
“There is a lot of money chasing a defined number of deals and the returns may not justify the investment. Also, banks may be retrenching but they are not disappearing, plus many smaller private equity backed companies – those sitting on $40m of EBITDA (earnings before interest, taxes, depreciation, and amortisation) are finding the high yield markets a more attractive place to raise capital.” Not surprisingly perhaps, selectivity is the key, according to Kasser.
“Overall, the global macro-economic environment has improved and people in Europe tend to feel more positive about the region’s prospects. Corporate margins are stable and coverage ratios are good. However, investors have to be patient and look carefully at the structures.”
Forbearance is not only required for identifying the best deals, but also for working out the finer detail of the structures. Café Nero’s recent £275m refinancing package is a reflection of the labour intensive process, as well as number of moving parts to contend with at the smaller end of the spectrum. The transaction, which took seven months to complete, included a slug of £100m senior debt, a £150m junior slice and £25m of cash.
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