NNIP head of the alternative credit boutique Gabriella Kindert, who is a co-author of the recent guidebook, said: “Despite their differing dynamics and risk parameters, alternative credit investments share a number of common features. These include a deep understanding required to assess the asset class and credit risk, the investment decision is bottom-up and the investment is illiquid.
“Transparency remains an issue in many asset classes,” she added. “And, it is not easy to find an appropriate, objective benchmark to assess the quality of investment selection and monitoring.”
True sources of alpha generation in alternative credit remain: 1, the assessment of assets on secondary and primary markets; 2, the quality of risk assessment and ability to avoid losses without compromising on the expected portfolio return; and 3, the costs and efficiency in managing assets.
Wallace Wormley, founder and managing director of UK-based private investment consultancy OSPARA, which advises Pan European institutional investors including pension funds, said: “For several years now, there has been a growing trend for institutional investors, sovereign wealth funds, pension funds and family offices to consider and use alternative credit in their portfolio constructions.”
One reason for this growth, according to Wormley is that “too much investor capital has been tied up in core debt exposure, with not enough alternative sources of return”. Another reason cited is that the marketplace has recognised this fact and “rapidly developed more products” within this sub-asset category.
“For example, there is an increasing influence of private credit within mainstream finance and it is playing a role in supporting the real economy,” he added. “This change is taking place as the shift from traditional bank lending towards private credit looks to be a permanent one.”
There are also regional variations in the growth and uptake in the sub-sectors of alternative credit. Take the US, where about ten times more capital is allocated to distressed debt compared to continental Europe, Wormley noted.
LIQUID V ILLIQUID
In terms of what investors should choose to invest in from the myriad of options confronting them, perhaps the starting point is to decide on whether to decide on the tradeable part of the market (including high-yield bonds) or the more illiquid section, which is known as direct lending or private debt.
The direct lending market in Europe is now comprised of more than 70 firms each with about €500m of AUM, with only nine firms having AUM in excess of €2bn. Despite all the pressures the banks face, direct lending firms account for less than 0.5% of the European lending market today.
Anthony Fobel, managing partner of BlueBay’s private debt business, which manages more than €7bn in direct lending funds, said: “Investors seeking to work out who will achieve the best returns will have to delve into the quality of the team, details of the underwriting process, rigor of the due diligence as well as the ultimate calibre of investments.”
Focused on ‘event-driven’ lending to, for example, facilitate an acquisition or growth financing for European medium-sized companies with €100m to €300m in revenues, BlueBay’s Fobel added: “These investors will also have to assess whether the team in question has the expertise to manage difficult situations, which will inevitably occur when the markets turn down.”
Despite BlueBay’s position as one of the largest and most established players in the fast growing European direct lending market, having recently closed its first senior loan fund at more than €3bn, Fobel noted that with this leading position come advantages as well as challenges.
“We are seeing a certain amount of competition and poor structures from the liquid loan market filtering down into the private debt market for larger deals, although covenant discipline remains a feature for most private debt managers,” Fobel remarked.
“The liquid leveraged loan market is currently very hot, arguably over-heated, with leverage multiples rising, price compression and poor terms,” he added. “More than 60% of these loans are now ‘cov-lite’, which is extraordinary given the lessons that you would hope had been learned following the financial crisis – but people have very short memories.”
