By Susan Kasser
Private debt doesn’t trade like equities or high yield bonds, but it is possible to find buyers and sellers in the right circumstances.
Life is so “easy” when you work in liquid assets. Your portfolio could use another tech stock? With the click of a mouse, it’s done. More telecoms for your high yield bonds weighting? Get on the phone and they’re yours. Even private equity fund interests have a thriving secondary market nowadays.
On the face of it, private debt should be the same, because marginal, crossover investors that enter this market tactically would probably prefer to get out again at some point, if they could.
Circular Pattern for Crossovers
The market for second-lien debt issued by smaller companies, with its high single-digit, often floating-rate coupons, became very popular last year as the credit cycle extended and these non-specialist investors searched for yield. A circular pattern formed in which second-lien issuance grew in response to this crossover demand and the new investors became more confident taking a share of bigger issues.
However, the crossover investors pulled back in mid- to late 2014, when the high yield markets sold off, likely either because they saw better opportunities again in their own markets, or because they needed cash to meet redemptions from their clients. This pullback by marginal buyers pushed yields up on new-issue second-lien debt.
Absence of Secondary Market, but Opportunities to Trade
One might think that they would also have been selling some of their private debt positions into the market. However, even had they wanted to, the asset class continues to lack a secondary market—even an illiquid one.
Still, it is possible to buy and sell on a secondary basis. Indeed, assuming a favourable environment, well-established counterparties in non-investment grade debt can go to the banks that underwrote the loans (with a list of the companies they’re interested in and the prices at which they would transact) and get plenty of “bites” on their line.
Not a Bargain Basement
It’s important to recognize that buying secondary private debt is not really about loading up on distressed assets or fire-sale bargains. Portfolios built through secondary transactions tend to have similar yields to portfolios built from the same assets bought at primary issuance. Investors generally don’t expect a higher risk-adjusted return profile just because they are buying secondary. After all, they are usually creating these opportunities for themselves in order to add to exposures they already have, and therefore have no incentive to buy anything but performing assets in companies they know and like, often paying close to par value. Their counterparties are rarely forced sellers: A few may be looking for cash to meet fund redemptions but most simply want to recycle capital back into their home markets.
A Subtle Skill
This makes buying secondary a rather subtle skill. It’s easy to spot chaos (Rothschild’s famous “blood in the streets”), but this is about marginal decisions made by marginal investors whom the purchaser (the liquidity provider) will have to identify and incentivize. It’s hard to say what the next opportunities will be, what they will look like, or when they could emerge—the circumstances around the opportunity in 2007 were quite different from those in place last year, for example. However, we believe that, by paying attention and being ready to act, investors that are committed to the asset class for the long term can create interesting secondary investment opportunities to consider.
Susan Kasser is head of private debt at Neuberger Berman
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