At a time when investors have become
cautious about immediate prospects for private equity, but are bullish on
corporate debt, a new asset sub-class seems to be emerging – private debt. Specialists
in the field say that assessing companies for debt instruments requires a
different set of skills to that of private equity investments. Causeway Asset
Management, a private debt manager formed in 2003, is offering a new strategy
for Australian institutional investors, which will focus on the SME corporate
debt market. Until 2007, Causeway focused on running proprietary portfolios for
its joint-venture partners, including a Canadian consortium bank.

The current
fund, Private Debt Opportunities Fund, has been closed to new investors. The
new strategy, with a similar risk/return profile, will be available as discrete
mandates or in a co-mingled vehicle. Causeway is looking for about $200 million
before the next close, with a draw-down over the next 12 months. Funds will be
invested typically over three years in loans ranging between $5 million and $15
million.

Over the past five years the manager has reviewed more than $3 billion
in loans and written about $350 million. Causeway is owned by joint managing
directors, Mike Davis and Tim Martin.
Davis was
the founder of the former Merrill Lynch Investment Management in

Australia
in the 1990s, prior to its merger with Mercury Asset Management, and Martin was
the Merrill Lynch investment bank treasurer and head of debt syndication for
the Asian region.

The firm has six full-time and three part-time staff in

Sydney.

Davis says there is a great opportunity in
corporate credit at the moment, in particular in the SME sector which has been
starved of funding from traditional sources due to the credit crisis. “Bank
lending for this sector has largely dried up and there are a lot of good
companies out there which meet our criteria for loans, “ he says.

Unlike
private equity managers, Causeway does not look to influence investee companies
but does require transparency as a debt investor. The firm assesses companies
based on a range of security factors, including underlying collateral,
inventories and contracts. It aims for a return of about 1 per cent a month
after fees and charges. Its own fees are a bit less than the average for
private equity.

Davis
says the new strategy will have little to no leverage, but can be levered at
the discretion of investors. Causeway’s management is advised by a credit
committee and an investment committee, both of which have independent members. “The
big difference between us and private equity managers who have gone into debt
instruments recently is that we start by looking at the creditworthiness of the
company.

We look at their ability to repay their debt and we take senior
secured loans,”

Davis
says. He believes that the time is opportune for super funds and other
institutional investors to fill the gap vacated by the banks, both from an
investment perspective and a social one, given that the SME sector is the major
employer in the Australian economy.

Figures on this sort of lending in the Australian
market are scant, however
Davis says that in the

US
the consumer finance and SME borrowing market over a cycle will have defaults
of about 2 per cent. Recovery rates tend to run at about 70-80 per cent. So,
Causeway expects about 1 per cent in defaults, which is factored in to the
overall expected return of 12 per cent a year after fees.

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