SPONSORED CONTENT | Private credit has come to the fore as banks have stepped out of providing finance for transactions in the wake of the GFC, and investors have sought diversified sources of risk-adjusted return. Investors see private credit as augmenting equities and fixed income strategies, and strongly emphasise that they will work with external managers after extensive due diligence in the selection process and oversight during the ongoing relationship.
Post-GFC, with new regulation on banks stemming from Basel III and the Volcker Rule, many banks left the private debt market, leaving asset managers room to fill in the space. The United States and Europe are the top two markets for private credit, and with concerns arising over whether the US is further along the credit cycle than Europe, investors are considering Europe’s private debt market, which exhibits attractive risk adjusted returns compared to similar asset classes, according to Natixis Investment Management. Natixis notes that the floating rate feature of European private debt provides a natural hedge against rising interest rates.
Asset owners are interested in investing in corporate credit strategies, but there is concern that it is late or “deep into an elevated business cycle,” with the risk of default rising, said Andrew Kemp, head of debt and currency at Frontier Advisers. But he noted that clients see corporate credit plays a role of diversifying against other assets such as equities, and against the duration risk of sovereign fixed income.
“Investment grade credit can sit along sovereign strategies and can be a useful diversifier,” Kemp said. “Sub-investment grade can also be an equity replacement, and another strategy, which includes less liquid, privately originated strategies, can be used at different points in the risk spectrum.”
Privately originated strategies offer other potentially valuable characteristics to institutional portfolios, Kemp added.
“On the corporate side, they lend to smaller businesses, which typically have less access to capital markets,” he said. “Some of those are actually very interesting because the protections available to investors in terms of covenants and the amount of the due diligence done up front can be quite strong, and probably stronger than the publicly traded markets. So, there is a wide cross section of managers and it’s becoming quite popular as the banks have stepped away from lending in that space through regulatory contrails and other reasons.”
Natixis Investment Managers affiliate manager, European private credit specialist MV Credit[i], currently manages eight senior-focused vehicles and two subordinated funds with total assets of under management of around €2.2 billion. MV Credit has established relationships with a select roster of private equity clients, and will extend credit to the companies owned by those private equity firms. MV Credit focuses on companies with EBIDTA from EUR30 million to 100 million, with a focus on industries that are resilient to credit cycles, said Nicole Downer, managing partner at MV Credit.
“MV Credit typically lends to companies in stable sectors like healthcare, and software companies that provide subscription-based services, such as HR, payroll,” Downer said. They shy away from companies that have strong retail or consumer focus.
“We are seeking good predictability of revenue and a strong diversification of revenues,” Downer said. “We prefer businesses that are business-to-business rather than business to consumer, avoiding fashion retail, or automotive. We’re also cautious about industrials that are capital intensive when they have problems with their leverage, the problem can quickly spread to one of liquidity.”
Funds tend to be closed-end structures with seven to 10-year maturity, with an eye to managing credit cycles defensively. Downer says in closed-end fund structures, a manager is not a forced seller, reducing volatility in returns, and offering the fund manager the opportunity to resolve potentially damaging credit situations.
MV Credit is selective in the deals in which it extends credit, and Downer said that on average, they will conclude 20 to 30 deals per year. MV Credit also separates out deal-making from oversight within their team, she added.
“From a monitoring perspective, again, we approach that in a slightly different way,” she said. “We’re one of the few managers who have a dedicated monitoring team who aren’t involved in the decision making or origination. Having this independent team ensures timely monitoring, high quality of information across companies, strong early warning signals to help reduce losses.”
For AustralianSuper, the role of corporate credit in asset allocation is to provide a different risk/reward proposition and therefore diversification to other investment classes in the portfolio, according to Roger Knott, senior investment manager, credit at AustralianSuper.
The nation’s biggest superannuation fund has invested in various forms of corporate credit, including investment grade corporate bonds, levered loans, high yield bonds and private debt. Knot said there was $4.1 billion in corporate debt investments in the fund’s Balanced Plan Option, constituting around 3.3 per cent of the Balanced Plan member assets of $125 billion.
“The corporate credit investments sit in either the fixed income portfolio or the Mid Risk portfolio, depending upon the characteristics of the individual investment,” Knott said. “An investment grade corporate bond sits squarely in the fixed income portfolio given its relatively defensive character. Levered loans and property construction finance sit in the mid risk portfolio.”
In 2019, AustralianSuper’s debt investment focus has moved to large-scale opportunities in real estate development finance and real asset mezzanine finance, in Australia, North America and parts of Europe, Knott added.
For AustralianSuper, default risk and mark to market price movements during the life of the investment are the most obvious risks of investing in corporate credit, Knott said.
“For a portfolio manager re-investment risk is a continual challenge given the bond or loan has a finite life,” Knott said. “For direct investments managed by AustralianSuper’s in-house credit team, the investment process is a thorough bottom-up one, including early stage vetting by a credit investment committee, followed by detailed due diligence covering business and industry risks, ESG and legal review, culminating in the final investment decision. External managers selected by AustralianSuper generally use much the same process.”
Downer also emphasised the importance of due diligence and expertise across credit cycles touting MV Credit’s 20-year track record in private credit.
“We look for trends, we draw on experiences of investing through a number of credit cycles, whether there are warning signals, and that’s led to a number of measures that we take within the firm. It also means that the one area we absolutely will not compromise on is the level of information. The one thing we’ve realised through the decades of investing is that nothing is more important than getting very detailed information on the companies you lend to help recognise signs of problems early on.
“Europe on the private credit side is in a zero-default position” Downer said. “Europe has been growing slowly since last recession. If you’re choosing good companies, and we believe we are – our companies are growing 10 per cent per annum with a backdrop of zero or 1-2 per cent growth in the economy.”
MV Credit also integrates environmental, social and governance processes into the credit process, asking for information from companies as part of its process.
“The good news is that ESG information is available because investors in private equity are asking for it as well,” Downer said. “The investor communities will push for information on the ESG side. What we also like is moving beyond industry practices and looking at diversity of management teams, the working practices, the ability to attract a variety of personalities, background, etc. That’s something we look for in portfolio companies that we are active with at MV Credit and the way we behave within the firm. It is part of our success – I truly believe one of the reasons we have lower loss rates is that the people who are making decisions come from different backgrounds, so approach situations differently, and that helps flesh out all the issues.”
MV Credit is an affiliate of Natixis Investment Managers[ii]. Louise Watson, Managing Director at Natixis Investment Managers, Australia, said, “We’re focused on offering Australia wholesale investors access to investment opportunities managed by highly active, high-conviction investment managers via our affiliate network.”
With USD 1,022.9 billion AUM (as at June 2019), and powered by the expertise of 24 specialised investment managers, Natixis Investment Managers is one of the largest asset managers in the world.
[i] MV Credit Partners LLP provides financial product advice and services to Australian wholesale clients as an Authorised Representative (No. 001273704) of Natixis Investment Managers Australia Pty Limited (ABN 60 088 786 289 and AFS Licence 246830).
[ii] Natixis Investment Managers Australia Pty Limited ABN 60 088 786 289, Australian Financial Services Licence no. 246830