Private debt markets are by their very nature less transparent than public markets, and managers in them should be held accountable for any misinformation and dishonest disclosure provided to investors, credit manager Polen Capital has acknowledged. But it has warned that over-regulation of the sector could restrict investment freedom.
The fund manager’s US-based head of credit David Breazzano said while he sees the case for more supervision of private debt, particularly following the entry of less sophisticated investors, “a regulator shouldn’t determine who’s a good manager and a bad manager”.
The comments came as ASIC commissioner Simone Constant told delegates at the Investment MagazineFiduciary Investors Symposium that the market watchdog is “accelerating” its supervision around private debt, especially in the retail market.
“My experience with some regulators in the past is they’re nice and noble people, but they’re not experts per se in the various asset classes,” Breazzano told the same symposium in the Blue Mountains on Wednesday.
“The concern would be them enacting some type of regulation that is detrimental to the clients they’re trying to protect.
“My recommendation would be just fair and honest disclosure, and then hold people accountable for misinformation, but let people do what they want to do, as long as they’re fully informed.”
There is certainly room for improvement in setting right expectations around private debt, even among institutional clients, Breazzano said.
“It’s easy to give money, and as money is flowing in a positive way, liquidity doesn’t matter that much,” he said.
“When people want to get their money back, I believe many of them do not fully appreciate that their money is locked up, and it’s going to be a bit challenging for them to get it back without taking a bit of a hit.”
Breazzano started his career in 1980 and has lived through multiple credit cycles. Even though new private debt managers are springing up like mushrooms, he said some would be in for an “eye opener” when the real downturn comes.
“One of the things that I think in lending that is important and underappreciated is the ability to restructure a borrower when they can’t pay you back according to the terms… [which] is somewhat rare today,” he said.
“We’ve been in a zero interest-rate environment for 15 years, and a relatively benign default environment for a long, long time, and that expertise just isn’t there to the extent that I think is warranted when we go into a more severe downturn.”
There are attractive opportunities in smaller sized private credit deals, Breazzano said, even though the average ticket size is getting bigger as the asset class grew to a trillion-dollar industry.
“For the big players, [smaller deals] didn’t move their needle, and you could get a significant yield premium in a smaller transaction for the same credit risk.
“It was just slightly less liquid. And the big players – the asset gatherers – just couldn’t participate.”
The only parameters the fund manager has is, one, only investing in companies with sustainable, predictable cash flows; and two, avoiding oil and gas companies in the energy, mining and property (EMP) sector.
“We can’t lend money to companies where their fortune is predicated on a commodity price that’s impossible to predict,” he said.
“We run relatively concentrated portfolios, less than 100 names, so we know what we own, and we don’t dilute our performance in our portfolio by buying secondary and tertiary names that we’re less confident with.”
This article was updated to reflect that David Breazzano started his career in 1980, not 1985.
