This is a sponsored article from Blackrock.
In an age where stock market volatility and geopolitical risk go hand-in-hand, savvy investors turn to income generating instruments to manage risk and diversify returns. Given this dynamic, it is no wonder the world of private credit is growing quickly, with institutional and high net worth investors turning to this asset class for diversification benefits, downside protection and favourable yields.
With private credit fundraising activities exceeding US$100bn for the fourth consecutive year in 2018 and global AUM hitting a record US$769bn as at June 20181, the private credit market runs deep. In addition, studies indicate that investors are well below target allocations to private credit on average and a third of investors plan to commit more capital over the next 12 months2.
Delivering attractive risk-adjusted returns
Private credit is credit extended to companies or projects on a bilaterally negotiated basis and is originated or held by lenders other than banks. It is usually not publicly traded and investors demand a premium for its unique structure, complexity and illiquidity. The illiquid feature of private debt means it is best delivered through a lock-up fund structure.
Private credit encompasses a wide range of strategies, all focusing on different part of the capital stack from senior to equity. While some private credit strategies seek to maximise risk-adjusted returns, the majority focus on downside protection and aims to deliver a steady income stream.
Private credit strategies and their risk / return objective3
The Global Financial Crisis was a major turning point for the private credit market. Capital restrictions and regulatory shackles severely limited access to bank credit, creating a supply-demand imbalance for capital. This glaring gap in the lending market was quickly taken up by asset managers and owners, drawn to compelling risk-adjusted returns on offer and enhanced income.
The higher returns available in private credit markets (compared with public credit) are well known; what is less known is the improved downside protection. This is driven by the bilateral nature of private credit and the customized structuring which goes into every deal. A private credit lender looks to be “senior secured” and target collateral as well as multiple covenants for protection. Though there are similar default rates between public and private credits, recovery rates are higher in private markets4.
So where does private credit sit within a portfolio? There is a growing consensus that credit should be a stand-alone asset class within an investor’s portfolio and, within that credit bucket, private credit plays an important role.
For those investors who have not yet taken that approach, private credit is being turned to for various reasons. The addition of private credit to a traditional fixed income portfolio can generate a higher yield by harvesting the illiquidity premia that accompanies private credit while gaining access to differentiated exposures that promote greater portfolio diversification.
For private equity investors, private credit can help dampen volatility while maintaining private equity-like returns. It is a valuable j-curve management tool with the benefit of immediate income and shorter fund duration; the average lock up is 5 to 7 years as opposed to 10 to 15 years for private equity5. This allows private credit investors to turn over funds two or three times over the course of a private equity lock up.
Where are the opportunities today?
Private credit is increasingly in the headlines due to the rapid growth in the asset class – fast approaching US$1tn6. The competitive nature of the industry has led to concerns of a decline in yields and credit quality. In certain areas we see the growth of covenant-light lending, though the market and opportunity continues to grow and there remains compelling risk-adjusted investments.
BlackRock follows a three-pronged approach to stand out and deliver higher returns: focus on middle-market senior loans not backed by sponsors; bilateral deals with higher pricing and stronger covenants; and more complex structured loans for companies without strong earnings history.
In developed markets, there are opportunities to lend into complex situations or to source deals from less competitive channels. Asia is an interesting market that remains less competitive from a private credit perspective. The higher growth rates we see in Asia creates strong demand for credit and a supply-demand imbalance provides compelling investment opportunities.
Hands-on private credit management
Private credit has delivered superior returns and yield, regular income and portfolio diversification in recent years7. The value-add that an asset manager brings is in the ability to originate and source original deal flow through extensive industry relationships; underwrite complex deals efficiently and effectively; and closely monitor them through a systematic risk management process.
As the world’s largest asset manager8, BlackRock is well positioned to do precisely that.
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In our next article, we will discuss the public market strategies that are available to seek alpha in an expanding alternative investments universe. Please click here to revisit our previous article on “Navigating investment opportunity as tide turns towards alternatives”.
2 Source: Preqin: ‘Alternatives in 2019’ report, as of December 2018. For illustrative purpose only. There is no guarantee that any forecast made will come to pass.
3 Source: BlackRock, March 2019. For illustrative purposes only. This information demonstrates, in part, the firm’s Risk/Return analysis. This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
4 Source: US Private Capital and BlackRock capital market observations as of 30 September 2018
5 Source: AIMA, BlackRock, as of December 2018
6 Source: Preqin: ‘Alternatives in 2019’ report, as of December 2018.
7 Source: BlackRock, as of March 2019
8 Source: Pensions & Investments, June 2018. As at 31 December 2018, BlackRock’s AUM totaled US$5.98 trillion.
In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.
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This material is provided by BlackRock and is intended solely for informational or educational purposes. This material and the information provided herein must not be relied upon as a forecast, research, investment or financial product advice and is not intended to be (in any manner) a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 2019 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.
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This is a sponsored article from BlackRock.