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FEATURE: Taking Measure Of The Hunt For Yield In Private Credit

Tom Burroughes

13 February 2017

There is a hunt going on among wealth managers - a hunt for yield. And that pursuit has seen a surge of interest in what might be loosely dubbed private credit. 

Family offices, private banks and other advisors to the wealthy, sometimes less inhibited in exploring more esoteric asset classes than rule-bound pension funds and retail investors, have been among the early adopters. Family offices, for example, often come up in conversation when managers of private debt funds talk about money-raising pitches.

Certainly, the demand for yield in an ultra-low interest rate environment is encouraging shifts into areas such as peer-to-peer lending, SME-related finance, and into funds that offer debt of varying maturities and sizes in a world where banks have retreated to the sidelines, at least for the moment.

“It seems that everybody is interested in it,” Mark Fitzpatrick, managing partner at Glide Capital, a Miami, Florida-based firm focusing on areas such as private loans, told Family Wealth Report. “Our business is going out there and finding family offices, RIAs and others that want to add private credit to their portfolios but who don’t have the teams to do it.”

“We like small business lending and real estate lending,” he said. Maturities of loans tend to be measured in months, not years. 

An issue, however, is that with some wealth managers leaving large banks in recent years and heading to RIAs and setting up on their own, they lack some of the old information and depth of data to help source new deals for clients, which is where a firm such as Glide, and its ability to due to the necessary due diligence and analysis, comes in, Fitzpatrick continued.

Private capital - a term that can cover debt, equity, real estate and infrastructure - is on the rise. Relatively illiquid compared with listed stocks and widely-traded credits, the premium that investors are paid for such illiquidity is attractive because interest rates are on the floor . Data from Preqin, the research firm, points to the trend. Through 2016, 130 private debt funds secured an aggregate $92 billion in investor commitments, falling from $97 billion raised in 2015, but is greater than in any other year since 2008. 

According to figures from the Alternative Credit Council and Deloitte in 2016, the private credit market grew from $440 billion in 2015, to $560 billion . In Europe, a boost is coming from institutional capital. In the US, the sector is by far the largest, in terms of total size and new assets raised. The research found that most financing is going to businesses with pre-tax profits of $10 million or more. Most loans are greater than $5 million in size and half are in the $25 million-$100 million range. In comparison, bond market financing, a common form of non-bank finance for larger corporates, is in the $100 million-$300 million range.

Private credit covers a multitude of channels including areas such as peer-to-peer lending platforms where conventional banks are taken out of the equation. This whole area is sometimes dubbed “alternative finance”, attracting the interest of the wider financial industry, and regulators. In the case of the latter, a concern may be that this is an area yet to be fully tested by a recession.

A number of participants operate in this market and one theme has been of how former bank employees have, since the 2008 financial crisis, taken their skills from large trading floors to create their own boutiques. Examples include the likes of Firebreak Capital and BroadRiver Asset Management . 

Can a good thing last?
A thought that comes up is that if there is a weight of money that eventually comes in from large institutions such as pension funds and life insurers, the influx of demand is going to force down returns, encouraging more strategies and push investors up the risk curve, leading potentially to disappointment and a period of lackluster performance. The hedge fund industry saw big institutional inflows over a decade ago, and a relatively feral beast turned into a domestic tabby cat. Could the same process repeat itself?

“When you see pension funds and others get into this you are going to see more pressure on this space,” Bob Press, founding partner, TCA, told this news service. For example, the TCA Global Credit Master Fund, one of the TCA offerings, is a predominately short-duration, absolute return fund specializing in senior secured lending and advisory services to small-caps located mainly in the US, Canada, Western Europe and Australia. 

“We have capacity constraints on everything we do. We know that strategies can’t be run above certain levels,” Press said. 

Wealth houses have definitely got a strong appetite for private credit, as demonstrated by the number of family office organizations at a recent US conference attended by Elissa Kluever, of Omni Partners, a specialist investment house with offices in California and London. Kluever is a partner and MD, credit & lending funds, based usually in the UK. “What I saw was a lot of interest in private credit from single family offices, multi-family offices, wealth managers in attendance, thinking of how to enter this space and grow exposure in a thoughtful way,” she told this publication. 

Omni has rolled out a number of funds in the private capital space, getting interest and capital from family offices along the way. “They are desperately seeking yield without taking undue risk,” Kluever said.
Traditional areas of credit, including municipal bonds, have seen yields come under pressure, encouraging a push into the private space, she said. 

“Family offices tend to be early adopters,” she said. Her firm continues to launch a fund focused on this market each year.

Asked about whether yields might be compressed if the asset class goes more “mainstream,” Kluever responded: “I’m convinced that a wall of money will come.”

Small- and medium-sized enterprise lending has the most potential to attract big institutional money; already returns on such credit on the safer end of the spectrum are starting to come down toward the 4-5 per cent range, she said. Family offices and other wealth managers could be encouraged to look to other areas, such as commodity trade finance, intellectual property, litigation finance and other sectors that aren’t as scalable,” she continued.

An issue for any investor is to realize that private credit is relatively illiquid and participants must beware liquidity mismatches of the sort recently highlighted when a number of UK-based commercial property funds shut their doors to redemptions immediately after markets were hit by the UK’s Brexit vote last June, she said. “Education is a big piece of what we do and we’re on an early journey on this,” she added. 

“The drivers of we have seen over the last three to five years haven’t changed much,” TCA’s Press said, referring to the departure of banks from some forms of business and personal lending. The interest rate environment remains as it is, he added.

TCA’s strategies are very specific with a focus on relatively short-term loans. One of its strategies, for example, targets a loan size of $1-5 million with a net return to investors of 8-12 per cent seeking a duration of mainly one or year or less; another product TCA looks to ticket sizes of $5, $10 and $15 million returns fall into the range of 15-20 per cent over maturities out to 2 to 3 years, but with a slightly different profile.

There seems little doubt that private credit is seen as a potentially busy area for wealthy clients seeking yield. As is so often the case, the early-adopter investors look set to be among the winners and it may be that the party will start to get crowded once the big institutional players come through the door