What is Private Debt
The private debt asset class primarily represents directly originated senior or mezzanine lending to middle market companies and real estate investors. It also includes opportunistic special situations and sector specialist strategies, for example in the healthcare and technology sectors, which may offer more attractive risk-adjusted returns. Private debt is an asset class within our Private Markets offering.
An Attractive Environment for Private Credit
In the aftermath of the global financial crisis, the deleveraging and increased regulation of banks resulted in significant opportunities in private debt as banks all but abandoned complex categories of lending given high regulatory capital requirements.
On the back of the bank failures in early 2023, meaningful deposit outflows from regional banks that have historically served middle-market borrowers and increased regulatory scrutiny are significantly hampering credit availability. Lending standards are tightening at small and medium-sized banks with corresponding shrinkage in loan books. This funding gap allows alternative lenders to step in to provide debt financing at a higher cost than would have been available from the banks. Larger borrowers are also struggling to access their traditional funding sources and are instead approaching direct lenders for debt financing.
Improved pricing reflects higher rates, lower capital availability and greater uncertainty
Higher Interest Rates
- Floating rate loans benefit from rising rates
- Rate impact on equity valuations makes non-dilutive financing attractive
- Higher interest rate floors in new deals
Higher base for returns
Limited Available Capital
- Withdrawal of central bank liquidity
- Tighter regulatory environment, increased bank scrutiny
- Lower syndicated loan issuance
- Fewer CLO buyers
- Lower refinancing activity
Increased negotiating power
Greater Uncertainty
- Higher input costs (wages, energy)
- Rising debt service
- Historically high leverage levels
- Limited interest rate hedging
- Defaults expected to rise in public and private market
Higher spreads
Partners Capital Approach To Private Debt Investments
Private debt offers a complexity and illiquidity premium on top of expected liquid credit returns. Private debt strategies typically include a high level of contractual return and a significant margin of safety from substantial equity subordination and asset coverage (low loan to value ratios), as well as tighter legal and structural protections than are typically available in liquid credit securities.
Institutional investors as a whole lag behind what we consider to be the optimal participation level in private debt, creating attractive supply and demand characteristics for those who have established access to many of the leading direct lenders and who have demonstrated an ability to identify and back emerging managers and niche strategies in the space.
We seek asset managers who have invested across multiple credit cycles, and who have a deep fundamental credit skillset with the structuring and workout capabilities to protect capital over the full cycle. As we have seen significant capital flow into the more “vanilla” parts of private debt such as corporate direct lending, we have increasingly focused on more specialised or less competitive areas of the market such as lending to healthcare and technology companies, lending to small businesses (through the US Small Business Investment Company program), real estate debt or construction financing, less liquid areas of structured credit and other niche/specialist lending strategies.
Our best ideas are captured by our private debt vehicle. The evergreen pooled vehicle has invested in over 50 private debt and uncorrelated strategies since inception in 2012. We also offer bespoke specialist mandates in private debt for large clients.
Case Study
In 2022, we invested in a healthcare lending strategy that provides capital to medium and large-sized life sciences businesses. The strategy provides capital to mature companies that have commercial stage products and predictable cash flows, avoiding early-stage companies that are subject to product approval and regulatory risk. The strategy focuses on downside protection, achieved through bilateral transactions with multiple tight covenants, low loan-to-value ratios, and often benefits from hard assets as collateral such as manufacturing facilities, specialist equipment and real estate. These companies exhibit resilient characteristics, as evidenced by the healthcare sector having the lowest default rate of any other industry sub-sector within the leveraged loan market over the past 25 years. The investment is further supported by secular tailwinds in the industry, namely an ageing population and increasing R&D expenditure, which is expected to lead to a significant financing need for these companies. The attractiveness of the opportunity set for the strategy has further improved over the course of 2022 as companies have been reluctant to raise capital through dilutive equity raises during a period of lower valuations, turning instead to debt capital solutions.
