private_capital

PCG News: Welcome to new investor - Aurora KiwiSaver

Thu, 02 May 2024 22:58:02 GMT

PCG is delighted to welcome Aurora Capital as its newest investor into the PCG Diversified New Zealand Private Debt Fund.

Aurora's asset allocation thought leadership will benefit their growing number of KiwiSaver members and provides NZ business with increased access to private debt solutions.

PCG Insights: Relative Value in Private Debt

Tue, 15 Aug 2023 09:43:08 GMT

Market performance data can help demystify the wider asset class and shine a light on where relative value might best be found both in the context of the domestic versus offshore market and more specifically within the domestic market.

The New Zealand Private Debt market has emerged over the past 18 months as a viable capital market funding source for NZ businesses. Whilst the domestic ecosystem remains small, new and unfamiliar to many domestic investors, there is a wealth of information and context available from offshore jurisdictions which can help borrowers and investors to navigate the path ahead in NZ.

Private debt is still considered to be a somewhat homogeneous asset class in the eyes of most NZ investors.

Global, regional or domestic private debt markets, and the differences in risk and reward between each, are only now beginning to come into some degree of focus for domestic NZ investors, many of whom are looking to access the asset class for the first time.

The more fundamental issues surrounding i) investors’ portfolio allocation strategies which are largely focused on a debate between determining an appropriate weighting between public market fixed interest and alternative market private credit and ii) borrower considerations when choosing between traditional bank loans versus a fund sourced private debt deal, masks a far more nuanced analysis which surrounds manager strategies, expertise and the nature of financing each provides.

This analysis additionally draws attention to both the markedly different competitive environments between jurisdictions which can result in a wide range of risk adjusted return profiles and to the divergent approaches adopted by managers all of which has the potential to deliver asset portfolios with a range of underlying performance and risk characteristics.

In general and for yield oriented strategies and investments, it is widely understood that private market assets have consistently outperformed public market assets (refer table below). Within private markets, yield assets specifically, direct lending and private debt (support of sponsor deals) have outperformed leverage loan participation based strategies.

Domestic v offshore markets

Commentators and fund managers seem to be fixated on defining private debt’s positive relative returns or perhaps more appropriately the favourable risk adjusted returns it generates. Globally, and as witnessed by the scale of today’s private credit market (which totals some USD1.5t), private debt’s place as a yield oriented complement to fixed income and cash is now universally accepted.

What is therefore more interesting for investors to understand is how the risk reward of investing in private debt might best be measured between various jurisdictions.

A recent report by Frontier Advisors (an investment consultant) suggests that regardless of the size of a given investment or underlying business, the level of credit spread generated is broadly comparable (Chart 1, below). Moreover, the measure of risk:reward, that is the credit spread per unit of leverage, is also broadly uniform and tends to move within a relatively narrow range over the cycle, even though this is on somewhat of an upward trend at present (Chart 2, below).

Intuitively, this makes sense as it is often the level of leverage in a given transaction which adjusts to reflect market conditions and economic performance more generally.

Chart 1

Chart 2

What is interesting is that with the advent of the NZ private debt market, we can now look to identify the premium available for investing in the NZ market. The presence of a premium might be viewed as the rate which is required to attract an investor into a new jurisdiction or for a domestic investor allocating to the domestic market relative to the larger market offshore.

At PCG, we consider the presence of a premium to be more fundamentally something driven by domestic supply and demand. NZ is populated with SMEs, historically serviced by a concentrated banking market which is now going through a significant change in its capital adequacy framework and a private debt market with limited domestic capacity which is simply either too far away geographically from the established markets of US, Europe (and even Australia) or simply doesn’t fit with the scale issues associated with investing multi-billion dollar funds.

Whilst data points in the domestic market are still limited, our analysis suggests credit spreads in the domestic NZ market range between 600-900 points over the floating rate basis and with modest levels of asset leverage which are significantly below those provided offshore. This translates to a range in return, per unit of leverage, between 200-300 points. These ranges are significantly above those available offshore and, importantly, are all NZD denominated.

Moreover, the domestic NZ market removes the significant issue of currency risk associated with all investment offshore. We consider the discount in returns from investing offshore, and the resulting increased risk of return variance from currency, to be a major disadvantage.

Within the domestic market

We contend that investors should aim to partner with managers that have the ability to be a lead or sole lender.

Credit spreads are consistently higher for managers with genuine origination reach. This means sourcing proprietary deals rather than sourcing an opportunity to join someone else’s (invariably a bank’s) transaction. This factor is demonstrable across jurisdictions and vintages and is perhaps even more pronounced in markets such as NZ where managers have less expertise and experience in managing funds and in understanding the impact which comes with knowing what to look for and why.

Chart 3

Chart 3 illustrates that credit spreads earned by lead and sole lenders have been stronger than those earned by lenders that are simply a participant in a transaction. While the chart shows Australian and Europe focused managers, the same pattern is observed in the US. Consequently, it is highly beneficial for investors to partner with managers that can act as lead or sole lender.

PCG’s portfolio is comprised 100% of loans which we have originated, structured and negotiated. We favour deals where we can control the relationship with management and equity and can determine how to manage the positions which comprise our portfolio rather than having to accept terms created by others who might have conflicts or other interests to protect.

This is critical in situations where an asset may under-perform. Expertise and experience in working out difficult situations talks to marriage of past examples and an ability for decisive decision making.

As the sole lender to the deals we create, we are free from the conficts which can often arise when working in a lending syndicate. We will not accept the risk that, as a participant, we can be dragged along when working with banks or other lenders with incongruent objectives. This is so much more acute an issue in markets such as those throughout Asia Pacific and Australia/New Zealand where there is no secondary market asset liquidity.

As the European market has matured, managers with genuine direct lending skill sets have carved out strong market positions and have capacity to write deals of various sizes which they can fund alone. In Australia, the market has experienced a proliferation and many of the new funds which have entered the market over the recent past have chosen to participate in deals brought to them by other lenders as their primary source of opportunity. We consider this to be a risk with inexperienced managers more generally.

In NZ, private debt managers are often managing funds for the first time. The nuance of strategy and positioning is arguably still forming and there is a sense of trial and error at play.

At PCG, our heritage and expertise is attributable to managing funds for investors over more than 20 years. We have seen the benefits of certain strategies over others and this has enabled us to optimise the positioning of our platform in the domestic market so as to maximise control, returns and origination.

We seek to avoid larger deals in the wider syndic ated market where controls are diluted. Retaining covenants as early warning indicators is central to our risk management. Early action not only maximises recoveries, it enables early remedial action to be implemented and provides a contractual engagement with aligned management and equity investors.

Chart 4

PCG News: KangaNews NZ Private Debt Feature

Tue, 02 May 2023 09:38:01 GMT

Changing Times Unlikely to Halt Private Debt Growth in New Zealand

Private debt has emerged as an asset class globally in line with constraints on banks’ capacity and willingness to lend and as low rates compelled investors to contemplate alternative income asset classes. In New Zealand, higher interest rates are changing – but not eliminating – the return equation while market users say the opportunity set is poised to increase further

PCG Insights: Private Debt - What Do We Mean?

Fri, 14 Apr 2023 10:00:25 GMT

PCG News: Loan-grown - Why NZ Investors are Open to Private Debt

Mon, 06 Mar 2023 02:07:19 GMT

NZ investors are slowly turning on to private debt as an alternative asset class but the pace may pick up in line with global trends, a new study suggests.

PCG News: A Private Debt Market for a Sustainable Aotearoa, NZ

Tue, 28 Feb 2023 18:49:47 GMT

Climate and Energy Finance Group (CEFGroup) 's new report, in collaboration with Griffith University , MyFiduciary Limited , and Private Capital Group , sheds light on developing a private debt market in Aotearoa New Zealand.

The aim of the survey is to understand the opportunities and barriers associated with developing a private debt market in New Zealand, and to elicit respondents’ views on how private debt can support the transition toward sustainability.

Key Takeaways

There is increasing interest in private debt (PD) among both PD and non-PD investors. PD is poised to grow further in the near future.
PD investors have had a good experience to date, and most are optimistic about PD’s growth potential.
In New Zealand (NZ), PD is an under-utilised investment asset relative to the scope to invest.
Main reasons for not investing in PD, among NZ respondents, are lack of experience, lack of liquidity and size of the market.
Compared to the UK, PD market in NZ is still in its infancy, with many investors yet to make their first commitments to the asset class.
NZ respondents prefer more conservative PD instruments characterised by lower risk.
PD investors, on average, are greater advocates of responsible investing.
Respondents, especially those that have had PD investments, think that it is a lot easier to achieve ESG and impact goals in private markets than in public markets.

Authors

Renzhu ZHANG

Strategic Postdoctoral Fellow, CEFGroup

Paul CARMAN

Founder and CEO, Private Capital Group

Ivan DIAZ-RAINEY

Professor of Finance, Griffith University Honorary Professor, University of Otago

Greg PEACOCK

Principal, MyFiduciary

Amanda SIM

Master of Finance Student, CEFGroup

PCG Insights: Loans v Bonds - Opportunity Across the Credit Spectrum

Sat, 03 Sep 2022 10:26:52 GMT

Private Debt (‘Loans’) offers a number of diversification benefits by targeting different parts of the market and borrower profiles compared with public credit (‘Bonds’).

The majority of Private Debt returns are generated through income rather than capital gains and are seen as an attractive source of higher yields, compared with traditional fixed income. Investors use Private Debt as a yield-enhancer within a broader fixed income portfolio and/or a diversifier within an overall growth portfolio.

The traditional investible world is sometimes grouped into very high-level buckets: equity risk, fixed income risk and alternative risk, but these groups are broad and therefore, miss the nuances. Just like we slice and dice the equity world into many different categories; growth, value, large cap, small cap etc, there are many different types of credit income risk.

We think Loans deserve a place in an overall credit allocation. When looking for income, investors should try and find as many sources as possible. It's about diversifying that income with exposure to more than one area of the market. Diversification is so important in credit income, because of that asymmetric risk to the downside. Wherever there’s a chance to diversify into different areas to achieve return objectives, that's a really smart thing to do.

When investors think of credit, they're mostly thinking about the fixed interest market. In our view, investors should look more broadly across credit markets. Private Debt and publicly traded bonds stand at distinct ends of the credit market. Loans contain maintenance financial covenants, numerous undertakings that often entail active on-going lender involvement and amortised repayments. Bonds on the other hand, contain only incurrence covenants, offering the issuer significant flexibility, with minimal bondholder interference and bullet repayments. As such, they are treated as two separate asset classes, with different market expectations and pricing considerations.

The characteristics of Private Debt, including its defensiveness given its place in the capital structure, high risk-adjusted returns, steady income production and the natural liquidity afforded by the short-weighted average life of Loans – compared to longer-dated assets – all help position it favourably relative to bonds. Private Debt can also be a more bespoke solution, enabling greater alignment with corporate and investor goals and a better ability to positively shape the corporate sustainability practices of borrowers. The strategies are well-suited to customisation for investors — such as liability matching or targeting non-financial goals for an investment, like social impact.

The correlation between stocks and bonds over the last two years is the highest since 1995-97, placing serious strain on the 60/40 balanced approach – previously a mainstay of investment portfolios. So, investors may ask how Private Debt fits into investment portfolios? It depends on the investor’s objectives. For instance, Private Debt may be especially helpful in alleviating the pressure that a rising rate environment places on distributions in bond portfolios. Private Debt could be a complement to, or substitute for, income-oriented allocations such as high yield bonds, dividend-oriented equities, or other fixed income. Private Debt can also be used to diversify return streams within a fixed income portfolio

PCG Insights: Flattening the PE J-Curve

Sun, 10 Jul 2022 06:09:00 GMT

As part of a flexible approach to cash management from investments, investors should consider a tactical allocation to Private Debt within an Alternatives portfolio.

Combined with an existing allocation to Private Equity, the consistent income generated from Private Debt can flatten the ‘J-Curve’ effect associated with Private Equity.

The lower return volatility from the contractual and linear nature of cashflows, enables investors to help meet their commitments to beneficiaries (social, impact, institutional), through an allocation to Private Debt. In the following example portfolio, a $50m Alternatives portfolio is split equally between Private Equity (PE) and Private Debt (PD). For simplicity, we assume: a) consistent drawdowns from the GP; b) exits split evenly across the years and; c) re-investment of individual loan assets at the same initial margin.

The PE allocation typically generates a higher return over time but LPs are faced with the associated challenge of managing the timing mis-match between cash outflows to meet capital calls and the receipt of cash from distributions.

In contrast, the PD allocation is immediately cash flow positive. While returns are typically lower relative to PE, it provides a regular and predictable income and cash flow stream with highly attractive risk-adjusted returns.

*Note: the capital investment has been excluded from the cash flow profile to isolate the distribution stream

The combination provides favourable capital gains from PE, which builds capital, and a low variance distribution based cashflow, from PD, which helps investors meet their own liability and distribution needs.

PCG Insights: Diversification in Private Debt

Fri, 01 Jul 2022 03:31:36 GMT

Private debt management is not so much about picking the winners, it's about avoiding losers and minimising their impact if they occur. Diversification is the key to minimising the impact of losers and can be viewed through a number of lenses. In this note, we discuss the importance of diversification by borrower number in a senior risk private debt portfolio.

At PCG, when undertaking fundamental analysis on a potential new investment, the first question we ask ourselves is can the borrower repay us - Are we going to get all our capital back at the end of the loan term? We seek to lend money to businesses where we receive a contractual return in the form of front-end fees and interest payments. If all goes to plan, the initial capital loaned out is repaid at the end of the loan term.

Investment returns can potentially be significantly reduced by a borrower default in a concentrated senior risk portfolio. This is where the initial capital loaned out is not repaid, in full, at the end of the loan term and losses erode portfolio returns. Success in a senior risk private debt strategy is not so much about picking the winners, it's about avoiding the losers and minimising their impact if they occur. How do we avoid the losers? Through rigorous assessment of borrower credit worthiness. Credit risk analysis is critical in identifying then avoiding the losers and is only developed through years of hands-on experience.

How do we minimise the impact of losers if they occur? No matter how well a particular risk is understood, unforeseen events can occur and, depending on the severity, could lead to a borrower default. Not all defaults lead to losses but the impact of loss from default can only be minimised through diversification

The impact of a loan default on investor returns is illustrated through a simple example. In the table above, we present three hypothetical loan portfolios. All portfolios are the same overall size and achieve the same pre-loss return. The distinguishing feature is the number of borrowers in each portfolio: 35/15/7. The risk and return dispersion, across the portfolios, can be seen through the default of one loan.

In a diversified portfolio, the return generated for investors is represented by the excess spread at the individual loan level. The excess spread is the required return above the base return plus an amount to cover any losses - that excess spread is multiplied across the portfolio. Not all loans will suffer from poor performance. In fact, the current rate of non-performing business loans in NZ is about 0.5% (RBNZ: S50 report). Recovery of the non-performing loan principal (through an enforcement of loan security), varies depending on the situation but is generally substantial. With excess spread generated on every single loan, the portfolio generates an excess return that is multiples of the loss that might occur. Diversity helps to ensure that the invested capital is protected and that investor returns are safeguarded.

The relative risk-reward between equity and credit investing is different. In public equity investing, the benefits of diversification diminish beyond a certain number of stocks. That doesn’t apply in credit because of the asymmetric risk to the downside in loans - meaning the value of the loan cannot increase the way a stock might, at maturity we will be repaid par. Conversely, equity values can rapidly diminish whereas debt downside is limited given loan security. We can make consistent returns if we invest in loans which perform but this return will be impacted if losses occur. The more concentrated the portfolio, the greater the impact of any losses.

At PCG, we think in probabilistic terms so we build and manage diversified senior risk portfolios for our investors. Loan selection is important but the stability of returns is maintained through diversification as this diminishes the potentially adverse impact of default.