6 min read 29 Nov 21
We explore three key themes that are helping to shape the present and future investment landscape for private credit. These multi-year themes highlight how the asset class is continuing to evolve and adapt in response to growing appetite from new and existing investors, as they look to diversify their portfolios and achieve their investment aims and objectives over the longer term.
The next generation’s capital is here, and it is more environmentally- and socially-conscious than ever before. Many believe we are going through a paradigm shift in investing, with the swing to sustainability being profound, urgent and irreversible. Public markets are evidently more advanced in terms of implementation, however the momentum in ESG these days in the private world is just as remarkable and palpable.
Private assets are well-suited to sustainable lending, in our view, as they can help to finance some of the solutions to the problems that the world is facing today. There are certain private credit strategies, like infrastructure debt and social housing, that can provide investors with an opportunity to invest in assets – including social infrastructure assets like schools and hospitals, or energy generation, heat and mobility – that naturally benefit from the momentum in key ESG and sustainability trends like decarbonisation, poverty alleviation and economic inclusion. Private financings can frequently be for specific projects with a narrow and defined purpose or involve lending to smaller companies that allow for the more precise targeting of capital – making them highly suitable for a multi-theme impact investment portfolio.
Recent innovations in private credit markets are also helping to drive ESG progress within the asset class. The issuance of ESG-labelled or ‘sustainability-linked’ loans (SLLs) in the leveraged finance market is emblematic of the way private companies are embracing change. While this appears to be a step in the right direction, the lender community must be assertive to ensure that hurdles set by borrowers and issuers when linking pricing to sustainability targets are meaningful and that the sustainability-linked feature is evidence of a proper framework, is relevant and is truly testing a company’s ambition.
While private lenders are helping to move the dial on ESG in private markets and encourage borrowers and issuers to adopt more sustainable practices via systemic and structured engagement, it is important to recognise that most private assets can suffer from a lack of robust and consistent data disclosure, including reliable data on climate risks.
This means encouraging borrowers and issuers to broaden their disclosures, including their future short, medium and long-term targets. In addition, private lenders are finding novel ways in which to rise to the challenge around ESG disclosure and data availability in private assets – including the development of big data initiatives.
Data is at the heart of investment and analysis across all asset classes. When it comes to private credit, private lenders are dealing with often complex investments, and lack of third-party views or information to invest. Investment is resource-intensive, from origination, due diligence and credit underwriting through to portfolio construction and ongoing monitoring of investments. Assets may also come with substantial amounts of underlying data which can conceal important insights into the risk of an investment, creating challenges.
Yet, the build-out of innovative technological solutions and sophisticated data analytic tools that extend beyond the capabilities of off-the-shelf software is turning some of these challenges into opportunities to gain greater insight.
Private lenders are already embracing big data techniques to address the evident gap in ESG data and disclosure in private assets.
Carbonator is a proprietary technology tool that seeks to approximate carbon emissions data across our private credit portfolios. Carbonator does this by utilising machine learning techniques alongside the application of other technology tools and techniques, such as internet data scraping, to generate approximated data points for investments where carbon data is either unavailable or has not been disclosed. The methodology and approach to generate carbon proxy data for a corporate borrower differs from the appropriate methodology for securitisations referencing an underlying pool of mortgages or loans or for real assets – which can be too bespoke to compare in the same way or there may not be obvious public asset comparators. In each case, the proxy data is used to put forward to borrowers, originators and issuers as a starting point for discussion and encouragement to get them to disclose a more accurate number. Innovative technology tools like Carbonator can therefore help to enhance a sustained and systematic engagement programme, and to help private lenders better manage and monitor ESG risk over the lending relationship and across portfolios.
In certain areas of private credit, speed to market can be a crucial point of differentiation. The ability to access, format and process large quantities of data provides a valuable advantage when evaluating purchases of residential mortgages and consumer loan portfolios, for instance. The absolute quantum of data required to perform this analysis is far beyond the capacity of off-the-shelf spreadsheet and database programmes, and proprietary Python-based databases and systems must be built to first store the data before analysing it. The outputs are subsequently used in negotiations to determine which portions of portfolios to include and exclude, and the appropriate price to pay.
While some alternative providers of capital have played to their strengths to build reputation among the borrower community and establish their presence in certain verticals and jurisdictions over the past ten years or so, others have looked to balance this with a healthy appetite for innovation. Taking tried and tested techniques of working in partnership with borrowers to new sectors and markets – as well as new parts of the globe – is helping to create differentiated sources of alpha and beta for underlying investors and build a strong origination pipeline for private lenders to remain highly selective when constructing portfolios.
For example, applying securitisation structures and techniques across multiple sectors and a wider set of private asset types, is leading to more tranching within the different verticals to appeal to different investor bases and target different risk/return objectives. Equally, we are looking to focus on growth potential in the years to come by further expanding into new regions, such as Asia-Pacific and the US. Establishing our origination presence globally is helping to expand the investable universe, and enabling us to build increasingly diverse deal pipelines and portfolios.
Looking ahead, we believe an appetite to come up with new, innovative investment ideas – that have the capacity to scale – is integral to private credit’s ongoing evolution and widening appeal among different types of investors and borrowers.
This article is adapted from our latest paper, The next phase for private credit markets.
The value and income from a fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast.