Opening the door to the diverse world of private credit

Private credit – historically seen as a niche asset class – has grown significantly in recent years and now represents an important source of financing for smaller companies that are unable to access traditional lending channels.

Indeed, the rise in non-bank lending is expected to continue. From $875 billion in 2020, total assets under management allocated to private debt are expected to hit $2.3 trillion by the end of 2027, increasing at a faster rate than alternatives overall, according to forecasts by Preqin.¹

Drivers of Private Credit Growth

The growth of private credit has been driven by a number of factors. In the aftermath of the global financial crisis (GFC) in 2008/9, the combination of tighter regulation and greater risk aversion has led banks to retreat from tailored lending. Non-bank institutions have stepped into this gap, providing flexible and customised loans to companies.

In a world of zero-interest rates and low bond yields, investors have also been attracted to the relatively high income on offer from private credit, compared to public assets. The potential for diversification benefits from a typically uncorrelated and relatively less volatile asset class has also fuelled demand for private credit.

As the market evolves, the investor base Is broadening from the traditional institutional investors. Accessibility is improving and new fund structures are opening the doors to potential opportunities across the private credit spectrum. 

Private credit and higher rates

A distinctive feature of the private credit market is that most of the lending is floating rate. The asset class has therefore helped provide investors with protection from the aggressive interest rates that have taken place over the past two years. 

One of the challenges of a higher interest rate environment is generating a sustainable real income. Private credit could offer a viable solution to both long term and near term needs with a level of “insurance” embedded via a two-way duration neutrality. 

On the upside real income is preserved from rising rates due to the floating rate nature of the underlying assets with a strong historic positive correlation with inflation. On the downside the income stream is often protected by the presence of zero-minimum, rate-fixing floors, providing a source of extra value in the face of low or even negative rates, ensuring nominal income is not eroded by negative rates.

Higher borrowing costs could also put pressure on corporates but here too private credit could help investors steer through a potentially challenging time. Many corporate and consumer borrowers entered this inflationary period in fairly decent shape at a fundamental level, although it is possible that with a return to more ‘normal’ base rates away from zero levels, the higher interest obligations could trigger a wave of defaults in weaker companies. 

However, this is a sophisticated universe and many of these companies have successfully refinanced shorter term liabilities, so could be prepared for the near-term higher funding costs.

These shifting macroeconomic and market conditions highlight the importance for private debt investors to remain forward looking, continually reassessing the evolving nature of risk factors, and most importantly taking a prudent approach to credit selection. Ultimately, careful credit selection is crucial to sustainable value creation when lending to companies which are often lower quality and smaller. 

A diverse source of income 

One of the main reasons that investors have considered an allocation to private credit in their portfolios is that it is a diverse asset class that can offer flexible exposure to alternative and differentiated types of income-bearing assets. 

With careful sourcing and structuring of debt instruments, investors do not necessarily have to take on undue risk to get well rewarded and improve their overall risk-adjusted return potential.

However, it is still important to consider what areas are adequately developed, provide diversification to an investor’s unique risk factors, and can generate a healthy yield pick-up relative to public market assets. At present, with ‘all-in-yields’ of around an estimated 10% available, private credit can represent a potentially attractive investment opportunity.

Beyond providing a potentially attractive source of risk-adjusted returns at a premium to more liquid public counterparts, private credit usually offers lower correlation to other asset classes and in turn lower mark-to-market volatility, particularly in downturns where correlations tend to increase. The returns are not contingent on short-term macroeconomic dynamics nor price returns; most private assets are held to maturity and benefit from long-term allocated capital from the investor base. 

The M&G Corporate Credit Opportunities ELTIF: A simple and diversified approach

A notable recent development in the private credit market has been widening access beyond the traditional institutional investor base. Evolving regulation has improved investor accessibility through the launch of products such as European Long-Term Investment Funds (ELTIFs), a sub-category of EU alternative investment funds. 

The M&G Corporate Credit Opportunities ELTIF, which launched in October 2023, seeks to provide easy and clear access to the expansive toolkit represented by the private credit asset class. The fund has a simple and diversified approach, investing in bonds and loans from across the private credit spectrum. 

With the flexibility to invest in both liquid (senior loans and high yield bonds) and illiquid corporate credit (direct lending and junior loans), the fund has the ability to adjust its allocations and capture value across different market conditions. 70-85% of the portfolio will typically be invested in the liquid ‘bucket’, with the remaining 15-30% in illiquid assets.

The strategy is targeting returns of Euribor +5 6% gross of fees over the medium term (with gross potential yields estimated at 9-10% at the end of October 2023)

Please note that the Fund is illiquid in nature because its investments are long term. For investors, this is an investment that has low liquidity. Fund may not be suitable for Investors that are unable to sustain such a long-term and illiquid commitment. A 10 years holding period is recommended. Where Redemption Requests are not satisfied, the investor may face a longer holding period than foreseen at the time of initial investment. 

Only a small part of the portfolio should be invested in an ELTIF. Target returns are not guaranteed.

Expertise in private credit

Successful investing in private corporate credit requires strong, embedded sourcing relationships with company owners and specialist market participants to source best opportunities. M&G is one of the largest investors in private markets in Europe and the fund benefits from the expertise of a team dedicated to private credit origination, analysis and fund management that can source opportunities across the spectrum. 

While credit selection is a key part of the investment process, the assessment of Environment, Social and Governance (ESG) factors is also integrated into the process. One of the benefits of private credit is that lenders often have close relationships with borrowers, which enables better monitoring, transparency and in some cases influence. Lenders are in a good position to engage with companies on ESG matters, encouraging them to consider ESG issues or even embed them in the terms of the private debt deal. 

A new solution 

As an ELTIF, the strategy enables wider access to private credit instruments that have historically been out of reach of all but the largest investors. This is part of the process of “democratising” private assets, opening the door to the attractive opportunities in private credit and private equity through new flexible and liquid fund structures. 

For instance, the fund will offer monthly liquidity for subscriptions and quarterly for redemptions (subject to notice periods)². There is no delayed drawdown period, with subscriptions invested on day one. The M&G Corporate Credit Opportunities ELTIF has a 50 year life which may be extended by up to 1 year.

These features mark the strategy as a clear and simple yet innovative solution that helps investors access an exciting and growing asset class. 

¹ Please refer to ELTIF redemption policy for further details about procedures and conditions for redemptions
² Preqin, “Global report 2023: Private debt”, (preqin.com), January 2023. [Quoted here: Private credit: A diverse and versatile toolkit for investors (mandg.com)]

 

This is a marketing communication. Please refer to the prospectus before making any final investment decisions. The views expressed in this document should not be taken as a recommendation, advice or forecast.

For Investment Professionals only. The distribution of this document/email/report does not constitute an offer or solicitation. Past performance is not a guide to future performance. The value of investments can fall as well as rise. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and you should ensure you understand the risk profile of the products or services you plan to purchase.