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Alternative credit
The case for investment grade private credit
Long a core allocation of life insurers portfolios, broader segments of institutional investors are recognizing the benefits of investment grade private credit. Originally concentrated in private corporates and infrastructure debt, investment grade private credit now includes more specialized areas such as credit tenant loans (CTLs) and esoteric private asset-backed securities (ABS).
Benefits of investing in investment grade credit
Diversifying a fixed income portfolio by adding investment grade private credit could offer meaningful portfolio benefits to investors. These benefits include the potential for yield enhancement, credit diversification, and greater downside protection.
Potential for enhanced yields owing to spread premiums over comparable public fixed income investments (exhibit 1).
Credit diversification may be achieved by gaining access to unique opportunities that are only available in the private markets. Strong relationships with agents, brokers, and issuers enable investors to access bespoke deals that provide portfolio diversification away from public corporate credit. Furthermore, there is a heavily negotiated transactions process which allows investors customization of deal terms to aid with portfolio needs.
Greater downside protection vs. public fixed income due to strong structural features that are inherent to the investment grade private credit market. Covenant protections support lower rates of loss and better recovery in significant credit-related events and provide an avenue for active dialogue with issuers early in the process.
Benefits of diversifying within investment grade private credit
Diversification within a investment grade private credit portfolio is not only prudent given where we are in the credit cycle, but it could also offer additional meaningful benefits. These benefits include enhanced spread premiums and a differentiated risk profile.
Enhanced and stabilized spread premium vs. private corporates. Investing in a diversified portfolio of investment grade private credit will enable investors to generate a higher spread premium compared to a traditional private corporate portfolio. Higher relative value in ABS, CTL, and infrastructure debt transactions results from a variety of factors including compensation for illiquidity and complexity. Additionally, investors can capitalize on market dislocation and achieve greater spreads during times of market volatility thus reinforcing the benefits of a consistent allocation across sub-sectors through all cycles.
Improved risk profile. With recession fears looming in 2024, it is prudent to not only maintain credit underwriting discipline, but also to consider shifting from credit risk to structural and complexity risk backed by high-quality collateral through investments such as private ABS and CTLs. Complexity stems from the unique and more esoteric nature of the collateral, as well as the intensive structuring process of the transactions, which, taken together, can create a more resilient portfolio in a downturn. Further, infrastructure debt, often seen as a complement to corporate credit due to its differentiated risk profile, is less credit sensitive and has built-in inflation protection. Sector tailwinds such as the Inflation Reduction Act in the United States, which incentivizes clean energy production and associated domestic supply chain, provide further benefits to diversifying with infrastructure debt.
Risk considerations of investment grade private credit
While the potential benefits of a diversified portfolio for insurers are clear, investing in investment grade private credit carries risk consistent with investments in other fixed income asset classes. Key considerations specific to these assets are:
1) Liquidity risk — while this is inherent in private markets more than publics, these assets are typically considered a buy and hold strategy.
2) Credit risk — often with only one rating from an external rating agency (or none), extensive research and disciplined underwriting is required.
3) Structural risk — structural protections, such as the debt’s seniority, covenants, and collateral need to be appropriate for the deal’s success.
4) Complexity risk — from sourcing and analyzing potential deals to negotiating and exiting investments, the unique nature of each opportunity requires specialist knowledge and skills.
5) Default risk — while covenants and deal structure can provide protection and reassure investors, all debt carries the risk that companies may not fulfill their repayment obligations.
The outlook for investment grade private credit
In our view, demand for investment grade private credit will continue to grow, even in the face of challenging credit environments, as investors seek an attractive spread premium to publics while diversifying portfolio risk.
We expect a robust pipeline of investment opportunities to persist across each sub-sector of the investment grade private credit market. Many issuers who may have been on the sidelines will need to access capital to refinance existing debt or source capital for strategic business objectives. Additionally, as banks continue to pull back lending in certain areas and look to manage their balance sheets more tightly, we expect increased interest from issuers to explore the private market, particularly in private ABS.
How Nuveen brings value to our clients
As an investor in the private placements market for over 50 years, Nuveen manages a current portfolio of $64+ billion across private corporates, infrastructure debt, credit tenant loans and ABS1.
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1 AUM is as of 31 Mar 2024
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors. The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on factors such as market conditions or legal and regulatory developments. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions made in preparing this material could have a material impact on the information presented herein. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. This information does not constitute investment research as defined under MiFID. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy. Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. This information does not constitute investment research as defined under MiFID.
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