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New institutional investor insights

Diversification is our highest-conviction idea. Institutional investors need to broaden market exposure to more opportunities and risks to reach long-term objectives in today's low-yield environment.

Best idea
  • Lending strategies that are focused on a diversified set of industries in defensive sectors, such as health care, business services, software-related technology and industrials.

Private credit

Opportunities and positioning

The asset class continues to be a good match for long-term investors, especially those with long-term liabilities. It’s worth noting that while generally less liquid than publicly listed assets, private credit offers a premium for this illiquidity.

When the next economic and broad market downturn inevitably arrives, we believe senior middle market loans could provide investors access to attractive yields from relatively conservative assets with inherent downside protection.

We remain focused on defensive sectors, such as health care and technology, while avoiding lending to borrowers in industries reliant on commodities and heavy cyclicals. We think it is essential for investors to partner with top-tier private equity sponsors with decades of successful experience investing in the same industries.

A secondary market for private credit fund interests is emerging due to the growth of private credit managers and the enormous interest in the private debt space over the past several years. Given the current income dynamic of these investments, we think this market could develop significantly over the next several years, offering opportunities for large institutional investors seeking to diversify their portfolios.

Even at this late stage of the cycle, there is a case for an allocation to mezzanine debt in a private credit portfolio provided it meets our strict lending parameters. This can position the portfolio for value and yield opportunities in the coming phases of the cycle.

We see more opportunities in the U.S. than in Europe. The maturity of the U.S. market allows direct-lending managers to be highly selective and hand pick the very best deals for their portfolios. In turn, investors have access to better market dynamics and more conservative assets.

Risks to our outlook

In the current market, we have seen more aggressive structures typically found in the larger broadly syndicated loan market continue to creep into the upper middle private market, such as covenant-lite loans. Given the increased competition for middle market loans, we are also seeing credits being underwritten with weaker overall credit profiles. We believe these trends will continue until there is some sort of credit event that gives lenders pause.

From an industry perspective, the increased importance of scale will drive smaller managers to larger, more diversified platforms. Merger and acquisition activity will continue to grow in private debt as the costs to compete for deal flow and support the required infrastructure will make it challenging for these smaller managers.

Portfolio context

Broad allocations to alternative, less liquid assets should be maintained in accordance with a portfolio’s long-term investment objectives.

Among a portfolio’s alternative exposure, capital currently reserved for, but not committed to, private equity is likely to be better rewarded on a riskadjusted basis in private credit for 2020 vintages.

While we continue to see select opportunities in mezzanine debt, in most cases we recommend that investors stay senior in the capital structure and increase their average credit quality given riskadjusted spreads. Senior mid-market private credit should outperform more junior, subordinated paper over the coming quarters given an expected uptick in default rates.

We like sourcing spread duration and security selection risk in private credit. The asset class provides clear access to manager skill as they leverage relationships in the origination process, improve credit selection through in-depth credit analysis and have room to negotiate favorable terms and bond structures.

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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 numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. 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 that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

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. Foreign 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. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria excludes securities of certain issuers for non-financial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. 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 suitable 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.

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