The World of Private Credit (Resize)

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The world of private credit and private debt (Straits Times)

Feb 26, 2024

Q: How can investors take advantage of the growth in private credit?

Private credit, also known as private debt, is a growing alternative asset class. It refers to financing or debt provided by non-bank lenders – so loans, for example, provided by a non-bank investor, often a fund.

Unlike private equity, which many may be familiar with, private credit does not involve owning shares in the target company.

It is part of the large credit universe, explains investment manager Pimco. There is public credit, which can be traded on markets, and private credit, which is not traded.

There is also corporate credit, referring to bonds issued by a company for ongoing operations, mergers and acquisitions or to expand its business. Bonds may be investment grade or high yield. Other forms of credit include mortgages for residential assets and commercial real estate lending, such as for malls and shopping centres.

Private credit includes direct lending, which involves loans to companies. There is also asset-based lending. This includes infrastructure debt, where the funds are used to develop new projects or improve existing assets. Investors can also choose to invest in distressed debt.

In a recent Financial Times article, Mr Shane Forster, the Hong Kong-based head of the Asia-Pacific private finance group at Barings, said Asia is about a decade behind the United States and Europe in private credit fund-raising, though it is starting to catch up.

A total of 38 Asian private funds raised US$10.2 billion (S$13.9 billion) in 2022 for such lending, compared with US$2.2 billion from 34 funds in 2013, said data provider Preqin. Globally, 271 funds raised US$242 billion last year.

Mr Forster said Australia, New Zealand, Singapore and Hong Kong are favoured as their legal frameworks provide more certainty if a firm defaults on a loan. Barings has focused on sectors that can provide “recurring revenue” such as healthcare, education, core consumer staples and food.

Growth of private credit

Private credit started becoming a key alternative source of funding for private companies after the global financial crisis as tighter regulation meant banks reduced lending.

Another reason was the rise of private equity. Private equity investors were keen on the speed and flexibility of these privately negotiated loans versus those issued by banks.

Investors were also hunting for yield as interest rates were extremely low.

Schroders Capital’s global head of private assets Georg Wunderlin is confident the private debt market will keep growing as economies continue to transition from an era of abundant cheap liquidity to an environment marked by more expensive debt costs. Schroders Capital recently established a debt and credit alternatives business.

Private credit from non-bank lenders could come from insurance companies, pension funds, hedge funds, foundations and endowments, sovereign wealth funds and other fund managers.

Better returns, diversification

Investing in private credit can deliver better returns. In a rising interest rate environment, the traditional fixed-income investments – bonds – could struggle to meet return and yield targets. Bond markets in recent times have been challenging, prompting wealthier investors to turn to private credit.

The higher premium partly comes from the complexity in underwriting and structuring these private loans.

Private market investment firm ADDX noted that in 2021, returns for private credit were 9.9 per cent, higher than the 5.28 per cent for the Bloomberg High Yield Bond Index and 5.2 per cent for the S&P/LSTA Leveraged Loan Index.

Investing in private credit can also help to diversify your overall portfolio, with a low correlation to listed stocks and bonds. Private credit also has lower volatility than that of public bond investments.

An International Finance Corporation report noted that the industry has been maturing and there are now knowledgeable fund managers with verifiable track records, making it easier for investors to select managers.

Some examples of private credit investments

Endowus has a private wealth arm that gives access to more investment products, including alternative investments like private debt, private equity and hedge funds.

ADDX offers private credit investments on its platform but investors have to be accredited. This means a yearly income of at least $300,000 or net financial assets of at least $1 million or net total assets of at least $2 million.

An example is the Helicap Fund 1, which lends to under-served individuals as well as micro- to small- and medium-sized enterprises in South-east Asia.

These end-borrowers are underbanked individuals and companies – for example, an entrepreneur in Jakarta needing financing for a motorcycle to make deliveries around the city, or a businessman in Manila who wants to start a grocery shop.

The fund has yielded around 10 per cent in net annualised returns. The minimum investment size on the ADDX platform is US$10,000.

Another investment opportunity on the ADDX platform are tokens with an exposure to the SeaTown Private Credit Feeder Fund. Fund manager SeaTown is indirectly owned by Temasek Holdings. It has deployed investments into secured loans or bonds.

Security tokens are digital securities, using blockchain for custody, ownership tracking, fund earnings distribution and secondary trading. The minimum sum is US$20,000.

A third example is the Azure-Lyte Fund from local fund manager Azure Capital. Lyte is a technology-based payments firm providing the risk and credit management system for the fund.

Azure CEO Terence Wong says the fund has a steady performance, with a 6.5 per cent yield, and is tapping the trend of providing investors with a risk-averse, stable, dividend-paying proxy.

The fund, launched in 2019, is only for accredited investors. The minimum sum is $250,000.

The fund aims to solve the pain points of freelancers such as property agents and salespeople who earn their income from commissions, says Mr Wong.

Take a new property project. The real estate agent seals the deal during the launch but often does not receive the commission until four months or even a year later because while a buyer has paid the deposit, the progress payments system means the developer receives its funds only as the construction progresses. It then pays the property agency, which then pays out the commissions.

“It is faster for resale property and HDB flats as there is a fixed date for completion, but there often is still a gap of two to three months before agents receive their commissions,” Mr Wong adds.

Property agents would welcome being paid earlier as they are already incurring expenses such as placing advertisements, transport and networking ahead of clinching the deal. Salespeople dealing in white goods also face a wait of some months before they get their commission.

This is where Lyte CEO Dennis Goh saw an opportunity to use the data on defaults to assess the risk of factoring – advancing the money for the commissions to freelancers. This would not only help their cash flow, but would also save the agencies from having to manage the payments.

How it works is that the fund’s investors provide the money, which can be advanced to the agents as their commission payments. LytePay pays the agents, using its artificial intelligence (AI) and machine learning to work out the amount, taking into account the risks of these individual agents.

The agents will pay a fee for getting their commissions earlier. So if the commission is $1,000, they would receive slightly less after Lyte deducts its fee. The fee provides the yield for the fund’s investors.

Lyte has inked deals with various property agencies in Singapore and has over 80 per cent of the local market. Another client is Gushcloud, South-east Asia’s largest agency for influencers.

Its access to the large number of transactions and data enables a better estimation of the defaults, which in turn contributes to the stability of the yield, Mr Wong says.

Mitigating risks

Illiquidity is one of the main risks. Lenders will often hold the debt to maturity, so the instruments are unlikely to be traded. It may not be easy to exit a private debt fund as its units may not be traded actively or regularly.

Private credit has various sub-strategies. One of the largest is direct lending, which refers to senior secured loans. In this category, ADDX says that capital preservation can be strong, as there is often recourse to the underlying company’s assets in the event of a default.

In general, private debt lenders have the flexibility to set their preferred lending terms. This means they have more influence when it comes to negotiating and structuring the loan. Apart from arranging for collateral to protect against defaults, they can put in place financial covenants to prohibit the borrower from taking certain actions that could increase the risks for lenders.

Schroders’ Mr Wunderlin says investors should choose wisely, and be patient, since there are many opportunities, and returns are generous.

Investors should also look out and make sure their mandates have flexibility. This means the fund manager has the flexibility to capture different opportunities during the cycle.

Bottom line

Private credit opportunities are open only to accredited investors but it may be useful for all investors to bear in mind the trend towards investments in private markets.

Investment involves risk. Past performance is not necessarily a guide to future performance or returns.

The value of investments and the income from them can go down as well as up, and you may not get back the full amount you invested.

If you are in doubt, you should consult your stockbroker, bank manager, solicitor or other professional advisers.