Finding value in private debt

According to new research, it has become harder for institutional investors to find compelling opportunities in private debt, because there is too much concentration in mid-market corporate lending.

A report by Willis Towers Watson, Finding value in private debt, found that assets allocated to credit strategies have more than tripled between 2007 and 2017. But the firm said too much money is going into one sector, mid-market corporate lending, meaning that investors are missing out on opportunities in less competitive sectors, which could offer better returns.

Willis Towers Watson global head of credit and diversifying strategies, Chris Redmond, said: “As the market widens, its complexities become more difficult to understand, with the majority of institutional investors continuing to concentrate their activities on mid-market corporate direct lending. The result is large capital flows into a squeezed portion of the market, creating downward pressure on returns and upward pressure on risk.”

While most private debt managers focus on ideas where funds can be quickly raised and which are scalable and profitable, Willis Towers Watson said that smaller, niche strategies, which are harder to scale, are more compelling, particularly when compared to higher valuations in other parts of the credit market.

Redmond added: “Investors who are willing to pair with specialist lending teams in specific geographies and assets are ultimately going to derive the greatest benefit in the long term.­­” In the same vein, taking on complexity and looking at asset classes blighted by poor prior performance can be well rewarded, he said.

“Understandably, many investors are unwilling to be a first-mover into markets that have experienced historical performance issues. US residential mortgages are a great example of this. It’s a sector that we believe has demonstrated improved fundamentals whilst delivering excellent performance, both on an absolute and risk-adjusted basis.”