Future of private November 2019 • privatedebtinvestor.com

How diversity will define the next generation

Contents

How to contact us

Senior Editor Andy Thomson [email protected], +44 20 7566 5435 Special Projects Editor James Linacre [email protected], Future of private debt +44 20 7566 5465 Americas Editor Andrew Hedlund ISSN 2051–8439 • NOVEMBER 2019 [email protected], +1 212 633 2906 News Editor John Bakie [email protected], +44 20 7566 5442 Reporter Adalla Kim Insight [email protected], +852 2153 3874 Contributors Claire Coe Smith, Rob Kotecki, Vicky Meek, 2 David Turner Key trends Five topics to be on top of Managing Editor, Production: Mike Simlett Head of Production: Greg Russell EDITOR’S LETTER Change is coming 6 Production Editors: Daniel Blackburn, Adam Koppeser Copy Editor: Eric Fish Head of Design: Miriam Vysna Analysis Senior Designer: Lee Southey Designer: Denise Berjak Head of Marketing Solutions: 8 Beth Piercy [email protected], +44 20 7566 5464 Private debt in transition? BlackRock’s A tour of private debt in Asia Views Subscriptions and reprints Stephan Caron on the trends to watch in [email protected] private debt on market developments in five nations in Customer Service the region 34 [email protected] What’s coming next? The market’s A wealth of opportunity There’s more Editorial Director: Philip Borel leading lights give their predictions 11 to Europe than direct lending, says Director, Digital Product Development: Amanda Janis Ready for anything EQT ’s Paul William Nicoll of M&G Investments 38 Director of Research and Analytics: Dan Gunner Johnson underlines the importance of a Going public-to-private How does it Head of Investor Research: Nicole Douglas defensive portfolio 14 work and how is it different to a private Managing Director, Americas: Colm Gilmore Making diversity happen The industry’s acquisition? 40 Managing Director, Asia: Chris Petersen diversity deficit requires broad action 16 Group Managing Director, Brands and Markets: Maintaining discipline in private debt Paul McLean Breathing life into ‘sponsor-less’ deals Fiera Private Debt on why managers may Chief Executive: Tim McLoughlin Interest in the ‘lower end’ of private debt look to lower lending standards 42 is going to pick up, say the EIF’s Francesco Battazzi and Marco Natoli 18 Faces of the future PDI’s Rising Stars come out to play 44 How private debt is being reshaped Our roundtable panel on competition, the Evergreen interest grows Evergreen credit cycle and diversity issues 20 funds have broad appeal, says Northleaf Capital Partners’ David Ross 46 What’s new in the Irish ILP Act? New bill should appeal to investors and managers, More is needed Tackling the lack of says SANNE’s James Kay-Hards 28 diversity is long overdue, says GLAS’s co-founder 48 The way forward in the US Three keynote speakers from PDI’s recent New Investing in late-cycle European private For subscription information visit York Forum share their thoughts 30 credit Barings’ Adam Wheeler on the privatedebtinvestor.com importance of risk management late Lower mid-market myths and in the cycle 50 misconceptions It’s all about credit fundamentals, says Tree Line Capital Funds in market Where are they focusing Partners’ Jon Schroeder 32 and which are the biggest? 52

November 2019 • Future of Private Debt 1 Face the future From growing The top three strategies are subordinated/mezzanine debt, markets to staff diversity, here are distressed debt and senior debt, with small allocations to venture debt, CLOs five private debt trends to track and others. Two-thirds of funds in the market are focused on corporates, with 22 percent looking at real estate and the redicting the future can be a precarious exercise for any asset class, writes James remainder focusing on infrastructure or a Linacre. But, in these uncertain times, the ability to anticipate bumps on the road diversified approach. Pahead is more important than ever. Innovation and new technology are entering the industry, so managers and service Private debt is developing in providers must find new ways of working to unlock new opportunities. But it is not just Asia-Pacific technology that is changing – cyclical changes are on the horizon and macro threats are “Asia is not a growing. monolith,” as Allianz It is all change once again in private debt. Here are five key things to bear in mind. Global Investors’ Sumit Bhandari It’s not just about notes. “You have a the US lot of countries North America may well be with different credit and business the most mature market – cycles and each of them is growing and the biggest – but there differently.” is so much more to private The large Japanese pensions have credit, which is truly a global stepped up their activity markedly, while asset class. Europe and Asia are both on there are also developments across the the rise. likes of South Korea, Singapore and While most capital in the US comes India, but China is particularly interesting from non-bank lenders, Europe is still “ Lower mid-market at the moment. bank-centric – although less so than 10 direct lending The government’s latest policy years ago. As Europe catches up with the guidelines for commercial banks and US, Asia-Pacific is catching Europe. Here managers will be regulation on corporate borrowing show the banks do have a stronger foothold, how supply-and-demand dynamics are but again, the picture is changing. in a position to changing in the country. PDI data show 795 funds in market Restrictions on offshore at the start of October. Of $256.3 billion quickly take action issuance by Chinese residential being targeted, $123.4 billion is focused developers imposed by the State on North America. There is $55.1 billion and protect investor Council’s National Development and targeted in Europe and $19.4 billion capital Reform Commission mean Chinese in Asia-Pacific. The bulk of the rest is ” offshore borrowers can only issue US multi-regional, with Latin America, sub- dollar-denominated bonds if they have Saharan Africa and MENA accounting Jon Schroeder existing debt to refinance. Liquidity has for just a small slice between them. Tree Line Capital Partners tightened as a result.

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Keep an eye on credit or structure. “There are some who which has for so long been a feature those covenants question whether there is a cycle, but of it. GLAS co-founder and group “Covenants are critical,” we believe there is one and we’re in the president Mia Drennan believes that says Theresa Shutt, CIO later stages,” agrees BlackRock’s head supporting diversity and inclusion at Fiera Private Debt. of European mid-market debt, Stephan must come from the top. At a recent “They enable us to track Caron. meeting with a client the performance of the Paul Johnson, partner at EQT Credit, she was asked about her own firm’s business and provide early warning signs says: “Everyone is saying we are on the diversity – and could point to the of potential problems.” cusp of a downturn, but the reality is that fact she was accompanied by two The frothiness of much of the market there have been plenty of pitfalls out senior female colleagues while sitting – where yields are historically low but there over the past five or 10 years.” opposite three men! leverage is high – has sharpened some Johnson points to macro challenges While she does not accuse them of investors’ focus on US lower mid-market being ‘pale, male and stale’, she notes direct lending. There, they can get this is certainly an issue elsewhere in enhanced yields and stronger creditor the industry. protections, with tighter covenants. Balancing portfolio company “Lower mid-market direct lending “ Everyone is saying investment teams is an important step. managers will be in a position to quickly Change has to come from the top and take action and protect investor capital we are on the cusp that means women-led management rather than being sidelined by weak or teams and supporting female non-existent financial covenants,” says of a downturn, but entrepreneurs. Initiatives such as more Jon Schroeder, founder and managing thoughtful parental leave and greater partner at Tree Line Capital Partners. the reality is that flexible working are a good start, but Europe has also become more there have been there is more to be done. competitive, with the amount of capital A roundtable of five leading raised over the last few years outpacing plenty of pitfalls out women in private debt agrees that the supply of M&A volume. As more greater flexibility is an issue but they capital seeks the same amount of deals, there over the past want to see the industry go further it is getting tougher to stay disciplined. than it has done. “The statutory right Leverage is being stretched and five or 10 years ” to shared parental leave has been lenders are even increasing the size of helpful but I think the more forward- the transactions they are targeting. That looking businesses will give equal pay Paul Johnson can put them into competition with the EQT Credit and benefits to working fathers taking broadly syndicated markets. But it is the parental leave,” says Barings director appearance of covenant-lite transactions Caroline Mortimer. Diversity applies in the European mid-market, mainly at not just to getting more women into the higher end, that has participants the boardroom, but to encouraging wondering whether they should be we have already seen – Brexit uncertainty, the development of a wealth of concerned. tariff wars, labour inflation – as evidence experiences. While cov-lite issuance is not a that there is quite enough to worry about Nicole Downer, managing partner problem in and of itself, covenants do without trying to guess when the cycle and head of investor relations at MV offer structural protection that investors will turn. And when it does turn, it can be Credit, has also seen the industry make might value when the turn of the cycle an opportunity. huge strides over the last two decades. does come. “I actually think it will be useful for Firms are promoting diversity not just investors to observe managers’ ability, because it is the ‘right thing to do’ Everyone wants not only to restructure a company, but to but because it is also economically to know when the grow it once it is restructured.” sensible. cycle will turn “For the first time, managers are “We seem to be in The real trend spotting a link between internal the latter stages of for the future is culture and positive economic an elongated credit diversity outcomes,” she says. We may not be cycle, but it’s very There are more at a eureka moment just yet – far too difficult to predict when things might women-led events much remains to be done for that – turn,” says Adam Wheeler, co-head of in private debt than but slowly but surely the wheels are Barings’ global private finance group. there used to be as turning and, if the industry continues That is why it is so important to take a the industry makes a conscious effort to make progress, it can finally “make lower yield in exchange for a stronger to address the gender imbalance lack of diversity an issue of the past”. ■

4 Private Debt Investor • November 2019 94% 410 $11.6 billion deals lead/ transactions commitments co-lead arranger closed issued to date Since Q4 2014 Inception Lower Middle Market. Higher Expectations.

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Editor’s letter

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Private Debt Investor rivate debt is changing. The real question is whether it is changing for the better. Published 10 times a year by PEI Media. To find out more about The answer, unsurprisingly, is not always straightforward. PEI Media visit thisisPEI.com In certain respects, the answer is an unequivocal yes. The market continues to P © PEI Media 2019 become more diverse, which is a very welcome development. There are more women in senior positions, more women speaking on industry panels and more events and networks. No statement in this magazine is to And though diversity is about more than just getting more women into the boardroom, be construed as a recommendation to buy or sell securities. Neither that is certainly part of it. this publication nor any part of it Yet fostering greater cognitive diversity and encouraging people from different may be reproduced or transmitted backgrounds to enter the industry is not in any form or by any means, electronic or mechanical, including just about ‘doing the right thing’. It makes photocopying, recording, or companies stronger and improves their “ Diversity is about by any information storage or retrieval system, without the prior economic outcomes. more than just getting permission of the publisher. Private debt is also diversifying Whilst every effort has been geographically. Although North America made to ensure its accuracy, the more women into the publisher and contributors accept remains the focus of much of the asset no responsibility for the accuracy class’s activity, Europe is catching up. boardroom ” of the content in this magazine. Non-bank lenders in the Old Continent Readers should also be aware that external contributors may are becoming bigger players – as they have represent firms that may have been in the US for some time – and funds in the market are targeting more than $55 an interest in companies and/or their securities mentioned in their billion for Europe alone. contributions herein. Asia-Pacific is also becoming more active. The Asian opportunity is now around 15 percent the size of the North American market, with almost $20 billion being raised to Cancellation policy You can cancel your subscription at any invest. time during the first three months But not every change is to be welcomed. Covenants are loosening on both sides of the of subscribing and you will Atlantic, and that is concerning to some in the market. Meanwhile, a consensus is building receive a refund of 70 percent of the total annual subscription that these really are the latter days of the current economic cycle, and although estimates fee. Thereafter, no refund is of quite when things will turn are scarce, the potential catalysts of a downturn are many. available. Any cancellation request needs to be sent in writing to That change may not be entirely bad. It should, for example, give managers a chance the subscriptions departments to show their worth, not only to restructure companies but to grow them following a (subscriptionenquiries@peimedia. restructuring. com) in either our London or New York offices. If even this can be a positive, then the winds of change sweeping through private debt really should help create a stronger, healthier, more diverse market. Printed by Hobbs the Printers Ltd hobbs.uk.com

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6 Private Debt Investor • November 2019 Our perspective is different. Partner with us to see how.

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KEYNOTE INTERVIEW

Private debt in transition?

The European private debt market is becoming increasingly established and mainstream. So, what shape will this more mature market take and what are the trends to watch over the medium term?

The private debt market has grown rapidly A recent report by GCA Altium showed SPONSOR in recent years, with investors increasing- that 50 percent of mid-market in BLACKROCK ly allocating to private debt strategies in a Germany were financed with private debt bid to generate returns in a persistently low – that’s up from just 16 percent in 2016, so yield environment. Yet, as signs emerge of significantly. According to Deloitte, the it’s quite a shift. We’re also seeing growth in an economic slowdown, can private debt annual growth rate was around 30 percent Benelux, Spain and Italy and early signs of funds continue to expand at the same rate? for the past five years. One of the biggest development in the Nordics too. How will this affect lending conditions? developments has been the emergence of a This is good news for investors, many of And, following particularly robust growth in more pan-European opportunity set. While whom were concerned that their allocations Europe, how will the industry settle and ma- much of the initial growth was particular- were too heavily concentrated in the UK, ture over the coming years? These are some ly UK-focused, we are now seeing healthy where there are attractive opportunities but of the issues we discussed with BlackRock growth across Europe. also a high degree of uncertainty. Our direct managing director and head of European Our experience is reflected in Deloitte’s lending strategy has approximately 20 per- mid-market private debt, Stephan Caron. data, showing that the UK still accounts cent exposure to the UK, which is relatively for around 40 percent of European private low for a pan-European strategy, but aligns European mid-market direct debt transactions; France now accounts for with our investors’ conservative view on the Q lending has expanded rapidly. 25 percent and Germany 11 percent. Ger- UK and their desire for a high degree of geo- What would you say are the most many is one of the fastest-growing markets graphical diversification. We have been able important recent developments? in Europe and so it is likely to have a much to meet those goals thanks to our strong lo- The market has certainly grown greater share over the next few years. cal presence in European markets.

8 Private Debt Investor • November 2019 Analysis

What developments would you of harmonisation but to an extent it restricts Q like to see? “Many companies competition. It’s a similar story with insol- Back in 2011 and 2012, when the asset class vency regimes – it would be great if Europe really started gaining traction in Europe, are not yet familiar could have, as an aspirational goal, a single there were high expectations that sponsor- regime across the EU. less transactions would be the main driver with direct lending of growth. In fact, the market has remained How is the industry evolving? largely sponsor-driven. institutions or how Q Over the past few years, we’ve seen That said, we think the direction of trav- greater segmentation of the market – a el is still towards convergence with the US private debt can work natural consequence, we believe, of a mar- in terms of dealflow and financing dynam- ket that is becoming more established. ics, but given we currently have roughly an for them” Previously, private debt funds tended to be 80-20 split of sponsored/sponsorless trans- chasing the same deals. Now, we find that actions in Europe, compared to 50-50 in domestic funds are financing smaller com- the US, it may take longer than expected pany deals, say in the less than €10 million to materialise. That’s largely because many EBITDA range, while the large players with companies are not yet familiar with direct €4 billion-plus funds target companies with lending institutions or how private debt can €50-100 million-plus EBITDA. work for them as an alternative to bank fi- Yet in the core mid-market space, there nancing. is less competition from funds and the op- A very long-term – and I should stress portunities are too small for the high yield aspirational – development would be some bond or syndicated markets. Commer- harmonisation in the regulation and insol- cial banks are active but tend to use club vency regimes across the EU. Currently, deals, which aren’t the most efficient way you have to have different vehicles and/or of achieving financing as they take time to licences in different member states to pro- arrange and agree on terms. We also see vide in Europe, as well as a lot of expe- that banks are rapidly scaling back their rience in structuring deals in different legal mid-market leveraged finance operations and regulatory frameworks. With local of- which tend to be less profitable and will fices across Europe, we can handle that lack come under more pressure with the new IFRS 9 rules. The lack of competition from banks in this part of the market is reflected Where do you expect to see most growth for private debt? in returns and means that the documenta- Q tion standards agreed as a lender can be bet- We’re already seeing significant momentum in Germany and expect to see continued ter – and that’s particularly important in this penetration of private debt in Spain and Italy, with banks in Spain in particular part of the cycle. teaming up with funds. Growth in the Nordic region has been somewhat slower, but we expect this market will open up in the short to medium term. This region has a So where would you say we are very vibrant market, the companies there tend to be well managed, the Q in the credit cycle? insolvency regimes are robust and, as an investor, you can take comfort in the legal There are some who question whether there systems. is a cycle, but we believe there is one and Further afield, the Asia-Pacific region is becoming increasingly attractive, we’re in the later stages. We recognise that especially as there is currently little competition – it’s difficult to establish in these a slowdown is occurring in the US, Europe markets because they are highly fragmented. India, for example, has a rapidly and China, but that central banks are also growing economy and recently saw insolvency law reforms which have helped being extremely accommodative – the Fed- increase recovery rates and speed up restructurings. We expect that to be a great eral Reserve recently reduced interest rates opportunity for private debt players like BlackRock who have local capabilities in and the European Central Bank is using un- those countries. conventional measures to support the econ- Direct lending has become an increasingly important part of the US corporate omy. Debt maturities have also been pushed lending landscape and the well-established direct lending market continues to out so that, even where companies are expe- expand, driven by demand from an increasingly broad array of borrowers for flexible riencing low EBITDA growth, they are still and reliable financing provided by non-bank lenders. We’re witnessing growth in generating enough cash to service debt. both sponsored and sponsorless opportunities in the US, across a range of industries. This lower-for-longer environment Providing capital to support the continued growth of technology companies, in could continue for quite some time. How- particular, is an area of high growth for direct lenders. Successfully investing in these ever, it is important to recognise that geo- opportunities, however, requires deep insight and prior experience of investing in political risk is high, with populism a global these types of companies. challenge. We observe various potential flashpoints from a US president facing an

November 2019 • Future of Private Debt 9 Analysis

impeachment inquiry and upcoming elec- Investors are allocating increasing amounts to private debt (%) tions, to US-China tensions and persistent Decrease allocation Leave unchanged Increase allocation instability in the Middle East. Closer to 0 20 40 60 80 100 home, investors have to navigate the un- certainties surrounding Brexit and populist Equities pressures across Europe. There’s clearly a lot of uncertainty and investors need to en- Fixed Income sure they focus on constructing long-term allocations that can navigate these dynamics. Real Estate

How can you mitigate this risk? Private Equity Q You have to build resilience across the portfolio and focus on downside man- Real Assets agement to counter uncertainty. At a high level, that means avoiding cyclical sectors Private Credit and focusing on more defensive businesses. We see a lot of opportunity in areas such as Source: BlackRock Global Rebalancing Survey 2019. Combined responses, December 2018. healthcare, technology and food and bever- age, which have historically outperformed We sometimes encounter situations to generate returns, and into alternative in more difficult stages of the cycle. where the headroom is too wide and EBIT- strategies, including private debt. Earlier Building resilience is also down to ef- DA adjustments too broad. Sponsors are this year, the BlackRock Global Rebalancing fective risk management and this is an area pushing hard – I’ve seen an instance where Survey, which maps the asset allocation in- where we have invested significantly in so- a sponsor was requesting that foreign ex- tentions of investors with a total AUM of phisticated systems that allow us to stress- change be excluded from the EBITDA defi- around $2 trillion of assets, suggested that test individual investments, but also to nition, yet that can have a significant effect more than 50 percent of these intended to track risk factors across all investments and on cashflow. You can’t be dogmatic about increase their allocation to private debt. identify correlations. This gives us a greater terms and can make an exception for out- In our view, most investors are still un- ability to assess the impact of macro devel- liers, for instance in counter-cyclical busi- der-allocated to the asset class. According opments on our portfolios on a daily level or nesses where you’ve thoroughly analysed to Preqin, the average allocation is around more frequently if we need to. the opportunity, but generally you have to 5.7 percent of their AUM, so we exptect Combining these tools with the insights take a robust view of which terms you are further increased allocations from a range of from the BlackRock Investment Institute, prepared to accept and which you’re not. investor types. companies, for ex- our in-house think-tank, gives us an addi- ample, generally find private debt attractive tional perspective on the opportunities and What trends do you think we’ll from a Solvency II perspective. We’re also risks in our markets. We also have an inde- Q see in the future? experiencing a significant uptick in interest pendent risk team that is represented on our We’re seeing a slowdown in new entrants from family offices and high-net-worth in- investment committee. They run their own to the market because barriers to entry have dividuals. risk dashboards and stress tests and have increased – you need scale now to invest in As investors allocate more, they tend to the experience and authority to challenge origination capability, IT systems, risk man- have more precise demands on the industry. our investment teams on downside cases. agement, more specialised fund structures We’re seeing requests for funds of one and And then, of course, we have to take a disci- and so on. Moreover, we expect further con- evergreen structures, for example, or mul- plined approach to documentation and not solidation and segmentation as the market tiple currency sleeves and levered and un- be afraid to walk away from a transaction if becomes more mainstream. levered sleeves. We’ll see more innovation we don’t feel that there’s enough downside here as the industry seeks to structure funds management. How do you see investor to meet investors’ different needs. Q allocations playing out? Sustainability is an increasingly impor- How do you approach Direct lending has enjoyed strong inflows tant factor in investors’ manager selection Q negotiating the legal terms? over the past few years and investors are decisions. At a minimum, investors expect We look at deals where there is lower com- becoming increasingly selective in allocat- managers to have robust ESG policies in petition because, in our experience, in situ- ing to the space. The single biggest driver place and to ensure that these policies are ations where you have 10-20 lenders vying for investors to allocate to private debt has integrated with their investment processes. for a deal, you may have to compromise on been low interest rates and that looks set Sustainable, well-run businesses are inher- terms. To find lower competition deals, you to continue. As we speak, you have around ently attractive to cashflow lenders. Direct have to have local origination capabilities, $16 trillion in negative government bonds lending offers significant opportunity to ac- but you also have to be prepared to draw a globally. Investors are switching away from cess such companies and achieve close align- line in the sand. fixed income, where they are struggling ment with investors’ evolving ESG goals. ■

10 Private Debt Investor • November 2019 Analysis

What’s coming next?

Some of the market’s leading lights give their thoughts on the future of private debt

Our panel What is the most exciting development?

Tim Atkinson KK: We are seeing a secondary market emerge for private credit fund interests. Given Principal, Meketa Investment the income dynamic of these investments, this market could develop significantly. Group ND: Fragmentation of the product offering. More sponsors are tempted to syndicate Nicole Downer facilities themselves to private debt investors through club deals or pre-placement. Managing partner and head of investor relations, MV Credit JGr: The growth of direct lending away from the private equity-sponsored market and Jeremy Ghose into non private equity-sponsored businesses. Head, Credit Management JGh: ‘ESG’-related private debt funds.

Jeffrey Griffiths TT: Innovative structures that enable new investors to access private Principal and global private debt credit. Most notable are the rated note structures tailored for specialist, insurance companies. The more diverse the investor base, the more accepted the asset class will be. Ken Kencel President and CEO, Churchill TA: Private debt evergreen or open-ended funds and Asset Management accounts continue to be of growing interest to investors Tod Trabocco and advisors. I don’t necessarily think there is a single best Managing director and co-head fit solution as it will depend largely on GP strategy as well of credit investments, Cambridge as LP preferences and constraints, but I expect more GPs Associates and LPs will work to find new structures and vehicles that work for them.

Which investor group is most likely to increase its exposure?

JGr: Public and private pension funds. ND: This asset class has been attractive to pensions and insurance companies that can match their long-term liabilities with higher JGh: Insurance companies globally. As we head back to the yielding, stable asset classes. This offers them a liquidity and ‘near zero’ world, the search for yield will intensify. complexity premium against a backdrop of historically low yields. Increasingly family offices are showing interest in this asset class. KK: Insurance companies are most likely to increase their private debt exposure. The private debt product has TT: As the credit cycle turns and high returning strategies like always made sense for them. From a geographic distressed see their opportunity set expand, investors across perspective, Asian investors, in particular from the board will allocate more to that specific strategy. Over the Japan, have increasingly begun to adopt medium to long term, retail investors will also gain access and we private debt strategies. see the early stages of this already taking root.

November 2019 • Future of Private Debt 11 Analysis

Where is the next greatest What strategy or region challenge going to come is the rest of the market from? overlooking?

ND: A macroeconomic slowdown that will test the portfolio TT: I’d have to say construction of managers as well as the underlying loss of Australia. It has some of the newest debt instruments. For excellent creditor example, ‘traditional unitranche’, first rights, a muscular loss/second loss unitranche or regulator and a unitranche ranking behind super historically robust senior term loans and/or RCF. economy. If you can manage the JGh: Direct lending will face a currency risk and challenging time as economies the plane ride, it slow and funds face a credit is worth a look. cycle for the first time in a decade. JGh: India will probably see some TT: Without question the credit of the biggest growth cycle will challenge private credit funds. in the private credit space Many will not make it, which means manager selection over the next five years, as the is paramount. But the asset class as a whole will perform economy’s growth is crying out for well in the next crisis. So, while the next crisis will capital and the banks and non-banking financial companies challenge private credit, private credit will are paralysed. meet the challenge. More pernicious is the onslaught of competition, particularly KK: We believe the market is overlooking (or from marginal players who act in at least not as saturated for) lending strategies haste. that are focused on more specialised industry segments, such as financial services or KK: Due to the inherent healthcare. multi-fund model of private credit managers, we believe ND: Junior debt, as everybody seems to that developing the appropriate have focused on unitranche and raising infrastructure to support several bigger funds in that space. We believe funds will be a prevalent challenge for significant risk-adjusted returns can be growing firms as they raise more capital. extracted here.

What is going to be the biggest change in private debt over the next three years?

TA: I wouldn’t attempt to make a call on KK: The increased importance of scale will drive smaller the timing of it when it will happen, but managers to consider selling to larger, more diversified I expect an economic pullback and platforms. M&A will continue to grow as the costs to compete increase in defaults will seriously test for dealflow and to support the required infrastructure will make the business models of many GPs who it challenging for these smaller managers. are focused solely on direct lending. TT: I believe the markets will be tested in the next three years JGr: Going through an increased (I concede I’ve been saying this for three years already!) and, to cycle will test managers and borrow Warren Buffett’s analogy, when that tide goes out, the clarify relative performance. naked swimmers will have to get out of the ocean. ■

12 Private Debt Investor • November 2019 IT TAKES IM GINATION TO GO FURTHER TO FIND VALUE

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EXPERT Q&A

A defensive portfolio will thrive whatever the wider economy has in store, says Paul Johnson, partner at EQT Credit

Ready for anything in private debt

What is driving the escalation in ically we would not have seen. Demand has SPONSOR LP appetite that we are seeing grown. Q EQT CREDIT for private debt strategies? That means we are still only really com- There is a growing acceptance amongst peting against the same number of firms. So, institutional investors that we are now in a most of the money is being targeted, is com- while there has been some returns compres- perpetual state of low, or even negative, in- petitive – absolutely. But what you are see- sion and the market is competitive, it has terest rates. Investors are searching for yield ing is that while managers are raising larger always been competitive and I do not think and private debt is providing that. successor funds, we are no longer seeing that competitive intensity is increasing. There are also nuances within private the volumes of new entrants that we did a debt. Direct lending has become increasing- few years ago. Direct lending has become a How do you approach ly mainstream and plays a part in the alter- true alternative to the banks, therefore more Q origination in this competitive natives portfolio of most investors. But, as sponsors are using direct lenders that histor- environment? everyone starts to question where we are in I think it can be easy to rest on the laurels the cycle, opportunistic strategies are now of an ever-increasing volume of deals com- also attracting more attention. ing to market. But, of course, these are deals that everyone is seeing, so we do not view Is there a danger that too much this as smart sourcing. Q money is being raised? How 9% Instead, we focus on building sponsor would you describe competitive Impressive returns are available relationships across multiple direct lending dynamics in the market? in senior secured debt deals. In 80-90 percent of cases, we believe The direct lending market, which is where we are only in competition with one or two

14 Private Debt Investor • November 2019 Analysis

other funds. Whilst we are still in competi- to rebuild from there. We have also already tion with the banks, the direct lending mar- “This is an illiquid started to see some macro-fallout. Clearly, ket continues to take market share year on we are not in a downcycle yet. Yet we have year. asset class, so you seen the impact of Brexit uncertainty, of We still take part in lender education tariffs and of labour and raw materials’ cost processes, of course, often led by debt ad- can’t evolve your risk inflation. There have been plenty of chal- visors who may invite 20 to 30 participants. lenges out there. But if that is the mainstay of your origination strategy depending on Such challenges will probably increase strategy, you are not going to end up with over time and I actually think it will be use- the terms you are after. There is no such where you think you ful for investors to observe managers’ abili- thing as a perfect deal with no competition, ty, not only to restructure a company, but to but creative deal sourcing is important. may be in the cycle” grow it once it is restructured. Simply doing a debt-for-equity swap Which markets do you see as does not, in itself, create value and get you Q particularly attractive right your money back. EQT has the advantage now? of its private equity heritage and deep op- Not even three years ago, there were 10 erational expertise to help grow these busi- times more deals in the UK than in the Nor- nesses if needs be. We also have a credit op- dic region. Fast forward to today and that portunities fund, which looks at distressed factor is less than five times. The UK and debt situations. France remain large and growing markets, but other markets came later to direct lend- Do you think private debt firms, ing and so the potential for growth in such Q in general, have sufficient work- markets is higher. out experience to weather a storm? EQT has completed five deals across Some, clearly, have the requisite skill set. Finland, Sweden and Norway in the past 18 Others do not currently but are intending months. Five years ago, I don’t think there to hire to address that. Others still intend to would even have been five deals in total. sell their loans to credit opportunities inves- tors if things do go wrong. What changes are you seeing in We are certainly getting probing ques- Q terms of pricing, structuring and tions from our investors, not only about the terms? deals will end up being fine. If you are lend- health of the portfolio today, but our strate- Pricing is probably 60 basis points lower ing 50 percent or even less of the value of a gy if one or two were to underperform. than it was a few years ago. This is as a result company on a senior secured basis, you have I think those questions are absolutely of competition and there is no avoiding this. ample buffer before you have to take control fair. In fact, increased investor sophistica- But this asset class still represents a pretty or lose money on a direct lending deal. tion around these issues is one of the biggest compelling proposition when you can gen- changes we have seen in recent years. erate 7-9 percent returns for senior secured Given that we are arguably on debt. Q the cusp of a downturn and What do you see as the biggest Terms are certainly weaker today than that European private debt is largely Q opportunities for the private they were a few years ago. You have to be unproven in that environment, how debt market going forward? prepared to walk away if you do not get the do you expect the asset class to fare On the direct lending side, we welcome the protections you are seeking. However, the when the cycle turns? prospect of a turn in the cycle because we size of the market is such that you can still Everyone is saying we are on the cusp of a know we have built a genuinely defensive maintain selectivity and rigour while re- downturn, but the reality is that there have portfolio. The opportunity will be winning maining active. been plenty of pitfalls out there over the past market share from others who may have five or 10 years. A lot of businesses have had more problems brewing, as we believe in- What about the level of risk tough times and many of those have been vestor appetite for managers that can prove Q being taken? self-inflicted. they are generating risk adjusted returns will This is an illiquid asset class, so you can’t There have been aggressive M&A roll- continue to grow and grow. evolve your risk strategy depending on outs that have produced negative synergies. Opportunities are also likely to increase where you think you may be in the cycle. Businesses have been financed on the basis for our distressed debt business, meanwhile. With private debt, you should always be in- of ambitious cost savings programmes that For the past 11 years, that business has gen- vesting in defensive businesses rather than just have not come to fruition. erated top quartile returns across vintages volatile, cyclical assets. Lots of companies have also tried to in- and so is well positioned to take advantage We do see deals that we have passed on crease productivity by changing the sales- of whatever may come our way, be that a for being too risky later being announced by force model. This has often resulted in continued benign environment or, indeed, competitors. I should add that most of these sales teams leaving and it takes a long time an economic downturn. ■

November 2019 • Future of Private Debt 15 Analysis

Making diversity happen

Guest comment by Nicole Downer

MV Credit’s managing partner and head of investor relations believes industry-wide action is needed to address private debt’s diversity deficit

ooking back at the last 25 years I am While finance professionals continue to pleased to see that the working world “As junior members be paid to do the jobs of two people, truly Lhas changed fundamentally. The days diverse teams will remain a distant aspira- when having a work-life balance was a dis- tion rather than an achievable reality. The tant dream for those wanting to forge a mature into senior industry must act on this cultural reform reputation and avoid being perceived as a that’s needed in order to allow parents to failure are no longer the norm. investment specialists parent, individuals to have time to enjoy Slowly but surely the tides are chang- their hobbies and, most importantly, to en- ing as the financial services industry tries to and become the courage a more culturally diverse perspec- adapt to a society which better values diver- tive before clients force it into action. sity and the importance of a good work-life leaders of tomorrow, This is what fundamentally prevents di- balance. However, there is a long way to go verse internal cultures in financial services for us all, unfortunately, as many exceptions being able to give and, in turn, diverse investment thinking. remain. perspectives rather Only an industry-wide approach A change in mindset will work In private debt specifically, some firms are than run numbers Different viewpoints enhance company cul- starting to realise that promoting diversity is ture and enable a more creative approach. not just the ‘right thing to do’, but it is also becomes imperative” At MV Credit, we don’t just talk about it; economically sensible. In line with broader of 32 members in the team, 18 are female. societal change, institutional investors are At the senior level, 38 percent of em- becoming more demanding when it comes ployees are women and at the managing to board and investment team composi- partner level we have 20 percent female rep- tions, as they also need to respond to their really need to happen tonight?’ or ‘this can resentation. This compares favourably to constituents’ demands for more diverse and wait until tomorrow’. This needs to change. the industry average of 19 percent of women sustainable investments. Additionally, for There is a common misconception that at private debt firms at all levels, 11 percent the first time, managers are spotting a link workaholics are naturally good profession- representation at the senior level and just 5 between internal culture and positive eco- als. However, as junior members mature percent at the managing partner level. nomic outcomes. into senior investment specialists and be- But increasing diversity does not stop But we’re by no means near a eureka mo- come the leaders of tomorrow, being able to with hiring women. It also means employing ment when it comes to diversity. We are still give perspectives rather than run numbers people from different backgrounds, ethnic- faced with a ‘drop everything’ culture across becomes imperative to clients. ity, sexual inclination and nationalities. We private equity, private debt and many other Such perspectives can only be informed firmly believe our diversity creates greater sub-sectors of investment management. by an established, well-balanced work and opportunities and fosters sharper insight From my experience in both investment personal life, but also with the skillset ac- for our investors, but promoting a culture banking and private debt, deadlines are fre- quired by having worked in varied envi- which truly embraces diversity needs to be quently artificial, and at present not enough ronments with multiple perspectives and an industry-wide effort. By doing so, we can people are stepping back to say ‘does that experiences. make lack of diversity an issue of the past. ■

16 Private Debt Investor • November 2019 Analysis

July/August 2019 • Private Debt Investor 17 Analysis

EXPERT COMMENTARY

Institutional investors in favour of sponsor-backed, syndicated deals have typically overlooked the lower end of the private debt universe, but the European Investment Fund’s Marco Natoli and Francesco Battazzi believe that will change

Breathing life into ‘sponsor-less’ transactions

Sponsor-less transactions are entering a new and competences in the specific niche and SPONSOR era. What was once considered the ‘lower asset with which they deal. Funds that orig- EUROPEAN INVESTMENT FUND end’ of the private debt universe, with high- inate through crowd-lending platforms are er barriers to entry and a more specialist also part of the sponsor-less space and offer investment style, is now attracting institu- managers can work directly with the compa- opportunities for further risk diversification tional investors in search of yield, portfo- ny to negotiate terms, impose covenants and and shortening the duration of a private lio diversification and stronger contractual enhance risk-adjusted returns. debt portfolio. terms. Indeed, the growth in allocations to While predominately long-term loans, Sponsor-less transactions therefore rep- private debt over recent years lays the foun- these transactions can also take the form of resent a big opportunity for investors to se- dations for an increasing number of invest- asset-based financing. In this category, we lect high-quality SMEs, diversify their risk ments into the non-sponsored area of the include managers specialised in leasing, re- and de-correlate from sponsored deals, to market. ceivable financing and export financing. exercise hands-on investment monitoring Lacking a private equity sponsor, Funds specialised in asset-based financ- and enhance risk-adjusted returns compared non-sponsored transactions are generally ing are exposed to lower volatility compared to sponsored transactions. less leveraged and more flexible on terms. to M&A financing or unsecured lending. However, institutional investors may Without the M&A component, they sup- Portfolio downside protection is key to find that they do not have the expertise or port an SME’s organic growth, innovation navigate through a potential downturn in the resources to analyse funds focusing on projects or capital expenditure. Critically, the credit cycle, and these funds require sponsor-less financing or other niche strate- without a private equity sponsor, the fund specialised teams with significant networks gies. This can particularly apply to investors

18 Private Debt Investor • November 2019 Analysis

such as pension funds and insurance compa- The EIF’s market breadth and reach also nies, which invest in a wide range of assets, benefits investors geared towards national or smaller investors such as family offices, “Fund managers investment opportunities, who now wish to which may not have the resources to carry pursue cross border investment opportuni- out extensive due diligence. can work directly ties. How is the sponsor-less transaction mar- Being a cornerstone investor with the company ket likely to develop going forward? The Having an experienced investor involved US is a strong example of funds choosing to can make this process easier. Since 2009, to negotiate terms, specialise in either sponsored transactions the EIF has invested in funds that primarily or sponsor-less. make smaller, sponsor-less debt transactions impose covenants, and In Europe, funds broadly still consider to SMEs, focusing first on mezzanine funds, both, but as the asset class deepens in li- and, since 2015, on senior credit funds. enhance risk-adjusted quidity and more funds are raised, a similar Thanks to our access to data for more bifurcation could emerge. than 1.3 million SMEs from our guarantee returns” Newer investors in search of yield, diver- business, we are credit-risk assessment spe- sity and low volatility are also likely to enter cialists, able to select sponsor-less funds that the asset class. have the sophisticated monitoring skill to asset classes such as equity and infrastruc- In these cases, getting the fund selection follow up portfolio companies, investigate ture funds by generating returns in a shorter right is crucial. different exit routes and offer different skills timeframe. Yet the EIF is also aware that the asset to the SME. In senior credit alone, the EIF Sponsor-less transactions not only offer class requires a wider, stable and diversified has screened over 180 funds since 2015, in- interesting risk-adjusted returns, but also a investor base to realise its growth poten- vesting in 38. conduit for institutional investors to make tial. The concentration of funds within es- We have supported the development of investments in the real economy – the SMEs tablished management firms and in certain this market with €4.5 billion invested in 113 that provide employment and economic geographies means that fundraising activity debt funds across Europe, of which more growth. in Europe is concentrated on a limited num- than €1.5 billion is invested in 38 senior However, due diligence and fund selec- ber of large management firms operating in credit funds, including strategies such as tion are not the only barriers to investment mainstream markets such as France, Ger- loans, bonds and asset-based finance. We in the asset class. Access to fund pipeline is many, the UK and Benelux. are also selectively investing in funds that also more difficult in the sponsor-less are- Therefore, we selectively invest also in originate their lending through crowd-lend- na. With smaller players operating in niche first-time fund managers outside the tradi- ing platforms: precisely six funds originating strategies, the investor itself must be more tional jurisdictions. through more than 10 platforms. active in scouting management teams across To those fund managers that are raising A cornerstone investment from the EIF Europe. These origination challenges pose first-time funds, we offer advice on market is often a signal to other investors that deep high barriers to entry for the unsophisticat- best practices and governance — analysing analysis of the asset class and extensive due ed investor. their investment strategies and encouraging diligence has taken place as well as that the manager to implement portfolio cove- funds’ documentation follows best market Accessing the fund pipeline nants to improve the risk-return profile of practice. Cornerstone investors typically The EIF has found that a fund-of-funds the fund. provide a high degree of guidance regarding structure provides a useful gateway through With interventions which encourage the economics, structure and governance of which institutional investment can flow into new funds to be raised, and interventions the fund. some of the specialist sectors in which it which offer new private investors a way to Our experience in risk-adjusted returns invests. The Asset Management Umbrel- access the market, a larger, deeper, liquid of SME credit across Europe has made us a la Fund vehicle, currently investing in the and more sustainable investor base is grow- knowledge leader in this area, with unpar- EIF’s portfolio of top-performing venture ing in sponsor-less transactions – one that alleled market reach and screening ability. capital, life sciences and offers institutional investors an alternative This has resulted in a portfolio construction funds, leverages on the EIF’s unique market asset class with strong portfolio downside focused on diversification, low volatility and positioning and its capabilities of sourcing protection. ■ low correlation with mainstream strategies. high quality managers across Europe and its Our pan-European approach means funds capacity to analyse those funds. are diversified across strategy, manager, sec- By channelling private investment into Marco Natoli is the EIF’s equity investments head of division for northern, eastern and tor and geography. our best-performing funds, we are ensuring southern Europe. He is responsible for Over this decade, we have witnessed the the sustainable, long-term supply of capi- managing investments in private equity, mezzanine/hybrid and debt funds. asset class offer predictable and stable cash- tal to SMEs. At present, the AMUF vehi- flows and low performance volatility to in- cle focuses on , life sciences, Francesco Battazzi is the EIF’s head of division vestors. The cashflow generation of senior growth capital and secondaries investments. for diversified debt funds. He is responsible for investments in private debt funds focusing SME financing also mitigates the so-called However, in the future, it may add more on senior credit and portfolio diversification, ‘J-curve’ effect present in other alternative compartments. across Europe.

November 2019 • Future of Private Debt 19 Analysis

ROUNDTABLE

SPONSOR DECHERT

How private debt is being reshaped

The asset class is seeing increased competition but continuing to grow and innovate. As Andy Thomson reports, it is also beginning to respond to diversity issues – though work remains to be done

n early October, PDI staged a roundta- ing in the segment of the market that I op- sure that the legal documents are robust. ble in London with five leading women erate in, mid-market loans, is the re-emer- When there is this competition and pres- in private debt to hear their thoughts gence of competition from banks which, of sure, we have to make sure we stay diligent on areas such as competition, the stage course, had all but disappeared. Indeed, the and don’t just accept anything to win a deal. of the cycle, regional comparisons and retrenchment of banks from the market is Precedents get continually rolled out and diversity issues. The fruits of the discus- what gave birth to direct lending and now what appear to be little things chip away at Ision are reproduced below. we see them popping up again. the protections that lenders have. It is really In club deals in Europe, especially in important that we keep pushing back. What are the opportunities Spain and Italy where their banking reg- Q and challenges in private debt ulation is at a different stage, we compete Zeina Bain: The big change is the sheer today? with banks – more so than in France and the amount of equity content in these deals. Vanessa Brathwaite: The main opportuni- UK where the private debt market has been Valuations have gone up ahead of leverage ties are coming from the big flow of assets around for a while and is a bit more mature ratios, so the equity cushion, if you look at under management into the asset class that in terms of everybody understanding where historical precedent, is much higher now we’ve seen in recent years and the ability they get value. – in terms of getting 35 percent or 40 per- to raise funds and deploy capital. Earlier cent equity – than a decade ago. So, while this year, we closed our fourth generation Caroline Mortimer: I would highlight covenants are an early warning signal, the of direct lending funds with more than €2 increased competition and the impact that equity investment professional will look for billion. We also see commitments coming is having on the legal documents because the warning signs that the investment case from a very diversified international in- there is a lot of competition and a lot of is not panning out well before the business vestor base. So I think it still remains very pressure for lenders to accept precedents gets anywhere near a covenant problem. attractive as an asset class for investors, but and agree to flexibility and, on day one, Given the growth that’s often being also for borrowers. when everything is going well, people don’t signed up for to underpin the equity case, If you look on the loans side, you see a necessarily focus on a portfolio company the equity investor is stressed way before big trend from bond to loan issuance. The underperforming. the lender needs to be. Clearly one can supply is good and should remain that way. I As a lawyer and as an investor, you really dictate aggressive terms on big deals given think one of the main challenges we’re fac- do have to expect the unexpected and make the large fee pot that makes them attractive.

20 Private Debt Investor • November 2019 Analysis

PHOTOGRAPHY: MICHA THEINER

Vanessa Marianna Tothova Zeina Bain Mikhaelle Caroline Mortimer Brathwaite Partner, Dechert Managing director, Schiappacasse Director, Barings Senior portfolio Intermediate Capital Partner, Dechert manager, Tikehau Tothova focuses her Group Mortimer trained as Capital practice on private Schiappacasse’s a lawyer with Hogan funds investing in Bain joined practice focuses Lovells and six years Brathwaite heads the various asset classes ICG’s European on the structuring, ago joined Babson senior loans business with a focus on debt subordinated debt establishment, Capital, which was at Paris-based Tikehau. and private equity for and equity team in management, merged with other She reports to Tikehau both first-time and April. She was with marketing and entities within the Mass private debt co-head established managers. Carlyle Group for 18 restructuring of Mutual Group. She is Cecile Mayer-Levi She also advises on years, where she was fund platforms and responsible for private across the three areas UCITS and other retail managing director in investment funds, debt, including the of private debt, direct funds and, generally, the European including hedge, debt, structuring of Barings’ lending and CLOs, on fund and asset team responsible real estate, private funds and working where Brathwaite management-related for deal evaluation, equity and funds of with colleagues on manages funds regulatory compliance. origination, execution, funds across a range of the execution of including unlevered She has over 12 years’ document negotiation, asset classes and fund transactions. Mortimer loan funds and some experience providing portfolio monitoring domiciles. She also focuses on private managed accounts. clients with advice and monetisation. At provides investor-side debt at Barings, which She invests in high- on areas such as ICG she focuses on advice in connection also has high-yield, yield bonds, broadly structuring, mergers seeking opportunities with investments liquid loans, real syndicated loans, club and liquidations of for the European into a variety of fund estate, alternatives and deals and unitranche. investment funds. investment strategy. structures. equities teams.

November 2019 • Future of Private Debt 21 Analysis

our clients quite a lot wondering what they should do. ‘I’m raising a new fund with some liquidity features, what liquidity issues might I be facing? What should I be focus- ing on in the documentation?’ Over the last six months, we have pre- pared lists for our clients of what they should be aware of in the fund documents. For ex- ample, we have been working on quite de- tailed gating mechanisms so that our clients can carry out whatever they have promised their investors in the case of a downturn.

Mikhaelle Schiappacasse: One thing that might indicate the market thinks we are coming to the end of the cycle is that more managers are talking about establishing funds pursuing distressed strategies, includ- ing special opportunities funds. In other words, they want to be ready to take advan- tage if the market falls. I’ve heard, although haven’t seen it my- self, that there are a couple of managers who went into the market with that strategy and have run into the problem that the cycle hasn’t turned yet and now the fundraising period is closed and there are limited op- portunities to deploy funds in accordance with the strategy. It’s a bit of a chicken and egg issue because you need lead time to get this type of fund up and running, but if you move too soon you won’t be able to invest effectively.

However, when there is such a big equity As well as distressed, is it also cushion, lenders can take some comfort that Q time to shift from corporate “I think one of the the sponsor has significant conviction and towards consumer, or towards real focus. assets or speciality finance? main challenges VB: We do see a lot more interest in those CM: The amount of equity in a transaction strategies within Tikehau. Our real estate we’re facing in the is important from a commercial perspective and private equity businesses have been but it’s key for the investment team that the growing. Although I have to say we still see segment of the market documents work as we all expect them to – a huge amount of interest in direct lending in the large-cap market there are high-pro- because we are very well established and that I operate in, file examples of flexible documents being were a pioneer in that segment of the mar- manipulated, for example, with cash leakage ket. But I also think it’s right to have some mid-market loans, such as disposals and dividends coming from diversification if you think you’re going into a source that wasn’t originally anticipated. a late cycle. It makes sense to have a broad- is the re-emergence You see that less in the mid-market, but er allocation. I’m not sure that peer-to-peer these large-cap concepts are creeping into lending is going to be as big a threat as we of competition from term sheets and we have to resist. thought given the regulatory scrutiny there now and volume will remain limited. banks” What about the late cycle talk? Q Are things already turning? ZB: In my mind there are two other driv- VANESSA BRATHWAITE Marianna Tothova: We have been hearing ers. One is you’ve probably seen bifurca- Tikehau Capital for the last few years that things are going tion between listed private equity firms and to slow down and clients are worried about non-listed ones but, in that search for larger the possibility of a downturn. We hear from AUM, a diversification strategy is one way

22 Private Debt Investor • November 2019 Analysis

of growing it rather than just making each The legal landscape is constantly evolving fund bigger. And the second is that as LPs and we need to be confident as investors that have more and more to deploy, they want we can exercise our contractual rights. more of a managed account type solution where an investment manager can be a one- “Europe has open Is there sufficient diversity in stop-shop across different asset classes. Q private debt and, if not, how and closed windows, does that get addressed? What similarities and CM: Being an in-house lawyer, I have ex- Q differences are you seeing whereas in the US perience from being in private practice at between the US and Europe? a law firm where women are very well rep- ZB: There is more homogeneity in the US you will typically find resented at the trainee, junior and associate compared to Europe. If you look at how dis- level and actually quite well represented at tinctive Italy and Spain are, you realise each a clearing price and partner level. European country is practically its own mar- As a client, it’s very rare for us to be rep- ket, whereas in the US it is so transparent the market just stays resented by an all-male legal team and it’s and there is equivalence across the whole great that we don’t see that as an issue. In market. There aren’t these pockets of dif- open unless there’s an private debt for in-house lawyers and the ferentiated structuring or where you have investment team, again women are well banks being as much of a genuine ‘take and extraordinary event” represented at junior and mid-level, but at hold’ alternative to debt funds. senior level I think it’s probably fair to say Point number two is that in Europe you that more can be done. There has been a lot ZEINA BAIN have variation according to fund currency, of progress that, so far, has been focused on ICG so sometimes sterling is popular, sometimes flexible working for mothers, but only talk- incredibly unpopular because if the Eu- ing about childcare for mothers is massively ropean funds are looking at a sterling deal they’ve got FX risk to think about and Brex- it has only exacerbated that. You do have points in the cycle where everyone would love to do a sterling deal but they’re becom- ing fewer and further between. The third point is the US market has that sheer level of liquidity and, just as you’ve found with the IPO market in Eu- rope versus the US, Europe has open and closed windows, whereas in the US you will typically find a clearing price and the market just stays open unless there’s an extraordi- nary event. So, if you’re a reasonably large issuer, the US market is your first go-to be- cause you know it will be there.

MT: Currency is obviously an issue for many fund managers. LPs want to invest in a number of different currencies and across different markets and the manager must somehow manage that currency mismatch at the fund level. This is one of the difficul- ties of the European market, but also one of the opportunities: you need to know the local markets in which you are going to lend and it can give you a great advantage if you know, for example, the Spanish market.

CM: Any investor working in Europe has to be an expert in each individual jurisdiction – we need to have a thorough understanding of important issues such as withholding tax, financial assistance and local insolvency laws.

November 2019 • Future of Private Debt 23 Analysis

outdated because flexible working should be One is that when I go to conferences, for everyone. unless you’re looking at service providers, The statutory right to shared parental it’s still 90 percent male. Part of this is prob- leave has been helpful but I think the more ably that there are entrenched networks. forward-looking businesses will give equal Being successful in the industry is still very pay and benefits to working fathers taking “If the cycle changes, much about who you know and it’s still a bit parental leave as they do to working mothers. of an old boys’ network. In addition, now that businesses recognise it’s going to be a Also, with closed-ended fund products, how valuable women are in the workplace, it’s performance fees or carry pay out over an really important to acknowledge that women real test for private extended period and those there at the be- aren’t great at self-promotion and don’t al- ginning of the life of the fund are more like- ways have the self-confidence to succeed. It’s debt managers to see ly to benefit than those more junior team those aspects that need to be addressed with members joining later, who might be wom- coaching, mentoring and training. what will need to en or otherwise diverse. To some degree, it’s the infrastructure that exists in the industry MS: I think on the service provider side of be done in terms of that is naturally biased against change, not the industry, such as legal and audit, there necessarily the people but the structure. is more equality in terms of gender diver- restructuring” sity, certainly than when I started. It’s still VB: I’m in an extremely fortunate position not complete. I could be wrong as I do not that all the senior portfolio managers or MARIANNA TOTHOVA really have a window onto the portfolio heads of business in private debt at Tikehau Dechert management side of the industry, but I have are women. So when I get asked this ques- observed a couple of things. tion, it’s a bit difficult. But we’ve all been in the market for 20-plus years.

ZB: I think for the past 17 years when I’ve been working in European leverage buy- outs, the ratio of female private equity di- rectors and above on the investment side has been less than 10 percent. The industry is opening up. What can firms do? What they can do is look hard at how they promote people, how they mentor people and whether they are making sure people have a voice that gets heard. But it’s also a very personal choice: when juggling family and an intense job, one has to accept that you cannot apply the same perfectionism you bring to your work to your home life. Another aspect is societal change. Pre- viously if anyone on a conference call said, ‘I’ve just got to step out now because my kids are piping up’ or ‘I can’t do this anti-so- cially timed Sunday phone call because of family,’ you’d have tittered. Now both males and females accept that and that’s a massive change; you don’t have to pretend you have no life outside work.

VB: I think in the UK there’s been a lot of focus on getting more women into the in- dustry and these things are evolving, but in terms of other issues of diversity, of race or even cognitive diversity … I’m not sure that cognitive diversity is changing very much. We are fishing in all the same pools for all the same people and that is something we need to think about as an industry.

24 Private Debt Investor • November 2019 Analysis

“To some degree, it’s the infrastructure that exists in the industry that is naturally biased against change, not necessarily the people but the structure”

MIKHAELLE SCHIAPPACASSE Dechert

What key issues will we be Hitherto you’ve seen equity investors di- Q talking about in private debt’s versifying into debt. I think there’s space for future? it to go the other way around, as is the case VB: The private debt market has been for ICG, leading to the emergence of cross- around for a while but there is more of a over capital as an increasingly important regulatory focus on it. To date it’s been all part of the investment strategy. Why? Some about people doing what their investors businesses are getting more mature and that asked them to do and structuring funds how sort of solution makes more sense than try- they want to, but I think going forward it ing to make 3x on a fairly mature buyout. will be similar to other asset classes in being There are families, founders and CEOs who asked for more regulatory reporting. I think don’t want the classic buyout with a three- the upcoming changes to Solvency II will to-five-year timeline, they want a more kickstart that whole process. long-term, partnership-type investor.

ZB: The blurring of lines between equity MS: We’re starting to see more multi-as- and debt is a key development because in- set hybrid fund structures – structures that vestors are looking across the whole risk/ are trying to mix long-dated assets with reward spectrum as opposed to one narrow short-dated assets and it is quite difficult deployment strategy. This encourages oth- to deal with the potential need to meet li- er strategies including core, core-plus, in- quidity requirements of investors while at frastructure or long-term rather than classic the same time dealing with the risk that a control leveraged buyouts – everything is particular position will need to be held to just part of that spectrum. maturity.

November 2019 • Future of Private Debt 25 Analysis

“When there is this competition and pressure, we have to make sure we stay diligent and don’t just accept anything to win a deal”

CAROLINE MORTIMER Barings

So there’s a lot of hard work around MT: I’m quite curious about how the regu- structuring, and managers are either mov- lation is going to evolve at the EU and na- ing from a more stereotypical hedge fund tional level given the importance of private structure into a closed-ended product with debt funds in the real economy and direct various liquidity management tools built in, lending and how that’s going to impact the or from more of a closed-ended structure deals that managers will be able to do in the but building in a mechanism for early with- future. drawal such as withdrawal proceeds being Obviously, there’s more firepower and paid out on a run-off basis or some kind of the possibility to do bigger deals. I think it evergreen mechanism. I would guess that will be interesting to see the effect of much this is likely to increase in the future because more money and much more competition the investor group interested in investing in in certain markets. more illiquid assets is broadening. But I’m also wondering whether there will be a push to get into markets that are CM: 2020 will be all about ESG. The com- less developed and where there is less com- mitment to ESG is already there in many petition; maybe certain markets outside of businesses – the employees drive it and the Europe. If the cycle changes, it’s going to investment team drives it but now demand be a real test for private debt managers to is coming from LPs. This means that we see what will need to be done in terms of need to be more formal in how we docu- restructuring and whether certain manag- ment our commitment to ESG and we have ers will, for example, take equity positions. to demonstrate to LPs how we are applying Those are all things I think that might be ESG in our everyday investing. interesting in the coming years. n

26 Private Debt Investor • November 2019 Analysis Private Funds CFO

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November 2019 • Future of Private Debt 27 Analysis

EXPERT COMMENTARY

Ireland’s new Investment Limited Partnerships (Amendment) Bill 2019 should appeal to both investors and managers, says SANNE’s James Kay-Hards

What’s new in the Irish ILP Act?

Ireland’s finance minister Paschal Donohoe As investment limited partnerships con- SPONSOR recently published the Investment Limited stitute a collective investment undertaking, SANNE Partnerships (Amendment) Bill 2019. The there is no tax exposure at a fund level, and bill includes changes to the existing leg- the ILP remains tax transparent, making this islation that will increase Ireland’s attrac- ing passport licence/mechanism. An ILP an attractive structure for investors wanting tiveness as a jurisdiction for closed-ended is a fund structure. It to maintain their current tax status. An ILP strategies such as real estate, private equity, is constituted pursuant to a limited part- must appoint a licensed AIFM, which may venture capital and infrastructure. These nership agreement, whereby one or more be Irish- or EU-domiciled. In addition, the highly anticipated changes will close the gap general partners enter into an agreement ILP must appoint an Irish-domiciled ad- between Ireland and other leading Europe- with any number of limited partners. An ministrator and depository to perform the an jurisdictions where funds are domiciled. ILP must have an Irish-domiciled GP, who respective functions required under AIF- The act provides for the establishment will conduct the day-to-day business of the MD. and operation of a regulated ILP structure. partnership. The ILP can be used in conjunction with The assets and liabilities of the part- Motives behind the amendments the Alternative Investment Fund Managers nership are owned proportionately by the The proposed amendments are set to re- Directive, which allows managers regis- LPs, with their liability being limited to the flect the significant changes in the global tered under AIFMD to market their funds extent of their capital account. The GP is closed-ended environment, in terms of across the EU and the European Economic liable for any debt, liability or obligation modernisation of the ILP and in terms Area using the European funds market- greater than the value of the partnership. of the relevant EU legislation. The Irish

28 Private Debt Investor • November 2019 Analysis

“As investment Key highlights of the bill

limited partnerships ƒƒUmbrella funds: GPs will have the ability to register and operate an ILP as an umbrella fund with segregated liability between sub-funds. constitute a ƒƒ‘Safe harbour’ rules: The introduction of ‘safe harbour’ rules allows LPs to collective investment participate in advisory committees, vote on changes to the LPA and conduct certain activities without losing their limited liability status. undertaking, there ƒƒAmendments to the LPA: Amendments may be made to the LPA with a simple is no tax exposure majority, rather than the unanimous approval, of the LPs. The bill’s provisions would allow changes to be made to the LPA if the depositary certified that the at a fund level, and proposed amendments did not prejudice LPs’ interests and if certain other requirements were fulfilled. the ILP remains tax ƒƒDual foreign name: The ILP would be able to register a ‘dual foreign name’ transparent” for non-English speaking jurisdictions and receive official recognition thereof.

ƒƒAIFMD alignment: Certain provisions, clauses and definitions have been amended to enable the new legislation to more fully conform with the directive.

ƒƒLiability provisions: The liability provisions (including those that apply to government stated, in Ireland for Finance: service providers) will now be in keeping with the standards governing other Irish Strategy for the Development of Ireland’s In- regulated investment funds, as well as AIFMD standards, thereby aligning the ternational Financial Services Sector to 2025, ILP legislation with recent statutory updates. that the modernisation of the existing ILP legislation was a key strategic priority to en- ƒƒAdmission or removal of GPs: The creation of a statutory vesting event whereby hancing the country’s position as a leading all assets, liabilities and property, regardless of the nature of the ILP, would be global fund domicile. transferred from the exiting GP to the incoming GP or the remaining GPs. It is expected that the changes will great- ly enhance Ireland’s attractiveness as one of ƒƒWithdrawal changes: Modifying the provisions relating to withdrawals the leading international fund domiciles for or redemptions to reflect other forms of collective investment schemes. both investment managers and investors. The ILP structure can cater for all major investment strategies and is a suitable vehi- cle for alternative assets, credit, lending ve- hicles, managed accounts, hybrid funds and hedge funds. Coupled with the potential removal of the national private placement regime, this will become an intriguing option for non-EU managers seeking access to capital in Europe. The reform proposed by the Irish gov- ernment is part of its action plan to promote Ireland as a centre for international finance and support the continuous growth of the Irish funds industry. The industry antici- pates that the bill, once it has been adopted, will provide certain other changes that will strengthen the operation of an ILP. These changes may include the ability to migrate a partnership into and out of Ireland on a statutory basis. ■

James Kay-Hards is the associate director for AIFM Services based in SANNE’s Dublin office.

November 2019 • Future of Private Debt 29 Analysis

Industry big guns point the way forward in the US

Three high-profile keynote speakers revealed their concerns and expectations for private debt at the PDI New York Forum, writes Andy Thomson

t the recent PDI New conservative,” he said. “This June, if you did investor. I can’t remember a time where so York Forum, a packed that same CFO report – not that we do it many governments have been in flux.” He room heard several lead- scientifically, but just anecdotally – I think added that investors “have to be very fo- ing lights of the asset you’re seeing a much more muted enthusi- cused on what’s going on in Washington”. class – (pictured from left) asm for the future.” Zelter said that distressed investing, Howard Marks of Oaktree Should another acute downturn be in a hallmark of Apollo, would look differ- ACapital, Jim Zelter of Apollo Global Man- the offing to test managers’ mettle, he not- ent in the future. “The crowd that should agement and Lawrence Golub of Golub ed, Apollo would be ready. complain about cov-lite the most is the dis- Capital – share their current concerns and “If you’re in credit, you’re paid to wor- tressed community. With cov-lite, [the] day predictions. ry,” he said. “We spend a lot of time think- of reckoning is further out. The playbook in ing about market structure and credit lines.” distressed in the past is much different.” Zelter: Expect a slowdown but He added that the firm does “fire drills” When Zelter joined the firm in 2005, no crisis where all positions are hit with a market cri- credit was a small portion of Apollo’s assets co-president sis stress test, including for liquidity. under management: private equity consist- Jim Zelter expects an economic slowdown. He considers global events as, if not ed of around $18 billion, while credit was However, he is not expecting a downturn on troubling, then certainly something to keep only “several billion”. Today, the picture the scale of the global financial crisis. an eye on. is completely different. Apollo oversees “If you take 100 CFOs last June 2018, “We see the populism around the globe $311.9 billion, which Zelter said was per- on a conference call, 75 or 80 percent would expressing itself in lots of different geogra- haps even greater than envisioned; and be positive and maybe 15 percent would be phies. You have to be attuned to that as an credit, at $201.2 billion, is the firm’s largest

30 Private Debt Investor • November 2019 Analysis

AUM driver. The bulk of Apollo’s cred- though holding such views could make it it AUM comes from insurance company easier for them to win their party’s nomi- Athene, which accounts for $119 billion. “I think you’re seeing nation. Private equity only makes up $77 billion of its portfolio, while real assets account for a much more muted Golub: Diversification is key $33.5 billion. Asked how his firm, Golub Capital, was “When LPs allocate to private credit, enthusiasm for the coping in “hyper-competitive” market con- they find that the allocation ends up in mid- ditions, Lawrence Golub said things could dle-market sponsored direct lending, and future” be a lot worse: “Imagine what it would be those allocations have faced a challenge de- like if [Democratic Senator and presidential ploying scalable capital,” Zelter said. “The hopeful Elizabeth] Warren gets her way and JIM ZELTER question is how will these asset classes per- the private equity industry is squashed.” Apollo Global Management form through the next downturn.” He added that a Democratic president and Senate could bring a “significant” in- Marks: You need to get the odds crease in tax rates and said “I think you on your side have to worry” with an impeachment “This is not like any other cycle,” said Oak- process against the president having been tree Capital co-chairman Howard Marks. launched. “Anyone who thinks Warren or “No one is fully confident and complacent Sanders could not possibly be a nominee is today. No one is self-assured. Indeed, the wrong,” he said. lack of confidence is one of the best things But far from having a downbeat view the market has going for it.” of current conditions, Golub provided However, Marks said this should lead no the forum with an early view of his firm’s one to assume that investors were all act- third-quarter survey of portfolio company ing in rational ways. “Even though they’re performance. This showed Golub’s compa- not thinking bullish, they’re acting bullish. nies delivering a revenue increase of more They’re not doing what they want to do, than 10 percent and an EBITDA rise of but rather what they feel they have to do. more than 13 percent during the quarter – They have to keep putting money to work “The lack of confidence the highest rate of EBITDA since the sur- in an environment where there is too much vey was first conducted. capital.” is one of the best things He said healthcare companies in par- Marks described these investors as ticular had shown outperformance over the “handcuffed volunteers”. the market has going last three quarters relative to the previous Marks felt the best response to challeng- four years. However, he put this down to ing market conditions was to try to get the for it” the prior underperformance of healthcare odds on your side by understanding where businesses as they struggled to keep costs we are in the cycle and acting accordingly. HOWARD MARKS under control, and said there was some He said there was always a balance be- Oaktree Capital “catch-up” going on. Industrial companies, tween the risk of losing money and the risk meanwhile, have been having a hard time of missing opportunities, and that the key owing to the rising cost of labour. was identifying the right balance between Golub said diversification was key to the two. Today, it was “important to worry Known as a contrarian investor, Marks avoiding downside risk and that it was about losing money more than missing op- said the key to success was not quite as sim- important to diversify in all sorts of ways, portunity. It’s hard to see what the missed ple as just doing the opposite of everyone including by industry and private equity opportunity is today”. else. “You first have to try and understand manager. However, the firm intended to He urged managers to be disciplined what the crowd is doing and why before you retain its focus on North America as “so by only raising the capital they need and think about doing the opposite.” much of Europe is controlled by banks and insisted there were no giveaways in today’s Marks questioned whether central banks ultimately by sovereign governments”. market. He said, to nervous laughter, that should still be stimulating the economy “in As a leading protagonist of unitranche the best any investor could do was to “buy the 11th year of an expansion” and suggest- deals, Golub was asked whether the size of the least worst”. Asked for estimates of what ed it was not their job to prevent recessions individual deals would continue to grow. returns investors could reasonably expect from occurring naturally. He said the limiting factor would be the from a range of private debt strategies, he He also said he thought it unlikely point at which these deals needed to be suggested around 6 percent for senior debt, that any Democrat candidate espousing syndicated – at which point the value of ne- 9 percent for junior debt and “somewhere “extreme” left-wing views would win an gotiating with just one or a small number of in the middle” for mezzanine. election against President Donald Trump, parties would be lost. ■

November 2019 • Future of Private Debt 31 Analysis

EXPERT COMMENTARY

Intact credit fundamentals allow for outsized returns while ensuring principal preservation, says Tree Line Capital Partners’ founder and managing partner Jon Schroeder

Lower mid-market myths and misconceptions

Many institutions have paused from making favours non-cyclical, asset-light, service-ori- SPONSOR new allocations to mid-market credit man- ented businesses that are capable of with- TREE LINE CAPITAL PARTNERS agers, given the frothiness in the market – as standing the next economic downturn. exemplified by historically low yields, peak Direct lending as a whole is a relatively leverage levels and deteriorating creditor ing sidelined by weak or non-existent finan- mature asset class, given the tremendous protections. These factors, combined with cial covenants. growth in over the the risk of late-cycle exposure, have driv- Tree Line Capital Partners is an estab- past decade. However, there are many mis- en investors to evaluate other niche credit lished credit platform with approximately conceptions among institutional investors strategies in the never-ending hunt for yield. $1.3 billion in assets under management when it comes to evaluating lower mid-mar- One subset of the broader private credit and which focuses exclusively on sourcing, ket strategies. We will address several of landscape that has generated significant in- underwriting and managing investments these misconceptions as well as provide sup- terest from institutional investors is lower in the lower mid-market. We have a foot- porting data from the more than $1.3 billion mid-market direct lending. By shifting their print across the US and broad origination in loan commitments we have issued to help focus towards the lower end of the market, capabilities focused on sourcing senior se- debunk these lower mid-market myths. investors are benefiting from enhanced cured loans with borrowers that generate yields and stronger creditor protections. $3 million to $25 million in EBITDA an- Misconception 1: Lower mid- These attributes are particularly im- nually. We apply a data-driven approach to market companies are sub-scale portant at this point in the economic cycle. our senior secured lending strategy with a and lack infrastructure, depth Lower mid-market direct lending managers heavy emphasis on credit fundamentals in- and durability will be in a position to quickly take action cluding leverage, margin, coverage, stability As the data in the table would suggest, and protect investor capital rather than be- and growth. We also have a sector bias that these are companies that not only have sig-

32 Private Debt Investor • November 2019 Analysis

nificant revenues and customer bases, but Lower mid-market misconception Tree Line’s portfolio which have been in operation for nearly two decades on average and which successfully navigated the last generational recession. On average, Tree Line originates 150-200 Companies are sub-scale $67m investment opportunities, but only closes Average revenue between three and five new investments each quarter, all of which is a function of our extremely selective underwriting processes. The result of our selective approach is a Companies lack infrastructure and depth highly diversified portfolio of senior secured 210 Average number of employees loans to companies that are regional lead- ers within their markets and that provide products or services that are critical to their customers. These attributes are critical to us as lenders given our acute focus on princi- Companies are less proven 19 pal protection, which dovetails well into the Average age of company next lower mid-market misconception.

Misconception 2: Lower mid- construction centred around high free-cash- but that simply is not the case. Tree Line has market companies will have a flow businesses. originated more than $1.3 billion in com- tougher time servicing debt in Additionally, this analysis reinforces the mitments across 86 transactions over the the face of a downturn importance of constructing a portfolio with past six years of operations with a consistent Lenders spend a significant amount of time reasonable leverage and strong debt-service and disciplined approach to underwriting focusing on downside scenario analysis. A coverage statistics. Investor concerns across and deal selection. critical part of this analysis focuses on a bor- the broader mid-market are certainly war- Uncompromising credit fundamentals rower’s ability to service debt, which is often ranted: according to Refinitiv, 73 percent are at the core of our strategy with 100 represented as ratio of free cashflow to debt of issuances in 2018 were percent of the transactions we have closed service, otherwise known as fixed-charge greater than 6.0x and 41 percent were in maintaining at least two financial covenants coverage. Running a sensitivity analysis excess of 7.0x. Having said that, leverage alongside weighted average leverage levels across Tree Line’s portfolio, if all borrowers is only as meaningful as the quality of the of less than 4.0x across Tree Line’s total lost on average 25 percent and 40 percent EBITDA used in its calculation, which leads portfolio. of EBITDA, the resultant fixed-charge cov- us to our third misconception. erages would be 1.4x and 1.1x respectively. It’s about knowing where to look This highlights the importance of portfolio Misconception 3: Deteriorating In a depressed interest rate environment the credit fundamentals prevalent in hunt for yield continues, but not all direct the mid-market have found their lending alternatives are created equal. Many way into the lower mid-market larger credit funds are combatting yield The headlines aren’t new, but the troubling compression by either subordinating at the “Leverage levels in leverage levels in the mid-market and the asset level into second-lien or mezzanine broadly syndicated loan market are ap- securities or by employing more aggressive the mid-market and proaching all-time highs. Compounding fund level leverage. this risk is the virtual elimination of main- As we approach the 10th year of an eco- broadly syndicated tenance covenants, combined with a signif- nomic recovery, it’s more important than icant and often uncapped level of EBITDA ever to peel back the onion on risk-adjusted loan market are adjustments. return. The lower mid-market offers a com- To put EBITDA adjustments in perspec- pelling niche where credit fundamentals re- approaching all-time tive, according to data from Xtract Research main intact and allow experienced managers covering the 12 months up 30 June 2019, to generate outsized returns without losing highs” 53 percent of sponsor-backed transactions focus on principal preservation. in the broadly syndicated markets allowed The commonly shared view that bigger uncapped addbacks for cost savings and syn- is better and lower mid-market companies ergies. That was up from 30 percent in the are inherently riskier simply isn’t true if one second half of 2018. takes the time to drill into the data. Investors As trends in the large corporate issuance that are willing to dig into the data, howev- market permeate the mid-market it might er, will be pleasantly surprised by the oppor- be a natural conclusion that those trends tunities that exist within the niche strategy will inevitably reach the lower mid-market, that is lower mid-market investing. ■

November 2019 • Future of Private Debt 33 Analysis

A tour of private debt in Asia

LPs and managers from across the region tell Adalla Kim how the asset class is developing

orth America may be the leading region when it comes to private debt, but Asia-Pacific is active as well. Japanese pensions, South Korea’s and Singapore’s Temasek Holdings are Nall making their presence felt, as are Blackstone and Allianz Global Investors in India. With Beijing also restricting offshore bond issuance, there is plenty for investors to keep on top of.

34 Private Debt Investor • November 2019 PDI Ad vf trim marks.pdf 1 2019-10-09 4:41:39 PM

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Japan Private capital invested into each country relative to annual GDP since 2014 (%) The latest Japanese LP to en- 0 0.5 1.0 1.5 2.0 2.5 ter the scene is the Pension Fund Association for Lo- UK cal Government Officials, known as Chikyoren. Its US public disclosures in May and September show it has cho- India sen BlueBay Asset Management and Bar-

ings for its private debt mandate this year. South Korea Chikyoren decided to allocate capital to private debt for the first time in July 2018, Japan when it issued a request for proposal. A To- kyo-based senior investment officer over- China seeing the process told PDI that the LP was looking for private corporate debt invest- ment opportunities in the US and Europe. Private capital includes private equity, private credit, private infrastructure and real assets. Rates were calculated based on annual private capital investment divided by annual gross domestic Japan’s Government Pension Investment product (current prices) Fund, the world’s largest public pension ad- Sources: Emerging Markets – EMPEA; all GDP data – IMF World Economic Outlook Database, ministrator by asset size, first expressed an April 2019 interest in private debt in April 2017. In Q3 it took a further step by issuing an RFP for wealth fund determine which sub-strategies has been another pillar of investments that a market research project on the asset class. and assets to pursue and which private debt foreign private equity and credit managers A Tokyo-based spokeswoman for GPIF fund managers it will work with. PDI under- have been focusing on. declined to comment on the details on stands that Temasek, as of the end of 2018, Unlike other India-focused opportunis- planned private debt allocations in order had around $400 million of direct private tic private capital firms looking to acquire not to influence the market. She added that credit exposure. bank assets via asset-restructuring company GPIF’s external asset managers would make platforms in order to liquidate the assets, the investment decisions on behalf of the India Blackstone is looking to take real estate and pension fund administrator. The recent defaults by non- debt-saddled businesses and make them vi- bank lenders in India reflect able again through sustainable capital struc- South Korea the country’s subdued lev- tures. Korea Investment Corpora- els of liquidity, especially Offering his view on how to price a tar- tion has a return bench- in the infrastructure and get investee company on a relative value mark for private debt real estate financing sector. basis, Kishore Moorjani, a Singapore-based strategies and asset classes Almost a year to the day after senior managing director at Blackstone Tac- in the mid-to-high teens, Infrastructure Leasing & Financial Services tical Opportunities Group, says his team net-of-fees, according to a defaulted on a series of interest payment and starts with a risk-free rate in India. It then source familiar with the matter. debt obligations in September 2018 Altico adds premiums for foreign exchange risk, It is understood that the sovereign wealth Capital India followed suit. legal jurisdictional risk and other situa- fund’s in-house private equity team has also Disclosures by the Reserve Bank of In- tion-specific factors. been overseeing its investments in alterna- dia from August show IL&FS and Altico are What Moorjani’s team pays to the banks tive assets, including real asset financing. both registered as non-deposit taking sys- is contingent on two things: “What pric- The source adds that KIC has commit- temically important investment companies, ing level they will accept and whether that ted an undisclosed amount to HIG subsid- or NBFCs-ND-SI, as per the central bank’s aligns with what we think is a fair return of iary Bayside Capital for its European spe- classification (there are 272 such entities the capital. And that is the price.” cial situations mandate. PDI data show that listed with the central bank). Blackstone Tactical Opportunities HIG Bayside Loan Opportunity Fund V As Altico did not have sufficient liquid- Group’s Indian NPL strategy includes buy- held a final close on $1.5 billion in June. ity to meet all its repayment obligations, ing a controlling stake in a local asset re- it “paused further debt payment to protect structuring company platform called IARC Singapore the interest of all stakeholders”, according (International Asset Reconstruction Com- Temasek Holdings is under- to a statement issued by the company on 22 pany) in which it is a majority shareholder. stood to have a target re- September. On the performing credit investment turn in the mid-to-high A source familiar with the matter has side, Allianz Global Investors has, since its teens for its private debt confirmed that Altico’s existing stakeholders inception in November 2018, been ramping strategy. This benchmark have asked a local Indian bank to oversee its up its capabilities via a dedicated Asia-Pacif- has played an important . ic team based in Singapore. role in helping the sovereign Acquiring non-performing bank loans Sumit Bhandari, the team’s lead portfolio

36 Private Debt Investor • November 2019 Analysis

manager, says opportunities in private debt The National Development and Reform investment vary across Asia. Commission – an agency under the State “Asia is not a monolith,” he says. “You “As the market Council, China’s chief administrative au- have a lot of countries with different cred- thority – in September imposed restrictions it and business cycles and each of them is becomes a bit tighter, on offshore bond issuance by Chinese res- growing differently.” idential developers. Now Chinese offshore The team provides US dollar-denom- maybe in the next six borrowers can only issue US dollar-denom- inated credit solutions to performing bor- inated bonds if they have existing debt to rowers. The financing has typically been to 12 months, all these refinance. used for acquisitions, re-financing and lia- Edwin Kam, a senior fund manager at bility matching, cashflow matching to debt 364-day and short- Value Partners, a Hong Kong-headquar- amortisations, or for growth capital. tered asset management firm, says liquidity For its senior secured debt strategy, the dated papers that we has tightened. His observation is based on team is looking to lend at an operating level the greater number of short-term US dol- with a gross IRR in the high-single digits. have seen might face a lar-denominated debt notes being issued, For its mezzanine debt strategy, it is target- with maturities of 363 or 364 days. ing returns in the mid-teens. rough time” “As the market becomes a bit tighter, “Consistent with AllianzGI Alterna- maybe in the next six to 12 months, all these tives’ broader strategy, we are looking to EDWIN KAM 364-day and short-dated papers that we invest into real assets and extract returns,” Value Partners have seen might face a rough time,” he re- Bhandari says. “We are looking at real cash- cently told a Harneys litigation and restruc- flows of the investee companies … the way turing seminar. to get your return is via self-liquidating Offering his outlook on a spike ofde- debt.” faults this year in the Chinese onshore debt His team has started deploying capital market, Kam says he has already seen an across the core markets in South-East Asia, increased level of defaults in the onshore South Asia and Oceania. He notes that most market. He notes that off- of the asset types in which the team is look- shore debt markets seem healthier because ing to invest are in the consumer-driven, offshore corporate bond issuers tend to industrial and speciality chemical sectors: be bigger companies. Some are also listed “Those will continue to form a big base of on multiple stock exchanges, including in what we do.” Hong Kong, mainland China and even in The Asia private debt team is the latest the US. addition to AllianzGI’s alternatives offering. “But mind that we are seeing more – let’s According to a London-based spokesman for say – ‘funky’ exercises, or incidents like debt the firm, it manages more than €24 billion exchange exercises, or some situations like in private debt globally. This includes in- offshore bonds paying the interest, but they frastructure debt investment AUM via both already defaulted onshore,” he says. Chi- closed-ended funds and separately managed na’s offshore US dollar-denominated bond accounts as of the end of June 2019. market is much smaller than the onshore “Asia is not a equivalent. China As the Asia Securities Industry and Fi- The government’s latest pol- monolith. You have a nancial Markets Association, an industry icy guideline for commer- body, explained in its latest report, pub- cial banks and regulation lot of countries with lished in June, there was $53.7 billion of on corporate borrowing Chinese dim sum bonds (yuan-denominated show how supply-and-de- different credit and bonds issued in Hong Kong) outstanding as mand dynamics relating to at the end of 2018. onshore capital are changing business cycles and each However, challenges remain as the defi- across China. nition of offshore loans seems to be chang- Ray Heung, a Hong Kong-based senior of them is growing ing, especially for those that are lending off- vice-president in Moody’s financial insti- shore from Hong Kong and Macao. tutions group, tells PDI that commercial differently” As Yichen Zhang, the founder, chairman, banks are not obliged to comply with the so- and chief executive of CITIC Capital, told called 1-2-5 policy guideline. “This is more the Milken Institute Asia Summit 2019: SUMIT BHANDARI about the larger banks,” he says. “But the Allianz Global Investors “Capital from Hong Kong and Macao was feedback that we got from that is basically considered as foreign capital in the past. But they are reaching the targets.” it is not certain this time.” n

November 2019 • Future of Private Debt 37 Analysis

EXPERT Q&A

As the private credit markets continue to expand in Europe, William Nicoll, M&G Investments’ head of institutional fixed income, says investors will do well to remember opportunities that exist beyond direct lending

A wealth of opportunity in private debt

How do you see the private private debt they focus too heavily on direct SPONSOR debt market evolving over the lending, which has become almost synony- Q M&G INVESTMENTS next five years? mous with the asset class. You cannot fit the The US financial markets are clearly the amount of money that wants to go into pri- most developed in the world and the rest of of the way regulators have moved. vate debt solely into direct lending, so the the world is attempting to catch up to a sys- We see the current trend continuing for savvy investors are realising that the private tem that is not totally bank-dominated. We the next 10 or 20 years as we fundamentally credit markets are more complex. are therefore seeing what could be perceived redraw how the markets operate to create If you go back to 2009 when we did our from the outside as a number of chaotic deeper and more interesting debt markets. first direct lending fund, it was very hard to market shifts, as each continent and jurisdic- I don’t see the future for Europe looking attract investors because it was very new, but tion works out what is going to be best for exactly like the US, simply because other there were huge opportunities out there. them. Europe, in the last decade, has gone regulatory forces are in play. Now it’s the other way around. from a position that was described as hav- That does not mean it will be plain sail- The direct lending space is going to have ing more than 80 percent of lending done ing in every market. Clearly, direct lending a credit cycle at some point that will result in by banks to something closer to 60 percent. is now a very crowded market, especially losses on those portfolios because that’s the We see the private credit markets con- in Europe. That may go through its own nature of the market. That will cause a hic- tinuing to take market share away from mini-cycle as part of the larger cycle that cup but will shift the spotlight to areas like the banks, not least because policymakers sees us end up with more debt finance private asset-backed lending, leasing and are quite keen to see a far deeper and more coming from asset managers and insurance trade receivables, which continue to develop structurally robust set of markets. This companies. as their own markets. means there will be unintended consequenc- It is also important that when investors es as the regulators act, such as we have seen What does that mean for the talk about private debt they don’t overlook in the speciality finance area, which will be- Q various participants in the markets like long-lease property and income come quite an important market in Europe market, particularly investors? strips, because each of those other private – possibly more so than in the US – because The risk is that when people think about markets has its own little cycle.

38 Private Debt Investor • November 2019 Analysis

As a general rule, we feel that when a debt. We are starting to see the distressed market starts developing, we probably have “The risk is that when players working up. a couple of years to make attractive invest- The other area is some of the more com- ments and then it will go through a cycle, people think about plicated ideas that have been around for a either because it gets too hot or becomes long time, like the way that banks are financ- difficult in some way. We advise people to private debt they ing themselves through speciality financing invest quite flexibly so that they can take ad- or regulatory capital trades. Those are long, vantage of new markets that come up and focus too heavily on complex transactions to do, because they re- to have the courage to move into the best quire a large amount of resourcing, so there new investments. We are bottom-up value direct lending, which are not that many people looking at them investors, so if a particular area looks like of- and there is still some price discipline. fering lower returns or worse structures, we has become almost As an investor you are looking for things will naturally cycle away from that. that aren’t popular. For many years we had The key thing is that private debt is not synonymous with the much less competition in private debt but just one market but lots of different lit- this has changed significantly as it’s become tle markets that really do not look at each asset class” more popular and there have been new en- other. If you’re lending to platform lend- trants to the market in the last five years. ers who are lending directly to consumers, for example, you will be affected by the How do you think the asset class economic cycle in a different way to other Q will respond in the event of a . The markets are quite separate and downturn and how should managers unless we have a really bad credit cycle, it is invest in that scenario? quite likely we will continue to see strong In general, private lending is well placed opportunities in some markets most of the where there are covenants that allow in- time. vestors to get in early to help companies or structures in difficulty. The concern is What should managers be that in some parts of the market there has Q doing now in anticipation of not been that discipline and covenants have changes to investor demand for the been eroded. We will not have those private asset class? assets doing better in a downturn than pub- They need to be looking at where the next lic assets, as we have come to expect. markets are going to grow, where people There is also an issue of timing. If the want to borrow money and where they can corporate environment gets challenging, generate good returns. They will need to the public markets will move quite quickly spend money on research to find the next but the private markets will tend to drift great markets, which will probably not offer more slowly. There will be a very different easy access. impact depending on what kind of a down- The R&D angle is quite important. Sim- turn we have and what sectors and geogra- ply following other market participants is phies it hits hardest. significantly less attractive in this area than in others. At the moment, there is too much What jurisdictions or strategies money and as soon as anything emerges as Q should people be looking at to a defined market investors are piling in and prepare for a change in the economic you have probably lost most of the return. cycle? From an investor perspective, you de- People really need to have open minds and fend yourself by having a sensible conver- the flexibility to look at private debt more sation with your asset manager and by not holistically in order to get the value that is being wedded to something in a race to get out there. money in the ground. It is better to be pa- We look at all jurisdictions and all asset tient. classes and seek to work out which deals make sense, even in some sectors that might Where do you see the be presumed to be very difficult, like retail. Q opportunities for investors right For us, it comes down to the protections now? that we can get, because that is really how We have definitely seen a lot of money you prepare for a change in the economic available to companies to be able to borrow cycle. Investors need to look for protections directly without covenants, so there will be that work in all reasonable circumstances an opportunity at some point for distressed and make sure that they don’t lend badly. ■

November 2019 • Future of Private Debt 39 Analysis

Going public-to-private

Guest comment by Alexander Griffith

Proskauer partner on how navigating the public-to-private process is different from private acquisitions

n 2018, there were 170 public-to-pri- holders accept it. The acceptance process During the period before the bidder is vate deals globally, worth $227 billion, then runs to a set timetable. disclosed as being interested in making an according to Bain & Company. Those The other route is via a scheme of ar- offer, no more than six parties – including levels had not been seen since the years rangement. Following discussions with target shareholders, equity funders and immediately before the global financial a prospective purchaser, the company’s lenders – may have access to information. crisis and the signs are that they will shareholders instigate the public-to-private Icontinue. process and vote on the proposal during a Certain funds’ requirements Public-to-private transactions are being court-convened meeting. If approved by The requirements for certain funds, es- driven by record amounts of dry powder 75 percent of shareholders by value (and a pecially private debt funds, make pub- among private equity firms (estimated by majority by number) from each shareholder lic-to-private deals significantly different to Preqin to be $1.54 trillion in June), by ris- class, the proposal is binding. private ones. A bid can only be announced ing multiples for private companies and by Hostile bids present a third route, once the prospective buyer can provide weak sterling, which has made UK public though few lenders would support them assurances that it can fulfil the full offer companies targets for dollar-denominated given the uncertainty over the outcome. amount in cash – assuming a cash bid – and funds. Blackstone’s take-private of Merlin that it has every reason to believe it will be Entertainments and TDR Capital’s acquisi- Differences in procedure able to implement the offer. tion of car auctioneer BCA Marketplace are for lenders The financing documents therefore just two examples. A big issue for lenders is the extent of due need to include specific provisions to pro- Yet for private debt funds, public-to-pri- diligence available in public companies. vide certain funds. This is also now com- vate transactions are often uncharted terri- This tends to be limited to publicly availa- mon practice in private transactions. How- tory. It was historically banks that led the ble information, which is less current than ever, in public-to-private transactions, the financing for such processes, which are would be the case for a private company. financial advisor is likely to subject private quite different from private company buy- As a result, lenders are likely to seek higher debt funds to much more detailed scrutiny outs – something private debt funds need pricing for their finance. over the sources of their capital than they to be aware of before becoming involved. Although it is possible to conduct more may be accustomed to. detailed due diligence, this can entail some The advisor may seek information on Types of public-to-private risk. If share prices move during the due fund investors, fund drawdown history, transaction diligence process, the buyer must announce limited partnership agreements, require- Regulated in the UK by the Takeover Code, an intention to make an offer. It then has 28 ments for drawdown notices and headroom acquisitions of public companies are subject days to ‘put up or shut up’. levels. They may also seek opinions on the to statutory rules governing the structure Rules governing secrecy pre-announce- enforceability of funding obligations and and process of the transaction. These are ment apply to all parties. Firstly, the finan- comfort letters from the fund manager. enforced by the Panel on Takeovers and cial advisor and bidder must consult the There will be a certain funds period in Mergers. mergers panel before approaching lenders. the credit agreement, usually running from The most common public-to-private Once approached, lenders must treat all signing to the latest date by which accept- process is the recommended bid. The board information as strictly confidential, and this ances might be received or a squeeze-out of the target company views the offer made need for secrecy must be communicated of minority shareholders might be imple- by a bidder – and, in particular, the offer clearly to anyone with access to informa- mented. During this period, a lender may price – as attractive and recommends share- tion. only deny funding under certain limited

40 Private Debt Investor • November 2019 Analysis

circumstances, all of which apply to the Public-to-private bid timetable bidder and not the target. This does not in- clude material adverse effect, which would require lenders to close the deal and subse- Ahead of bid announcement ■ Due diligence phase completed quently accelerate. ■ Term sheet negotiations take place ■ Deal is priced Credit documentation The fact that public-to-private transactions Offer announcement date ■ Announcement (can be made up to 28 days (Day -28) before the offer document is sent) entail unique processes means that facilities ■ Finance documents executed; finance agreements contain undertakings over and commitment becomes live above those in a private acquisition. These ■ Finance documents must be published online might include undertakings to comply with no later than 12.00 noon on the business day the code, keep lenders informed of any de- after the announcement velopments and not to increase the offer Offer document is sent price or amend the offer document. An important undertaking for lenders is Day 0 likely to be that the bidder does not act in a way that could trigger a mandatory offer. The target company’s directors must advise When the bidder and those acting with it shareholders of their views on the offer within 14 days (such advice is normally sent out with the gain an interest in 30 percent or more of 14 offer document in a recommended bid) the target’s shares a binding offer has to be made to all shareholders at the highest Earliest possible closing date (the offer period can be extended if there are insufficient acceptances) share price over the previous 12 months. 21 The bidder only has to acquire a majority shareholding rather than the 100 percent Acceptance levels are announced and, if there that lenders will expect. are insufficient acceptances, the offer period is Lenders are also likely to require that extended 22 an offer cannot be declared unconditional (or the first business day after an as to acceptances at a level below 90 per- extended closing date) by 08.00 cent of the shareholding. This is because once 90 percent acceptances have been Last day for the offer to become unconditional (acceptance condition must be fulfilled by this achieved, the bidder can re-register the date) target as a private company; this would 60 enable the bidder to ‘squeeze-out’ or pur- Earliest date on which the offer can close (if it chase remaining shareholders to gain full became unconditional on day 60) ownership. This would ensure that lenders 74 can take share security over the target as a going concern. Last date for the offer to become wholly Private debt funds should be aware that unconditional (if it became unconditional on day 60) the terms of their finance will not remain 81 confidential in a public-to-private trans- action. Offer documents must describe First drawdown needed to meet consideration deadline on day 95 the debt-financing arrangements in detail, 81-94 including the amount of debt, repayment terms, interest rates, security, key covenants Last date for payment to shareholders who have and lender names, all of which will be pub- accepted the offer by day 81 licly available. 95 Financial assistance rules mean the tar- get must be re-registered as a private com- Last possible day for a bidder to issue squeeze-out notices for companies not listed on a regulated pany before it can grant guarantees or secu- market (such as London’s AIM) rity for its acquisition debt. As a result, it is 180 customary for lenders to take two English – one from the bidder’s spe- cial-purpose vehicle stack before the deal Notes: 1. This timetable is a simplified version that does not include steps in the process for hostile bids closes and one from the target group after it 2. The timetable assumes that the public-to-private is not competitive has re-registered. ■

November 2019 • Future of Private Debt 41 Analysis

EXPERT Q&A

The long boom in fundraising may tempt managers to lower lending standards or drift from their original mandate. However, Philip Robson and Theresa Shutt of Fiera Private Debt argue that in today’s market rigour and focus matter all the more

Maintaining discipline in private debt

For private debt managers, it is the good Theresa Shutt: LPs have become more SPONSOR times – such as the current, long econom- aware of the increasing levels of dry powder FIERA PRIVATE DEBT ic expansion – where competition for deals and the growing competition. One of their really heats up. As this expansion has been biggest concerns is that their managers may so volatile and uncertain, LPs have made Is there too much money in be taking more risk in order to deploy capital plenty of commitments to private debt Q private debt markets now? and accepting more covenant-lite loan struc- funds. This in turn has left managers with Philip Robson: The question isn’t wheth- tures, particularly in the sponsor-backed war chests, but without the opportunities to er there’s too much; it’s how those com- market. In some cases, managers may be get- match. mitments are deployed. There’s been spec- ting pushed into loans that have very mini- According to Preqin’s 2018 Private Debt tacular growth over the last few years of mal covenants or no covenants at all. Report, there was a record $309 billion in dry allocations to both private debt and private To justify cov-lite deals, managers may powder as of June last year and 53 percent equity. attempt to assure LPs that a particular com- of managers said competition for deals was GPs that might have raised $300 mil- pany is so strong that covenants are not the biggest challenge they faced. We spoke lion-$400 million a few years ago are required. Investors are savvy enough with to Philip Robson, corporate and infrastruc- raising a billion or more now. With that private debt as an asset class to be anxious ture debt financing executive vice-president kind of money, there’s more pressure to about these kinds of responses. at Fiera Private Debt, and Theresa Shutt, deploy and to do so more quickly. This I read recently that acquisition multiples the firm’s chief investment officer, about the can make it too easy to yield to the temp- for PE-backed leveraged buyouts are aver- market and their philosophy for weathering tation to loosen standards or to allow aging 10x EBITDA, which is historically the good times. style to drift. quite high. That typically means higher

42 Private Debt Investor • November 2019 Analysis

leverage in the debt world as well. While do covenant-lite loans. We strongly believe ness for later. For a lender, it’s all about the our maximum threshold for leverage across that covenants are critical as they enable us downside. We do look at EBITDA growth our strategies is 4.5x, we’ve been increasing- to track the performance of the business to determine whether the company can ly hearing about leveraged buyouts being and provide early warning signs of potential generate sufficient and sustainable cashflow done at 6-7x total debt to EBITDA, which problems. Covenants also provide us with to service the debt, but we spend a signifi- is nearing 2007 levels. the ability to intervene in the business to cant portion of our credit analysis reviewing We frequently get asked about leverage ensure a better outcome. worst-case scenarios. ratios for the underlying loans in our port- While financial covenants are important Credit isn’t rocket science, but 30 years folios, and investors are digging deeper into to track performance, we also structure what of credit experience can’t be replicated. A lot what is actually senior secured. There’s been we call ‘moral hazard’ covenants to ensure of our LPs want to do direct investing but this move towards unitranche structures tighter controls over our investments. These the ones that have tried it learn quickly that in private debt, where the LPs may think are covenants that prevent borrower man- it’s a specialised skill set and that it’s difficult, they’re getting mostly senior secured debt agement from taking certain actions that requiring a very different mindset than mak- investments, only to look closer and discov- could be detrimental to the business and to ing a private equity investment. er quite a few slices of mezzanine debt. our position as a lender. These covenants can restrict distributions and asset sales and PR: There is a growing conversation about Given those tendencies, how prevent the borrowers from changing the LPs wanting to partner directly with private Q are LPs handling manager nature of the business. debt investors. A large enough pension plan selection? These covenants don’t exist in big deals or can afford the costs PR: When we raised our first fund in 2004, it and time required to build out a 15-person was really a ‘trust us’ argument which, to be debt team to start acting like a co-investor or brutally honest, was more about luck. Now, “Covenants are critical a partner in the private debt space. In Can- LPs are looking more closely at the tenure of ada, I can count the number of players that the managers, and by that I don’t necessarily as they enable us to size on my fingers and toes and as a group mean the tenure of a specific fund. they tend to be shrinking as closed DB plans LPs and their consultants are looking track the performance are increasingly in deaccumulation mode. much more closely at the experience and ca- I worry about this trend because that pabilities of the people inside the manager. of the business and big pension plan has to write a big cheque What is their experience with finding loans? to co-invest at a level that will move its re- Or fixing them when there are problems and provide early warning turn needle. The size of that commitment protecting their capital? could potentially have a negative impact on In our world, a lot of LPs are closed, de- signs of potential its overall private debt diversification and it fined-benefit plans. That means the capital might not appreciate the full risks involved. is locked and there aren’t 5,000 workers out problems” Our last fundraise was north of $800 there still making contributions. Capital lost million, but our average investment is still through a broken private debt investment is sub-$20 million, and that’s diversification lost for good. So, they’re asking about the THERESA SHUTT which works in our investors’ favour and process, the controls, the internal govern- protects our own balance sheet. I fret about ance structure that ensures the firm doesn’t LPs chasing yield and losing sight of the fact drift from its mandate, and at a manager’s and that’s concerning. I was on a panel re- that they don’t have the expertise that comes track record in working to minimise down- cently and a fellow panellist shared an an- from being beaten up year after year in the side risk and recover LP capital. ecdote about PE firms that insist their lend- lending business. ers use their lawyers to structure the credit TS: Five years ago, investors used to focus agreements. As a lender I can’t imagine not Where do you see the private on the net return number, because they having our own counsel during the negoti- Q debt market, as a whole, were highly focused on fees. Now they have ation to protect our interests as a creditor. heading in the next year or so? significantly more experience and are asking PR: It’s been long enough into this expan- the right questions about debt and So many private equity firms sion that I’m getting worried. A lot of the leverage. Q have launched their own private timeless standards are still relevant. Having Before making an investment in our debt funds. How has that shaped the done more than $4 billion in private debt in- funds, LPs will spend significant time eval- industry you operate in today? vesting as a firm, while only having written uating our underwriting process. They will TS: We’re going to have to look at their off $5.6 million, we know the old ‘Cs’ mat- come in for an on-site visit and will want to performance over the long term. Fun- ter most in this business: the character of the understand why a particular investment met damentally, our belief is that an equity borrower, the cashflow, the collateral and our criteria. They want to know our thinking investor thinks differently to a debt in- the capacity to pay. No matter how much and be comfortable with our analytical abil- vestor, and that’s really important. Their money gets raised or what players venture ity and experience with different industries. experience is all about the upside and into this space, the winners will understand We like to stress with LPs that we don’t growth and what they can sell the busi- those four factors. ■

November 2019 • Future of Private Debt 43 Analysis

Faces of the future

Private debt’s next generation of leaders met in London this summer, writes James Linacre

DI’s first list of Rising Stars was published this year. It celebrates 30 Pof the hottest talents in private debt – those who might not be the best known just yet, but seem destined for great things. To celebrate the list’s launch, PDI hosted an evening reception at Home House, in London’s Marylebone for very quaffable cocktails, canapés and convivial conversation with the men and women who we believe will be lighting up private debt in the years to come. The event was co-hosted by law firm Debevoise & Plimpton and also attended by nominees of sister title Private Equity International’s equivalent list – the 40 Under 40. The result was an evening full of bright-eyed, forward-looking young professionals eager to discuss not just what they have achieved so far but what is coming next. Of course, the 30 Rising Stars are based not just in London, but all over the globe. Plans are well afoot to host our US winners in New York. The list is based on nominations from the market and supplemented by supporting evidence in the form of key achievements, with some of the 30 selected directly by the PDI editorial team. All nominees were under the age of 40 on 1 April 2019. The youthful achievers were nominated both from within their firms and externally. In fact, it was a condition of the nominations that every internal nomination had to be accompanied by an external recommendation as well. The resultant list of nominees is a true who’s who of the industry’s future leaders. Next year’s list is sure to be just as strong – which may well be true of the cocktails as well! ■

44 Private Debt Investor • November 2019 Analysis

PDI’s 30 Rising Stars

Sikander Ahmed – NBK Capital Partners William Hayles – Credit Suisse Private Funds Group Roy Awad – Debt Managers Tor Holberg Herno – BlackRock Stephanie Berdik – Kirkland & Ellis Guillaume de Jongh – Capzanine Taylor Boswell – Carlyle Group Marcin Leja – CVI Jared Brimberry – Alaska Permanent Fund Corporation Rony Ma – KKR Grant Chien – InfraRed NF Investment Advisers Nicolas Nedelec – Idinvest Partners Scott Colton – Paul Hastings Adrien Paturaud – Goodwin Procter Alex Cota – Stroock & Stroock & Lavan Ruth Pearson – LendInvest James Del Gaudio – Pennsylvania School Employees’ Timothé Rauly – AXA Investment Managers – Real Assets Retirement System Rodolfo Sánchez-Colberg – Parliament Capital Management Elizabeth Di Cioccio – Mercury Capital Advisors Brett Shapiro – Varagon Capital Partners Nicole Drapkin – Owl Rock Capital Partners Hernán Sorate – Lazard Kirsten Glaser – Rivercrown Group Sloan Sutta – Crayhill Capital Dev Gopalan – Angel Island Capital James Wallington – CVC Credit Partners Bobby Hagedorn – Missouri Department of Transportation Molly Whitehouse – Mariner Investment Group and Highway Patrol Employees’ Retirement System Felix Zhang –

November 2019 • Future of Private Debt 45 Analysis

EXPERT Q&A

Evergreen interest grows

Evergreen funds appeal to a broad range of investors and provide increased access to private credit. These fund structures are gaining popularity with global investors, says Northleaf Capital Partners’ David Ross

Northleaf Capital Partners is an independent green structure is one with which they are SPONSOR global private markets investment firm with familiar and comfortable, as it more closely NORTHLEAF CAPITAL PARTNERS more than $13 billion in private credit, private resembles a public market fund. equity and infrastructure commitments under management on behalf of public, corporate What are the benefits of How common will and multi-employer pension plans, endow- Q evergreen funds and which Q evergreen funds become ments, foundations, financial institutions and investors like them? in private credit? family offices. Based in Toronto, Montreal, The private credit asset class has been attrac- It is natural that as private credit matures as London, New York, Chicago, Menlo Park tive to investors given the strong returns, an asset class, we will see new fund struc- and Melbourne, Northleaf’s 140-person team muted volatility and portfolio diversification tures develop in response to the increasing is focused on sourcing, evaluating and manag- it provides. Private credit evergreen funds demand from both institutional and non-in- ing private markets investments globally, with offer all of the advantages of the asset class stitutional investors. Closed-end funds are a focus on mid-market companies. with the additional benefits of enhanced li- likely to remain the most common structure In 2018 the company launched Northleaf quidity, shorter investment periods, better for institutional investors due to the under- Senior Private Credit, an evergreen fund for visibility to capital draws and consistent and lying characteristics of most private market mid-market direct lending. David Ross, Lon- ongoing exposure to the strategy. investments. We still regard the closed-end don-based global head of private credit, ex- These characteristics appeal to a broad fund structure as a very attractive way for pects continued growth of evergreen funds in range of investors, including institutions, investors to access private credit. We see the sector and increasing commitments from family offices, high-net-worth individuals evergreen funds as a growth driver, tapping new investor types. and independent asset managers. The ever- into incremental investor demand.

46 Private Debt Investor • November 2019 Analysis

How do you manage the tension Looking at barriers to entry for Do you need to make different Q between investor demand for Q prospective future funds, is it Q kinds of investments for your liquidity and the need to invest in hard to run an evergreen vehicle? evergreen fund? illiquid assets? There are significant challenges to launch- It is crucial to avoid compromising the We spent a significant amount of time de- ing and efficiently managing evergreen quality of the investments, or change the signing the mechanics of our evergreen funds. For this reason, we believe that firms underlying investment activity, to achieve fund, Northleaf Senior Private Credit. It with broad operating platforms and depth the evergreen fund structure. We continue was incredibly important that the fund’s of credit investment capability will be best to invest in high quality senior secured deals liquidity provisions were driven by and positioned to offer evergreen structures. with attractive terms and returns. North- aligned with the strategy of the fund and the On the operational side, a fund manager leaf’s differentiated sourcing platform ena- natural liquidity of the underlying assets. It needs to be able to integrate the selection bles us to remain highly selective while still is the relatively shorter weighted average of individual assets with the active manage- maintaining a steady investment pace. life of the diversified portfolio of loans that ment of the entire portfolio. This requires underpins and allows for the liquidity provi- the capability to consistently originate a Away from evergreen funds, sions of our vehicle. large pipeline of deals. For Northleaf Sen- Q what kind of challenges will More specifically, we included a number ior Private Credit, that means selectively lenders face in the future? of design features in our evergreen fund investing in 20 to 30 deals each year, with a We use pattern recognition and trend structure to manage the tension between the target total portfolio that is diversified with analysis to frame and focus our investment illiquid underlying assets and the investor 70-plus positions. strategy and enable us to assess future po- desire for liquidity from the fund. The asset In addition, effectively managing such tential risks. In recent years, and over the class benefits from natural liquidity through a large and diversified portfolio requires course of the past decade in particular, the maturation, amortisation and refinanc- an active risk management process, which borrowers have created efficiencies in their ing of the underlying loans, which can be begins at the time of credit selection. At supply chains to cut costs, shorten time lags used to help provide investor liquidity. Northleaf we have a dedicated portfolio in the delivery of goods and reduce working We have structured Northleaf Senior strategy and analytics team that is involved capital, but leaving little margin for error or Private Credit with a three-year ‘lock-up’ throughout the investment and portfolio volatility. period that matches the approximate three- management processes. One of the biggest threats facing bor- year average duration of the diversified The team’s mandate is to supplement rowers and lenders is the potential unwind- portfolio of underlying loans. We find that traditional bottom-up credit analysis with a ing of some of those efficiency trends, in- while investors are attracted by the flexi- top-down portfolio diversification and risk cluding increases in labour costs, potentially bility of a liquidity provision, the ability to management perspective. The added layer driven by global macro threats such as the maintain stable and ongoing exposure to the of analysis and oversight helps to build an trade war between the US and China, Brexit strategy and asset class is equally important insulated, ‘all-weather’ portfolio that is a and so on. There are also heightened oper- - as is the ability to deliver ‘pure play’ private key success factor for an evergreen fund. ational risks with respect to issues such as credit exposure without including public se- cybersecurity. curities or significant cash holdings in the fund’s portfolio. Will investors pay more heed to Our fund facilitates this by reinvesting Q ESG issues in the future? principal on behalf of investors and by con- ESG considerations are becoming increas- structing a diversified portfolio of approx- ingly important to private credit investors. imately 70 individual loans. Importantly, Over the long term, investors will benefit the fund was structured to provide access from fund managers integrating ESG con- to mid-market loans for investors interested siderations, such as climate-related risks, in making a strategic allocation to the asset governance structures and social risks, into class. While the liquidity provisions enable their investment and portfolio management investors to redeem their exposure over four process. quarters, the fund is not designed for inves- At Northleaf we recognise that respon- tors looking for a short-term trade. sible corporate behaviour has a positive in- We believe that Northleaf Senior Pri- “We see evergreen fluence on long-term financial performance. vate Credit is the first – and, so far, only This belief has underpinned our approach – mid-market-focused private credit ev- funds as a growth to private markets investing since our incep- ergreen fund. Some evergreen funds offer tion and we established a formal Responsi- a mix of exposure across both public and driver, tapping into ble Investment Policy in 2011. Northleaf is private fixed income, but that sort of mix a signatory to the Principles for Responsible means that investors are not able to benefit incremental investor Investment and we are committed to up- fully from the private market return premi- holding those values and applying the prin- um. By contrast, Northleaf Senior Private demand” ciples of the PRI across all of our investment Credit invests 100 percent in private loans. activities. ■

November 2019 • Future of Private Debt 47 Analysis

Frankly, more is needed

Guest comment by Mia Drennan

A growing number of women are entering the industry, but the co-founder of GLAS warns there is still a long way to go

ntil recently, there were limited a meeting with three male investment pro- Addressing the issue women-led events in the private fessionals where I was accompanied by two A more practical requirement that needs to Udebt markets. However, I have senior female colleagues. be addressed is to provide portfolio compa- noticed an increase in the variety and fre- Despite the call to action and renewed nies with more balanced investment teams, quency of these events and of specific panels purpose we should also consider the reasons in which there are women-led management addressing diversity. These events are being why there is a lack of available female talent teams and the founders are female entrepre- held all over the world and seem to be in at the top. The industry has always been dif- neurs. response to the industry’s need to embrace ficult to get into, and has traditionally been Supporting diversity and inclusion must diversity and shift the gender balance in this full of alumni who are ‘pale, male, stale’. come from the top. Some firms have been male-dominated space. holding themselves accountable externally As a delegate at a recent one-day confer- and provide reports and statistics. Promot- ence in London, it was impressive to see the “Supporting diversity ing sponsorship and mentor programmes number of senior women who operate as in- as part of their recruitment and retention vestors in private debt. However, there is still and inclusion must policies can benefit companies, and such a significant gap to be filled, which is further schemes are on the increase. Management hindered by the lack of available talent to come from the top” should also visibly support female talent choose from. who wish to become involved in external Industry studies suggest diversity and networking bodies. gender are being targeted through recruit- Other key initiatives involve providing ment, and that younger women are being For the few women who are successful support to women through parental leave, hired in greater numbers, from more diverse enough to get a role and develop significant including through flexible working. One channels and that they are being encour- careers, it has been a brutal industry. Individ- senior fund manager told me her fund held aged to develop their careers. However, this uals are expected to work exceptionally long regular lunch sessions with eight to 10 em- needs to be coupled with the right retention hours, weekends and late nights, with harsh ployees selected at random. These employ- policies. travelling schedules, and deal with an ‘old- ees were invited to share their backgrounds, boy network’ mentality to source investment which broke down barriers and helped with Diversity lacking opportunities. Women have also been ex- team composition and future collaboration It is easy to point out why diversity works pected to do this while being paid less. as many attendees found they had more in and the positive impact on investment re- Those who do make it to the top, such as comment than they realised. turns that can be achieved through execut- legendary investor Nicola Horlick, have been Statistics are still difficult to get hold of ing a meaningful diversity policy. Investor branded ‘superwomen’. With all this in mind with regard to diversity and gender balance. advocacy through environmental, sustaina- it’s hardly surprising that few women are in But it is encouraging to see that far more bility and governance reporting and other this industry and that there are few wom- attention and investment is being made. n specific-led diversity requirements are in- en-led funds. Also, it has been proven that

creasingly putting pressure on fund manag- women are less likely to apply for roles for Mia Drennan is the co-founder and group ers to ‘walk the walk’. which they may feel underqualified, where- president of Global Loan Agency Services. At a meeting with a large pension fund as the opposite is true for men – something She is a banking professional with expertise working on global restructuring cases and client I was asked about my own firm’s di- that could have an impact on the number of workouts and has more than 20 years’ versity policy and gender balance. This was suitable applicants available in the first place. experience in capital markets.

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privatedebt.com Analysis

EXPERT Q&A

Adam Wheeler, co-head of Barings’ global private finance group, discusses the importance of discipline and risk management in today’s late-cycle environment

Investing in late-cycle European private credit

What is your view of the private more flexible financing solutions in the last SPONSOR credit landscape overall? couple of years, but it is still a relatively new, Q BARINGS Private credit is very much a global asset and emerging, opportunity set. class and we see opportunities across the regions where we invest – North Ameri- mid-market companies, although the mar- As you look across the European ca, Europe and Asia-Pacific. That said, the ket has evolved considerably over the last Q private credit market today, relative value of private debt investments in decade. Since the financial crisis, regulations where are you seeing opportunities? each region tends to shift over time depend- have forced European banks to reduce lev- Broadly speaking, we can characterise much ing on underlying market characteristics erage, which has impacted the banks’ ability of the activity in the European markets into and dynamics. to lend to borrowers and created a gap in the two distinct ends of a spectrum. At one end North America, for instance, is the most market for direct lenders to fill the shortage are banks, which have been restricted in the mature market, and also the largest and of capital. amount of debt they’re allowed to hold and most developed from both a borrower and Asia – specifically Australia, New Zea- in their ability to lend to borrowers. On the investor standpoint. Most of the capital in land, Singapore and Hong Kong – is less other end of the spectrum is the broadly the market comes from non-bank lenders. developed than Europe, with most financ- syndicated loan market, a relatively liquid In Europe, on the other hand, banks still ing still provided by banks. The market has market where large pools of capital are pro- provide a significant amount of financing for started to open up to non-bank lenders and vided to (typically) larger companies.

50 Private Debt Investor • November 2019 Analysis

In between the two ends of this spectrum We also believe there are certain ad- is what we view as the true mid-market – a Barings’ approach vantages to investing in sponsored versus ‘sweet spot’ in terms of debt facilities, where non-sponsored deals at this, or any, point in private companies typically have enterprise to investing the cycle. For one, sponsored transactions values of €65-€250 million. This can be an are often stronger on corporate governance. attractive area for private equity sponsors, as As we consider the private credit The ability to conduct due diligence also it can give them the ability to work with just markets today and going forward, we tends to be significantly better, as you often one capital provider to complete financing. believe prudent risk management is have greater access to information such as It is also advantageous from an investor’s key. At Barings, while we continue company financials. standpoint, as it can provide an opportuni- to seek and uncover attractive ty to invest in high-quality companies, but opportunities, we are disciplined Related to being late in the through a private investment that offers when it comes to the types of Q cycle, are there certain trends a potential yield premium relative to the companies that we lend to. or behaviours that have emerged in broadly syndicated loan markets, with great- Capital structures and leverage recent years? er downside protection. associated with a prospective deal In Europe, one trend we continue to see is Traditionally, the UK, France and Ger- remain paramount to our analysis, increased competition – and in some cases many have been the largest markets in Eu- in addition to the covenants that more aggressive behaviour – among market rope and continue to account for the majori- we lock into transactions. As part participants. Over the last several years, the ty of dealflow. More recently, we have begun of our risk analysis, we also have a amount of capital raised in the space has to see attractive opportunities outside of robust environmental, social and outpaced the supply of M&A volume; more these markets, including where the market governance policy in place. capital is seeking the same amount of deals. share of banks continues to decrease. One Ultimately, we don’t think in This increased competition has, in our example of this is in the Benelux region – terms of cycles; we build well- view, led to some style drift. We have seen Belgium, the Netherlands, and Luxembourg diversified portfolios of low-risk some instances in which leverage has been – where private equity sponsors are increas- assets that we believe will deliver stretched to maintain price, for example. ingly seeking financing solutions from non- attractive risk-adjusted returns We have also seen some lenders increase bank lenders. Having traditionally sought through multiple cycles. the size of the transactions they’re targeting, the majority of their funding from banks, which can put them in direct competition these sponsors are turning increasingly to- with the broadly syndicated markets. ward more flexible funding structures. Tied to this increased appetite for risk The Nordic region is another specific across the market, documentation has be- opportunity, in our view. Nordic banks – come a bit looser. Recently, we have seen traditionally the market leaders – are unable covenant-lite transactions creep into the to hold as much debt in transactions as they higher end of the private mid-market – €40 did in the past, which has opened the door to €50 million EBITDA businesses. to managers to compete for deals. While covenant-lite isn’t broadly bad – it has very different implications in the Where do you think we are in more liquid broadly syndicated markets, Q the credit cycle and what are for instance – covenants play an important the implications of that? role in the private markets. Specifically, in We seem to be in the latter stages of an the absence of liquidity, covenants can offer elongated credit cycle, but it’s very difficult structural protection and the ability to act in to predict when things might turn and what “The amount of a downside situation. that may look like. When considering in- Also related to this is the number of new vesting in this environment, we think a dis- capital raised in the entrants to the European market in recent ciplined, through-the-cycle approach to the years. This space can be challenging for new asset class is key. space has outpaced entrants, for a couple of reasons. For one, Rather than chasing high absolute re- because it’s a bilateral market, a lender needs turns and investing in higher-risk transac- the supply of M&A scale in order to access dealflow. A strong tions, we think there is an opportunity for origination network is also critical, particu- lenders that are focused on where they see volume, meaning larly for accessing proprietary transactions. good relative value. Often that means taking Absent that, the primary way of access- a lower yield in return for a stronger credit there is more capital ing dealflow is through auction processes or structure. Regardless of where we think and other highly competitive situations. we are in the credit cycle, it’s important to seeking the same Ultimately, we believe more established keep in mind that private credit is an illiquid managers that have strong partnerships with asset class, meaning once you invest, your amount of deals” financial sponsors, intermediaries and port- ability to sell is fairly limited. folio companies are at an advantage. ■

November 2019 • Future of Private Debt 51 Data

Funds in market

PDI was tracking 795 funds in market at the start of October. So where are they focusing and which are the biggest?

Geographic focus (%) Proportion of funds in market by target size (%)

Capital targeted: $256.3bn 0 10 20 30 40 50

Asia-Pacific Rest of the >$1bn world 8% 1% $500m-$1bn $250m-$499m Europe 21% $100m-$249m $50m-$99m

Multi-regional North America <$50m

22% 48% Undisclosed

Strategic focus (%) Ten largest funds in market

Distressed debt Subordinated/mezzanine debt Senior debt CLO Other 2% 3% Subordinated/ mezzanine Venture debt debt 3% 33%

Senior debt Distressed

29% 29% Apollo Owl Rock European Capital Principal Apollo EIG Energy Partners Sector focus (%) Finance Hybrid Fund XVII Fund I Fund III Value Fund $5.0bn $3.5bn Infrastructure Diversified $3.5bn $3.0bn 9% 3%

AMP Capital Steadfast Infrastruc- Alcentra ture Debt Global Fund IV Credit Fund Real estate Corporate $3.5bn $3.0bn Distressed Energy 22% 66% & Special Investment 3G Special Situations Opportuni- Generali Real Estate Debt Situations Fund V 2019 ties Fund Investment Fund (GREDIF) Source for all data: PDI $10.0bn $3.0bn $3.0bn $3.3bn Figures may not add up to 100% due to rounding

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$1.3B 94% $3-30M $5-150M Issued Agent or Lead Target Investment Commitments Lender EBITDA Size

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