Mission - ‘To provide Investors with a genuine alternative inflation hedge in an increasingly uncertain and volatile world’
In our continuation in the Alternative Investment Series, we look at Small Medium Business Private Debt / Direct Lending and why this could be a suitable investment.
Private Debt / Direct Lending is a fast-growing investment sector, but what constitutes Private Debt / Direct Lending, and who are investing in this sector. It is very much going back to basic investing, Private Debt / Direct Lending is a credit that is extended to companies, typically SME’s, in return for security pledged by the borrower, which is originated by lenders other than banks.
The reasons Private Debt / Direct Lending has grown so much as a sector is because after the global financial crisis banks stopped lending to small and medium-sized business due to changes in regulation, mergers, downsizing and a reduction in their balance sheets. All of which has meant that traditional high street banks have less money to lend, so they are looking to make the most profit from what they have to lend, and are concentrating on commoditised lending (mortgages, car loans credit cards etc.). According to a recent Economist Article Non-real estate commercial lending, only accounted for 10% of high street bank lending in 2017.
But why are investors so keen to fill the gaps left by banks? It is safe to say that currently Investors are sailing their ships through unchartered waters. Political events such as the Trump presidency and the UK’s vote to leave the EU are causing sharp moves in markets and currencies. Government and corporate bond yields are low, interest rates have turned negative in some developed markets while other markets are raising rates, and many assets look overvalued, especially those considered ‘safe harbours’. We live in a world of volatility and low returns in which yield is becoming harder to find, while inflation risk is returning.
It is perhaps no surprise then that non-traditional sources of return have captured investors’ imagination. The global private credit market (of which direct lending forms a major component of), for example, is expected to break the USD 1tr market by 2020, according to the Alternative Investment Management Association (AIMA) Alternative Credit Council. And 62% of institutional investors plan to increase their allocation to private debt in the long term, according to research group Preqin.
Direct lending to real companies is an easy to understand investment strategy which delivers absolute returns uncorrelated to the major asset classes, while also offering a hedge against inflation. As it becomes less esoteric, even conservative investors such as pension funds and university endowment funds are taking an interest.
A recent PWC report produced on the private debt sector concluded that for a balanced portfolio (50% Equities and 50% Bonds) a small exposure to private debt (15%) not only increased average returns, but also decreased volatility and importantly correlation. To obtain true diversification, portfolios must be constructed with assets that are minimally correlated to each other.
Source PWC
Typically, as banks aren’t lending to SME’s, funds that specialize in this sector are able to ask for more and more security, normally in the form of invoices, inventory, unencumbered assets, land, owned by both the company and significant members of staff and in many cases personal guarantees.
One of the funds we promote, through their dedicated, London-based finance arranger, has lent over GBP 725 Million to 650 companies since 2011, helping to create jobs, save jobs, create wealth and generate taxes. All the while returning an average of 5.79% over that time.
Summary
Asset-backed lending has proved over the 5 years to be a suitable investment for those looking for modest returns with low volatility.
As with any investment, this should be looked at as a minimum of 5-year investment.
But with the growing number of SME’s in the UK (according to government figures 2.2 Million new SME’s have set up since 2000) and with only 4 in 10 of these companies able to secure capital from their first choice lender, this investment sector looks as though it will continue to grow as an investment choice for both the institutional and retail investors alike.
Please do not hesitate to contact us if you have any questions