The universe of deals is bigger than many realise
While a large part of the market consists of buying and selling positions in funds, there is a lot of opportunity outside of that, from providing liquidity to business development companies to buying portfolios of non-performing loans from banks. Some of these deals require the buyer to take direct exposure on the balance sheet.
“If you hold loans or participations directly, you have to be prepared for some to go awry,” said Jeff Hammer, global co-head of secondaries at Manulife. “This means having the skill set in-house to amend, extend and restructure as needed.”
A dedicated team is useful
Many secondaries funds buy credit opportunistically or have a sleeve dedicated to it. It is hard, however, to find assets that produce equity-like returns without moving into the stressed space or applying leverage. Throw in a relative lack of intermediation – a majority of credit secondaries deals are proprietary in nature – and the benefits of a dedicated team and fund become clear.
“You have to stay in the flow, to be active with conversations and be part of this fast-changing landscape, and to do that you have to focus,” said Olga Kosters, head of private debt secondaries at Tikehau. “There are quite a few GPs and LPs who, post-covid, started revisiting positions and taking a more proactive view.”
Covid–19 could catalyse GP-led credit deals
The credit GP-led market was growing before covid-19 and may have benefitted from the crisis. Open-ended funds that gated during the crisis still need liquidity for LPs that want to redeem, and there are private credit fund managers who see a host of lending opportunities and are fully drawn. The reduced exit pace is also making GPs think carefully about liquidity management.
“Roughly a third of our deals have been GP-led, either providing balance sheet liquidity in areas such as BDCs or helping GPs wrap up funds,” said Toni Vainio, a partner with Pantheon. “Refinancings will probably slow down because of covid, with lower exit volumes. Most direct lending funds have a term of seven years; funds could end up with quite a substantial portfolio left at the end of year seven.”
The secondaries market can be an alternative to new issuances
Limited partners invest in credit secondaries funds for diversification, a low-risk steady income stream and quick money back, the panel heard. In a world where investment-grade bonds are yielding little, credit secondaries could act as an alternative to climbing the risk curve to get good returns on new, high-yield issuances.
“Returns in the secondary market are driven not only by the soundness of the investment, but also by the circumstances of the deal,” said Hammer. “You make money not only on underwriting the credit risk appropriately, but also by capitalising on the deal dynamics opportunistically. For the equivalent credit risk, the secondary market can provide investors with a premium over new issuance market returns.”
The world of private credit would appear to have all the hallmarks of an attractive secondaries strategy – if investors know how to find and navigate the right deals.
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