How do LPs position alternative credit in their portfolios? (Round Table Alternative Credit - part 2)

May 19, 2025

The growing need for diversification, the demand for EMD and NAV loans: in part 2 of this Round Table, six experts discussed some important trends and developments within the Alternative Credit landscape.

By Hans Amesz

This is part 2 of the report. Part 1 can found here, part 3 will be published on Thursday 22 May.

Has the shift from banks to alternative lenders and the increasing need for diversification among LPs significantly increased interest in these strategies over the past five years?

Medema: ‘Definitely. But I wouldn't say that we are replacing banks, rather that we are working together. Banks are still strong at what they do, they want to maintain customer relationships and have the infrastructure to originate loans. What they can no longer do is keep these loans on their balance sheets. Most customers already have a well-established direct lending portfolio. They don't want to sell their direct lending investments, but are looking for something to complement them. Asset-based finance offers that flexibility through multiple sub-segments. Asset-based finance or speciality finance often conjures up the idea of something complex, but it's really about financing the real economy. So we spend a lot of time on education: explaining how we acquire those assets, how we assess them, how we manage them. That gives investors a clear picture of the risk they are taking. When it comes to track records, it's not just about how long we've been active as managers, but about the historical performance of the underlying asset class. For some strategies, that history is short (five years, for example), and that period was relatively quiet economically. So we always look at how long the data history is. For example, we use 40 billion data points on consumers.’

Brooks: ‘The asset classes of trade finance and working capital finance are no different from other private credit strategies, where banks’ requirements to hold more capital for non-investment-grade loans after the financial crisis have led them to focus more on investment-grade loans, creating a financing gap. The use of trade finance by institutional investors has really taken off in recent years. Acceptance and approval by some of the largest consultants has helped this process considerably.’

Leticia, you work with Emerging Market Debt (EMD). How do LPs position this: within private credit or within EMD? How do you convince them to take steps with regard to this sub-strategy?

Ferreras Astorqui: ’When we talk to LPs, we usually hear two objections. Firstly, the perceived risk: many investors see emerging markets as very risky. They often have a conservative profile. In most cases, these are insurers and pension funds with 97% of their balance sheet in Europe or other OECD countries. Secondly, accessibility. For those who do want to diversify into emerging markets, the question arises: how? Outside capital market indices, there is often little direct access to emerging markets. When positioning blended finance, we emphasise two things: the risk-mitigating measures in place that ensure an attractive risk-return profile, and the advantages of working with public sector institutions when it comes to origination and local knowledge. We also highlight the low correlation with other EM exposures and the fact that the portfolio is highly diversified. Because blended finance funds often do not have an external rating, it takes more work to talk to investors about risks, performance and the strength of the data, which can sometimes be a challenge when attracting a broad pool of institutions. However, for investors with sustainability ambitions, such as climate or net zero targets, this strategy helps them to actually deliver on these commitments. More and more investors want their investments to have a positive impact, but with clear KPIs and in the context of existing sustainability regulations (such as Article 8 or 9). A major challenge is where to place this strategy in the portfolio. Some institutional investors have an impact bucket, which is a good fit for blended finance. But many do not. In practice, it usually falls under the fixed income segment or the alternative credit section.’

How do Dutch LPs position these types of strategies within credit?

Simons: ‘That depends very much on the structure of the portfolio and which buckets already exist. Many pension funds have an EMD bucket, so blended finance would fit in there logically. But in practice, it is often very different from what people are used to. Although it seems logical at first glance, it often proves difficult in practice. It is somewhat easier for larger investors, especially if they have an impact bucket, which is becoming increasingly common. But small to medium-sized pension funds still have a lot of work to do to broaden their fixed income segment. They are currently focusing on the first step: diversification towards direct lending. Hopefully, this will be followed by more scope for the strategies we are discussing here. Foreign investors seem to have made more progress in this area. They have generally been investing in direct lending for some time, which makes expansion into alternative credit a more obvious step.’

Medema: ‘Among global investors, private credit allocations are still dominated by direct lending. But over the past two years, asset-based finance has really become the focus. Even if a client doesn't know exactly what it is, they have read enough about it to ask: “Tell me, what do you do in that area?” Some investors are increasingly looking for a multi-sector approach, so not either direct lending or asset-based finance, but a single vehicle that gives you access to multiple private credit strategies.’

Ferreras Astorqui: ’That's a good point. Many investors don't yet have an impact-focused sub-strategy and may not be very familiar with these investments, so we compare it to something they do know. In my case, many investors are unfamiliar with blended finance. As part of our introductions, we therefore often compare the underlying assets with infrastructure debt, as many of our funds invest in infrastructure or other real assets and investors are often already familiar with infrastructure debt or even infrastructure equity. This comparison works well, as performance can be equally robust and investments in real assets are virtually the same regardless of the country, so we can establish a familiar basis and then build on the nuances of emerging markets.’

Henriot: ‘We are seeing a huge increase in knowledge among investors. Private markets were first opened up through private equity, then through direct lending. Now, during meetings, we are increasingly hearing that direct lending feels saturated, especially in the mid- to large-cap segment. Diversification is therefore a key theme. Investors are looking for different maturities, different risk profiles and different underlying assets. RCF (revolving credit facility), for example, is largely a liquidity product with less financing, while trade finance assets (such as factoring) are supported by a commercial transaction, not a financial one. This automatically creates a de-correlation with traditional credit markets. Investors find that attractive. As for the track record, yes, we can rely on it for most strategies. But for some, such as NAV lending, it is more difficult. These types of strategies have not been around for very long and there are less than ten years of reliable statistics available. That is why we use an external rating, so that investors have a framework for positioning the strategy from a risk perspective, even without long historical data.’

Brooks: ‘Our strategy can be viewed in different ways. The asset class's low default rates and improved risk-adjusted returns mean that it can complement any credit strategy by offering zero duration, low volatility and diversification. The short maturity of the underlying assets also means that it has favourable Solvency II treatment.’

How do you explain NAV loans to LPs? They often have exposure to private equity themselves.

Henriot: ‘It does require some explanation. Some investors initially think that this is private equity risk. But when we work with a BBB rating, the return is typically around 8% to 9%, not 15% to 20%. It is essentially an investment grade credit profile. Yes, the underlying assets are private equity (PE), but the enormous diversification and low LTV mean that the risk is very different. For example, a NAV loan fund has ten to twenty lines of investment (i.e. loans to a PE fund). Each of these PE funds in turn contains ten to twenty companies in their portfolio. So with ten NAV loans, you have exposure to 200 companies, with low LTVs. Even in a severe scenario, such as during the financial crisis, the portfolio is demonstrably sustainable. If a private equity company goes bankrupt, which is rare, there is often something of value left over. Even if you sell at a distressed level, you often still get 40% of the original value, which means twice the coverage on your NAV loan. That is why we usually receive a BBB rating from a reputable agency. It is simply a safe profile.’

What can you say about the bad press NAV financing has been getting lately?

Henriot: ‘There are actually two types of NAV loans. The low LTV bank variant (LTV of 10% to 20%, low risks) and the deep LTV variant (with LTVs of 50% to 70%, which feels more like equity risk). Our funds focus on the former, where there is a strong alignment of interests. Fortunately, the International LP Association recently drew up clear guidelines for NAV loans, just as it did for cap calls years ago. So there are now clear rules of the game. NAV loans are a form of leverage, cheaper than funding at company level, and can potentially create a lot of value if structured properly. If a fund has already called up all its capital but still needs more to stimulate growth at portfolio company level, NAV lending is a simple and inexpensive way to inject additional capital into the portfolio companies. Everyone benefits. The lender sees that the money is being reinvested, so the collateral grows along with it. The LP may receive a slightly higher return. The GP can create more value and therefore earn more carry. The system works, and since guidelines for NAV lending have been established, the tone of the debate has completely changed. Everyone now feels much more comfortable with NAV financing.’