NN IP: Positive sentiment for private debt continues
NN IP: Positive sentiment for private debt continues
Looking for opportunities to allocate, investors seek alternatives in the private market space in view of continued volatility of the public markets and to mitigate the potential impact of rising inflation and interest rates. Private debt has become the fastest growing segment in the private market as investors seek out diversified sources of return.
Research shows that two thirds of investors plan to increase their investment in private debt. Nearly 40% of new private capital manager searches conducted by global consultant bfinance on behalf of clients in 2020 was for private debt, versus 23% in 2019.
Many companies are seeing the benefits of alternative lending sources, even more so in a post-Covid world. NN Investment Partners (NN IP) expects private debt to play a bigger role in corporate loans, infrastructure, real estate and global trade finance in the coming years and sees it become more prominent in investors’ portfolios.
The influence of ESG
Environmental, Social and Governance (ESG) factors will continue to be further incorporated into private debt. It is expected that the focus on sustainability in the asset class will increase and that governments may use regulatory levers to bring more private investments into the fold.
Niels Bodenheim, Head of Alternative Credit at NN Investment Partners: 'Private debt proved its resilience during the pandemic. However, as more and more investors turn to private debt for yield in a low interest rate environment, sourcing attractive opportunities will become increasingly difficult. At NN IP, we will continue sourcing investment with focus on diversity in counterparties and reduced dependence on key relationships by growing further in new areas such as trade finance and maintain full control of flow of all new investments and partnerships.'
NN IP, focused on high credit quality senior secured loans, sees spread pick-ups of up to 400 basis points versus public investment grade bonds, relevant swap curves or reference rates in the following segments of the market:
European asset-backed securities (ABS) offer attractive yields compared with other fixed income categories. From a valuation perspective, current spread levels provide an attractive entry point for investors with further tightening possible beyond that seen earlier this year.
AA, A and BBB-rated ABS offer good potential for tightening, although this potential is less in AAA-rated ABS it does provide positive carry. Additionally, as inflation uncertainty increases, NN IP sees rate volatility as an increasing risk for fixed income products while the floating-rate nature of ABS gives protection against higher interest rate volatility.
Spreads to other investment-grade fixed income products can go up to 300 basis points depending on the respective sub-asset class and rating.
Trade finance includes loans that reduce importers’ and exporters’ risks related to payment and delivery. An estimated 80-90% of world trade relies on it, according to the World Trade Organization. The amount of financing currently being supplied, however, is around USD 1.5 trillion short of market demand.
The fundamentals on trade finance are solid, with default rates on trade finance products ranging from 0.03% to 0.24%. The average time to recovery for trade finance products is 120 days, compared to 437 days for other asset classes. Spread pick-ups over USD Libor are around 300-400 basis points in asset-based transactions, leading to a residual risk premium of 200-300 basis points vs. a liquid benchmark of similar rating, duration and industry.
Dutch Residential Mortgages
The outlook for Dutch residential mortgages is positive despite the pandemic. House prices went up by 8.3% in 2020, with low mortgage rates fueling activity on the housing market. House prices are expected to increase in 2021 by between 3-5% and in 2022 by between 1-2%. Spreads over swaps are up to 200 basis points.
Although increasing unemployment and diminishing state support for companies and households will take its toll, the Dutch Central bank believes it is unlikely this will jeopardise the Dutch financial sector’s stability.
Commercial real estate debt
After a significant dip in transaction activity between April and July 2020, the market for CRE debt in Europe is recovering. Uncertainty around the outlook in sectors such as retail, leisure and offices, has resulted into higher loan spreads.
Residential and logistics continue to be the sectors outperforming the rest of the market, with both loan spreads as well as asset valuations moving into pre-Covid territory on the back of the asset classes’ resilient nature (residential) or ability to profit from an acceleration of the e-commerce trend (logistics) driven by Covid-19. Premiums to similar rated investment-grade public bonds are around 100 basis points.
Despite the slow start in 2020 due to the pandemic, the market for private placements recovered quickly in the second half of the year.
Investing in the real economy by financing general corporate purposes through a multi-corporate credit solution (covering investment grade rated traditional loans, private placements, corporate guaranteed loans, green loans as well as more complex structured deals) can generate illiquidity risk premium to investment-grade public bonds of up to 75 basis points and provide an additional level of diversity.
Infrastructure assets provide essential services and are characterised by stable, long-term cash flows, often derived from contracts with premier tier counterparties, including governments. For managers of liability matching portfolios, infrastructure debt may provide an interesting alternative to public bonds with a similar risk profile.
Many European infrastructure debt portfolios have proved to be highly resilient to the impact of the COVID-19 pandemic and, as a result, pricing levels for most infrastructure debt assets have quickly returned to pre-COVID levels. The illiquidity and complexity premium to investment-grade corporate bonds is around 100 basis points.