This asset class primarily represents directly-originated senior or mezzanine lending to middle market companies and real estate investors. It also includes opportunistic special situations and sector specialist strategies which can offer more attractive risk-adjusted returns. In the aftermath of the global financial crisis, the deleveraging and increased regulation of banks resulted in significant opportunities in private debt as banks all but abandoned complex categories of lending given high regulatory capital requirements. Private debt offers a complexity and illiquidity premium which we expect to average 300 bps in excess of liquid credit returns. Private debt strategies typically include a high level of contractual return and a significant margin of safety from substantial equity subordination or asset coverage.
How we invest
We look for managers with experience of investing across multiple credit cycles and a deep fundamental credit skillset, but with the structuring and workout capabilities to protect capital through the economic cycle. As we have seen significant capital flow into the more “vanilla” parts of private debt, we are increasingly focused on more specialized or less competitive areas of the market such as lending to small healthcare and technology companies, lending to small businesses (through the US Small Business Investment Company program), real estate debt or construction financing, less liquid areas of structured credit and other niche/specialist lending strategies.
Our best ideas in private debt are captured by our Phoenix vehicles. Our evergreen Phoenix II pooled vehicle has invested in over 30 private debt and uncorrelated strategies since inception in 2012. We also offer bespoke specialist mandates in private debt for large clients.
In 2017, we co-invested with a healthcare private debt manager to provide a senior secured loan to a private DNA screening company which was founded in 2009. The company will use the proceeds to continue to commercialise new products and refinance existing indebtedness. The deal was structured as a senior secured loan with a low-teens contractual return, with additional upside from warrants. We estimated that the loan-to-value was less than 20% and that our principal would be well covered even in a liquidation scenario. Our base case returns are in the mid to high teens, with further upside in the event of a successful IPO.