Attractive investment opportunities in private debt

Increased interest rates and volatility on the bond markets are putting pressure even on investors with a long term investment horizon. Where can they achieve reasonable returns and gain some protection from the vagaries of public markets? LGT Bank provides answers to the most important questions.

Oyvin Furustol Team Head Portfolio Advisory Asset Class Specialists, LGT Bank (Switzerland) Ltd.

What is private debt?

Bonds that are not traded on a public market are also known as private debt and provide capital to privately owned companies. Most companies take on debt to finance their operations and drive growth. This debt capital can be raised through a bond issue or a bank loan, but access to these sources of capital has declined in recent years. For small and medium-sized companies, privately issued debt has become an important source of funding - and therefore a growing asset class for investors. According to Pitchbook, the global private debt market has grown to over USD 1.5 trillion in assets under management by the end of 2023, with a rapidly growing number of providers. 

How does private debt differ from traditional forms of financing?

Unlike many bank loans, or even most public bonds, private debt is a bespoke transaction between the lender and the borrower. This means that the transaction is better tailored to the needs of the borrower and lender in terms of pricing structure, covenants and collateral. This flexibility also offers the opportunity to create effective protection for investors. Crucially, these tailored terms lead to lower default rates and higher repayment rates.

Is private debt different from the public bond markets?

One key difference is the interest rate. In contrast to traditional bonds, private debt typically has a variable interest rate. This offers investors the advantage that interest payments also increase when market interest rates rise. Traditional bonds suffer price losses in such a market situation. Another feature is the illiquidity premium: investors receive an additional return for not being able to sell the bond on a daily basis, for the lock-in until redemption.

Private debt strategies at a glance

The various private debt strategies can be divided into two categories: Capital preservation strategies, such as senior corporate loans or asset financing (e.g. music licenses or aircraft), seek stable returns. Yield enhancement strategies, such as mezzanine loans or distressed debt, seek higher returns by incorporating equity participation.

How does private debt differ from private equity?

If a company goes bankrupt, lenders have priority over shareholders in the liquidation process. This leads to greater repayment security, but also to lower return prospects for those invested in private debt. Another difference is the capital commitment. Loan agreements have a limited and predefined term (typically three to five years). Both the paid-in capital and the interest are paid out at the end of the term. The sale date of shares is uncertain and dependent on a company sale.

How can you invest in private debt?

Investments in this asset class are typically made via closed-end funds. Investors familiar with private equity investing will find that private debt funds use very similar closed-end structures. However, they have a shorter term and a shorter payback period than their equity counterparts. Some funds are structured as evergreen portfolios with no capital calls or distributions and offer investors limited liquidity on a quarterly basis. It is also important to note that investments in private debt often require the investor to have professional MIFID status. The asset class is therefore only open to wealthy and experienced investors.

A word on the market environment: Attractiveness of private debt?

The market situation is currently attractive. There are promising yield expectations thanks to higher prime rates, rising credit spreads and increasing refinancing requirements. Senior loans - the most conservative part of the private debt spectrum - are currently offering yields in the low double-digit percentage range. For riskier private debt strategies, yields are expected to develop similarly to private equity.

LGT and the private markets

Over 20 years ago, the Princely Family of Liechtenstein, owner of LGT, decided to invest the proceeds from a company sale like endowment funds at elite American universities. Specifically, this Princely Portfolio invests a considerable portion in private market and alternative investments. LGT clients can now also participate. LGT also offers other investment opportunities in private markets, such as private equity, private debt and impact investing.

Biography

Oyvin Furustol has been working for LGT since 2015 and focuses on private market investments. After studying at the University of Fribourg, he worked as an economist for the Swiss Economic Institute at ETH Zurich and then for a major Swiss bank in various investment positions. During this time, he also completed his training as a Chartered Financial Analyst (CFA).