Direct Lending

Key takeaways

  • Private debt describes any non-bank lending of a company that is not issued or traded on the public markets.

  • Private debt investments have grown considerably in the past decade and found their spot in the portfolios of institutional investors.

  • Private debt provides access to a broad opportunity set that is capable of meeting varying risk/return goals and regular interest rate income streams.

  • Direct lending becomes increasingly a dominant source of financing for small and medium sized companies, whereas investors benefit from attractive (floating rate) income, senior secured creditor positioning and financial covenant protection features.

  • Besides strong selection skills, a successfully run private loan portfolio requires a very high degree of diversification (across managers, sectors, geography, vintage, loan level).

Direct Lending Investments

What is Private Debt

Private debt can generally be described as any non-bank lending of a company not issued or traded on the public markets. It represents the “private” financing of a company and typically, it references companies in the small- and middle-market segment. Private debt has been one of the fastest-growing asset classes in the recent decade. There have been two dominant factors for the rapid growth of the asset class:

  1. Investor demand for steady interest income and attractive return generation as conventional fixed income markets offer currently only minimal yields at elevated risk levels.
  2. Supply has increased as companies have turned to non-bank lenders after the financial crisis in 2008 due to tighter bank regulations and the inherent stricter lending requirements.

Private debt includes a wide range of investment strategies, which offers investors access to a broad opportunity set capable of meeting varying risk/return goals and needs. While private debt is considered a stand-alone asset class today, many underlying investment strategies are not new to institutional investors. They have historically been classified under different asset classes such as private equity, hedge funds and real estate.

Investment strategies that fall within the private debt asset class include lower risk strategies such as direct lending (typically senior secured), trade finance and secured lending (i.e. collateralized by real estate), and high return generating strategies distressed debt, mezzanine debt or special situations.

Evolution of the Private Debt asset class

For most of the 20iest Century, US commercial banks were the primary lenders to small- and medium-sized enterprises (SME), but two major events – the regional bank consolidation beginning in the 1990s in the U.S. and the global financial crisis in 2008, led to a decline in SME lending. Hence, US banks started 20 years ago to scale back their middle-market lending activities. The introduction of more stringent banking regulations after the financial crisis served as an additional accelerator of this trend. Since the beginning of 2009, European banks began to restrict their middle-market lending activities as well. The lack of “traditional” bank lending in this space has created the opportunity for attractive risk-adjusted investment opportunities.

Attractiveness of Private Debt

An increasing number of institutional investors has tapped the private debt and direct lending market as a strategic portfolio allocation. Their interest has been fueled by an appetite for steady high-income streams; the attractiveness of a senior secured creditor position; and in search for reduced correlation among their asset mix in the portfolio construction.

Direct lending is characterized by flexible and creative financing solutions that are unique to each opportunity. However, there are certain structural features that are common to most loans: security, structural seniority, floating rate pricing, contractual yield and amortization, financial covenant protections, and management access. Additional direct loan features may include warrants or other equity-linked structures that potentially provide capital appreciation in certain situations. In aggregate, these qualities contribute to direct loans’ markedly different risk-return profile from conventional fixed income securities.

Consequently, such investments serve as a source of meaningful portfolio diversification and increase the risk-adjusted return when added to a traditional portfolio of stocks and bonds.

Selection and Diversification a necessity for Success

A stringent loan selection process and the avoidance of concentration risk are the two key features to build up a successful direct lending portfolio and taking advantage of the superior risk-/return characteristics of the asset class. Other meaningful success factors are an efficient cash management in order to avoid unwanted return dilution as well as long term experience and expertise in manager selection.

Decade-long Experience

We invest in syndicated and private loans since more than a decade and have established relationships with the pioneers in the direct lending industry. With more than USD 0.5 bn invested in private debt and syndicated loans we are among the most experienced investors in this area. Our investment universe is populated by a high number of specialists across geographies, specialization and return profiles. We have a successful track record and offer commingled investment solutions as well as bespoke mandates for any risk-/return profile.

Bespoke Private Debt Portfolio - Profiling and Constructions

A stringent loan selection process and the avoidance of concentration risk are the two key features to build up a successful direct lending portfolio and taking advantage of the superior risk-/return characteristics of the asset class. Other meaningful success factors are efficient cash management in order to avoid unwanted return dilution as well as long term experience and expertise in manager selection.

Alpinum IM provides access to the wide and diverse universe of private debt strategies and also offers bespoke investment portfolios, which we illustrate in more detail below:

Direct Lending Investments Workflow
Alpinum Investment Management Direct Lending
Direct Lending Report
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