By A Paris – Having entered the year with a record fundraising pipeline, according to a report by McKinsey, private debt was set for success in 2021. And the asset class did not disappoint; with strong returns and growing inflows, investors continue to allocate to this sector in search of opportunity, risk mitigation and diversification.
Data from Pitchbook shows that private debt generated a 9.2 per cent in Q1 2021, with preliminary Q2 2021 returns of 9.1 per cent being suggested. Distressed debt, venture debt and infrastructure debt helped push the private debt returns overall to 15.2 per cent, according to the data provider.
“Growth in private debt continues to be fueled by long-term secular trends, in particular, the disintermediation of bank lending channels due to regulatory developments in the wake of the GFC, as well as sustained low interest rates on traditional fixed-income securities due to accommodating monetary policy,” details the McKinsey Global Private Markets Review 2021.
Broader assets class applications
Private debt investments can not only act as a diversifier within investor portfolios, but such assets can also form part of a broader cashflow or liability driven investment solution. In this context, this year has seen the asset class being promoted in more depth to pension schemes.
In May this year, BlackRock launched a private debt income fund specifically designed to meet the needs of UK pension schemes. The fund aims to provide investors with a yield premium relative to liquid credit markets, reliable income, and capital preservation.
The asset management giant also revealed the role private markets can play within US public pension plan portfolios. In a study which leveraged data from over 85 public pension plans, the firm outlined the challenge these institutions face, namely: “Liability growth and increasing required benefit payments and put additional pressures on investment portfolios to outperform following periods of market decline, such as during the first quarter of 2020.”
According to the study, private assets can offer diversification benefits and help these plans mitigate risks. BlackRock outlines: “The study modeled the potential impact of reallocating 5 per cent of each plan’s exposure from public equity to private equity, and found expected returns increased by more than 70 basis points, on average, bringing many plans within reach of their assumed return. Risk increased commensurately, but portfolio efficiency (return per unit of risk) increased by an average of 3 basis points.”
In an article, Schroders investment professionals, Jon Exley, Solutions Manager and Clement Yong, Fund Manager, Multi-Asset, explain: “The “real asset” nature of underlying debt in private credit deals, such as infrastructure and real estate, means defaults are typically lower. Infrastructure – think roads, telecommunication networks, schools – tends to be less sensitive to the economic cycle.”
Focused strategy
Private debt gained significant momentum in the wake of the global financial crisis, as institutional investors sought to fill the void left by the tightened bank activity.
Asset Management firm, Mercer explains: “Private debt has consistently given investors access to higher returns coupled with lower risk, compared to high-yield bonds or broadly syndicated leveraged loans.” In view of this, it follows that investors are showing a strong appetite for the asset class in the current climate, as it offers strong cash yield and return potential, as well as with diversification and risk mitigation benefits.
However, investment selection will be key as the sector comes under growing regulatory scrutiny. Experts at PwC note that investors will “need a strategy that focuses more closely on strategic positioning, operational excellence and capital efficiency in their business and the portfolios they manage.” 
