Nick Dignam from Fortitude Investment Partners shares insights with Lachlan Maddock from Fortitude Investment Partners on how a diversified portfolio in mid-market private equity is structured. The Inside Adviser
The world of alternative investments is at a crossroads. As markets defy expectations and liquidity concerns take centre stage, investors find themselves forced to rethink how they deploy capital in an increasingly complex environment.
Five curly questions to ask your private credit provider
While the private credit market surges, doubling to $2 trillion globally since 2015, its prominence is forcing investors to become more judicious about the providers they introduce into their portfolios.
The asset class now represent approximately 10 per cent of the total corporate loan market and is expected to grow further. According to Joe Millward, founding partner at Epsilon Direct Lending, a driving reason force behind this growth is the desire of investors to avoid the “inefficiencies and poor service” associated with bank lending.
“Many small and medium sized businesses are also finding it increasingly difficult, and expensive, to get loans from the banks, opening up opportunities for non-bank lenders in this space,” he says.
The banks’ collective loss is the private debt market’s gain, as the sector has swelled to accommodate demand. But “not all providers are created equal”, Millward believes. The industry stalwart says there are five important questions any investor should be asking of their private credit provider, starting with its level of transparency.
“How transparent is the fund?” he says. “The more transparent the fund is about the kinds of loans it invests in the better. Investors should be able to find information about loan criteria and loan quality in the fund’s documentation.”
The second thing to question is whether the fund’s loans are rated by a credible third party.
“Ratings of the loans in the fund should be supported by reputable third-party ratings models such as Moody’s or S&P,” he explains. “Investors might also want to look at how many favourable overrides (when exposures are approved outside the lender’s credit assessment criteria), have been applied versus unfavourable overrides.”
The methodology used to value the fund is also vital, he warns. And the monitoring of the loan must be robust and transparent.
“Private credit funds need to have the proper mechanisms in place to ensure portfolios are valued accurately. This is best done independently, and funds should have appropriate checks in place to do this,” Millward explains. “Funds [also] need to closely monitor every loan they invest in. But they need timely and accurate information to do this well (ideally monthly) and should also be in a position to share this information with investors where appropriate.”
The final factor is broad, and in many ways simplistic. But making sure the fund managers are doing what they say they are doing is a crucial element, Millward says.
“If a fund says they invest in non-cyclical loan but has a portfolio full of exposures to consumer lenders or property developers, then the fund is not true to label. If the fund manager suggests they are a direct lender, but the majority of their loans are originated through syndications teams and publicly rated bond issuances, this is a red flag.”
