The conundrum of liquidity and search for yield

Sovereign bonds of developed countries bottomed out in 2013 and probably completed the 30-year fixed income bull market. On the contrary, traditional fixed income investors, who have hoped to get the necessary yield of at least 4-5% to satisfy their needs such as endowments with annual expected payouts, are facing a challenging financial landscape nowadays.

Until last year, investors were able to stay on the sideline, but as they have seen their traditional fixed income portfolios generating negative returns, they are recognizing that the time for waiting is likely over and actions that address the significant negative asymmetry in their traditional fixed income portfolios need to be taken.

We are living through unprecedented times with plenty of liquidity in the world’s financial system whether it is on the central banks’ balance sheets, the companies’ balance sheets or in the vaults of the banks. The biggest issue is that cheap capital usually creates imbalances as capital is getting wrongly allocated for various reasons, creating new bubbles only to see them bursting in regular frequency, whereas for other private companies well needed working capital remains a scare source.

The partly draconian regulatory changes politicians were voting for on both sides of the Atlantic are being implemented over a stretch of several years, and in contrary to common expectations, these measures do not really help the economy as a whole. All the liquidity in the system does not help if it is not transferred into the real economy via credit to create any multiplier effect. It is correct that large companies have tremendous advantages tapping into the capital markets and borrowing at unprecedentedly low rates and for unusually long maturities. However, these companies use cheap capital to retire equity or for dividend payouts, both not adding to the productivity of the company. On the contrary, middle-market companies that are desperate for a credit in order to ramp up a business or to expand a lagging business are excluded from this equation of cheap refinancing.

The problem is that many SMEs are too small to gain access to corporate bond markets and therefore find themselves ever more squeezed by banks as these have significantly tighten their lending restrictions. Banks that are in the gatekeeper position of providing loans to the economy have defined new risk limits and capital requirements and therefore have less interest in providing loans.

How can liquidity conditions help to bring capital in front of companies that need it and what can be done to help investors who wish to have higher yields with more predictable return expectations? Private Debt/Credit and Direct Lending are the “buzz words” of today that could bring together investors searching for yield and those who are desperate for working capital.

One challenge here is that there is no clear definition of those phrases and thus many potential investors turn their back to this opportunity believing that Private Debt is highly risky as it represents solely mezzanine debt or corporate distressed debt.

As a matter of fact this impression could not be further from the truth; the spectrum of investments is very broad and offers something for all levels of risk appetite. The common denominator is the debt-like character and private negotiated syndication. Examples would be trade claim financing, traditional bridge financing, middle-market direct lending and litigation financing or commercial real estate loans. The common gross return expectation across the segments is approx. 9-15% and can get higher as a compensation for longer lock-ups or more equity like investments.

The other challenge investors find themselves confronted with is the fact that those investments are (1) usually more on the illiquid side and packaged with more illiquid redemption structures, even possible with a Private-Equity-like structure where capital is called over time; (2) have a J-Curve effect and (3) have a lifespan of several years.

However, the big advantage is that Private Debts, compared to Public Fixed Income and Private Equity, are usually monetized differently: mostly deleveraging starts right away as given loans are self-liquidating, but they can also be modified or even legally restructured as those are bilateral agreements. Those monetization strategies are not dependent upon a capital-markets exit. This is one reason why Private Debt offers compelling diversification benefits across different market environments, in particular compared to traditional asset classes.

In the second part of the article, we will highlight a few investment examples PLEXUS has researched and consider them as interesting for allocation.

Three different sectors, loans and return streams that demonstrate the variety of possible investments in this asset class will be provided as a showcase: A private mortgage loan provider, a direct lender to US franchise businesses and a third case that is involved with litigation financing.

Über den Autor

  • Matthias Kirchgässner

    Matthias Kirchgässner

    Senior Analyst/Partner

    Bevor Matthias Kirchgässner, Dipl. Betriebswirt, seine eigene Gesellschaft Cross Atlantic Alternative Asset Consulting gründete, war er als leitender Produktmanager für kundenindividuelle Hedge-Fonds-Portfolios bei Allianz Hedge Fonds Partner in San Francisco, Allianz Alternative Asset Management und der Nachfolgefirma NEXAR Capital in New York tätig. Als selbständiger Berater ist er auch für die PLEXUS Investments AG tätig.

    Davor war er als Produkt Manager bei der ehemaligen Deutschen Investment Trust (dit) und Allianz Global Investors (AGI), verantwortlich für strategische Produkte, Produktentwicklung und Implementierung in Frankfurt. Er startete seine Karriere als Berater für große Privatvermögen bei der Dresdner Bank in Köln. Insgesamt verfügt er über mehr als 17 Jahre an Erfahrungen auf dem Finanzmarkt und im Asset Management.

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