No Longer a Sleepy Corner of the Market: Three Questions on Private Fixed Income

1. There have been many headlines over the past few months about booming demand and insatiable appetite for private fixed income. What’s driving that demand, and is it sustainable?

The irony of these headlines is that, for decades, private fixed income[i] was a relatively sleepy corner of the financial market. Insurance companies dominated the buyer base. Private fixed income didn’t really start to catch on outside of the insurance industry until after the global financial crisis, when massive new regulations caused traditional bank lenders to retreat from the markets. Demand for debt was still there, and so issuers and buyers began to turn toward the private markets. The growth of this market hasn’t been an overnight sensation—it’s been a steady build over years. Investors increasingly migrated to the private market and traded relative illiquidity for potentially higher yields, increased diversification and covenants to protect in downside scenarios.

Today, private fixed income is no longer that sleepy corner of the market. In our view, demand for fixed income is very robust, and we expect it to keep growing. The regulatory pressure that initially attracted issuers to the space still exists, and banks continue to pull back from lending. We believe the private fixed income market will continue to grow as an important source of capital for investment grade entities seeking financing. In turn, we expect the number of issuers in the private market to increase the investment opportunity set and eventually, liquidity. Furthermore, we expect the momentum effect to continue – as more institutional investors enter the private fixed income space, others are likely to evaluate and consider investing in the space themselves.

2. Have you seen issuers and investors crossing over to private fixed income from the public markets?

Yes. We think the convergence of the private and public markets is a major theme in fixed income. In our view, private markets offer a lot of elements that make it an attractive alternative to public markets. We’ve already talked about the momentum effect—we’re seeing more and more non-insurance investors expand their credit mandates as they realize private fixed income offers more than just a potential yield pickup. For issuers, in addition to what we’ve already discussed, deals can be done quietly and efficiently, the investor base is broad, and custom structures and covenants can be negotiated.

We expect this convergence to continue as the private fixed income market becomes more mainstream. We think the investor base within the private market will continue to grow and diversify, providing greater liquidity as the market expands. Eventually, we think credit investors could possibly become agnostic to whether a credit opportunity is public or private, enjoying the expanded opportunity set offered by both markets and focusing on the specific opportunity on offer.

3. Which areas of the market look the most interesting to you?

We think the specialty finance area could offer some interesting opportunities and potential diversification. The specialty finance market includes esoteric structured deals that tend to be too new, unique or complex for the public markets. For research-oriented asset managers with expertise in specialty finance, these esoteric deals can offer the potential for an attractive premium versus more traditional transactions.

On a more short-term horizon, we think fund finance (funding cash flows for private equity funds, etc.) and real estate could bring some interesting opportunities to the private markets. Fund finance issuance has increasingly come to the private fixed income market as regional banks—meaningful lenders to funds in the past—have tightened lending standards and, in some instances, stopped lending to the space completely. We also anticipate opportunities in the real estate market. While the sector’s woes have been well documented, issuers may opt for the private markets for discretion, potentially offering a premium to help mitigate headline risk. We expect real estate issuance to pick up as extension options expire and rate expectations normalize.

[i] We define private fixed income as non-registered investment grade lending.

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Any investment that has the possibility for profits also has the possibility of losses, including the loss of principal.

Diversification does not ensure a profit or guarantee against a loss.