Substantial ‘dry powder’ in private equity could fuel buyout deals

A discussion of private markets

Elaad Keren – Senior Managing Director, Co-Head of Private Fixed Income, SLC Management:

IG private fixed income offers the potential for enhanced yield without sacrificing credit quality. The possible benefits of IG private fixed income, many of which are shared across other private credit asset classes, include:

• Yield premia – IG private fixed income can offer higher returns for a given unit of risk. This stems not only from the lower liquidity characteristics of these assets, but also from the origination efforts and complexity factor requiring premiums for investors

• Diversification – Compared to public markets, IG private fixed income can offer greater possibilities for diversification by sector, asset type, geography, and ways to access certain credits, with the opportunity set often expanding further the longer in duration an investor goes

• Investor protection – The structure of private debt agreements often involves rigorous covenants, which can offer investors added protection thanks to improved access to information, deal monitoring, and security from collateral

Several factors in today’s markets point to both opportunities and risks for IG private fixed income. For traditional industrial and utility credits, especially new entrants, the market has shown healthy demand, sometimes with over-subscriptions and pricing inside of the tighter end of guidance. 

This type of market may call for a disciplined approach, as the relative value and ability to negotiate terms is less consistent across deals than typically seen. We believe this type of environment calls for a selective deployment of capital by asset managers.  While we are cautiously optimistic, the continued rise in bond market yields could negatively impact issuance. On the other hand, with market consensus now tilting toward higher for longer rates, issuers may be motivated to come to market now rather than hope for lower rates in the next few quarters. (Sources: Private Placement Monitor, Preqin, 2023). 

Jake Garmey – Managing Director, and James Scott-Williams – Managing Director, Crescent Capital Group 

We expect that the previously discussed market factors driving potentially increased activity will have a pronounced, positive impact on the lower middle market niche in direct lending as well. As with IG private fixed income, the lower middle market can offer the potential benefits of higher yields, credit diversification, strong deal covenants, and access to information. However, the lower middle market can offer further benefits of a considerably more specialized market, with the increasing demand for capital met with a smaller subset of lenders.

The shift toward private credit is also more pronounced in Europe, where the banks have reduced participation in leveraged lending, particularly to lower middle market companies, due to consolidation in the banking market and regulatory factors. We expect the approximate US$275 billion in uninvested buyout capital in Europe (source, Preqin, October 2023) to provide a stable base level of activity for several years.  (Sources: Private Placement Monitor, Preqin, S&P Leveraged Commentary & Data, 2023). 

Abbe Borok – Managing Director and Head of U.S. Real Estate Debt at BGO

With respect to U.S. CRE value add lending, a combination of current market conditions and secular themes could potentially drive activity in this space:

• Defensive positioning – Debt investments can help ride out market volatility and uncertainty over central bank policies, inflation, and possible recession scenarios

• Structural advantages – Floating rate structures are common in CRE lending, which can provide an opportunity to benefit from rising rates while holdings loans in property sectors experiencing secular tailwinds

• Volume of opportunities – Nearly US$900 billion of CRE debt has been and will be maturing from 2023–2024; over a third of that was issued 2020 or later. In addition, with over US$149 billion of dry powder waiting within U.S. value-add and opportunistic equity funds, the market is poised for a flurry of activity

• Secular transformation of real estate: Digitization, shifting demographics, hybrid work, health care expenditures, and housing affordability are trends that are developing rapidly while representing long-term shifts in the sector. That can mean opportunities for lenders to finance the future of real estate assets. (Sources: Moody’s, 2023).

The importance of expertise

While the opportunity set across the private credit universe may be considerable, it is critical for insurers to also be aware of the risks, which can range from creditworthiness of a given issuer to liquidity. Gaining exposure to the most compelling opportunities in such a diverse market while managing risk could boil down to the quality of the asset manager an insurer partners with. Those with the right level of expertise, experience and deep industry relationships can go beyond just matching their clients’ flows through the broadly syndicated markets, and can extend to truly seeking value through sole lender, small club, or narrowly syndicated investments as well.

Disclaimer

This material contains opinions of the authors, but not necessarily those of SLC Management, its parent company or its affiliates. Commentary is provided for informational purposes only. Forward-looking statements are not guarantees and are subject to change. All statements are as of the publish date, unless otherwise noted.

This discussion is intended for institutional investors only. It is not for retail use or distribution to individual investors. The information in this document is not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information contained in this document. 

Sun Life Capital Management (U.S.) LLC is registered with the U.S. Securities and Exchange Commission as an investment adviser and is also a Commodity Trading Advisor and Commodity Pool Operator registered with the Commodity Futures Trading Commission under the Commodity Exchange Act and Members of the National Futures Association. In the U.S., securities are offered by Sun Life Institutional Distributors (U.S.) LLC, an SEC registered broker-dealer and a member of the Financial Industry Regulatory Authority (“FINRA”). BentallGreenOak, InfraRed Capital Partners (InfraRed), Crescent Capital Group (Crescent) and Advisors Asset Management (AAM) are also part of SLC Management. 

BentallGreenOak is a global real estate investment management advisor and a provider of real estate services. In the U.S., real estate mandates are offered by BentallGreenOak (U.S.) Limited Partnership, who is registered with the SEC as an investment adviser, or Sun Life Institutional Distributors (U.S.) LLC, an SEC registered broker-dealer and a member of the Financial Industry Regulatory Authority (“FINRA”). In Canada, real estate mandates are offered by BentallGreenOak (Canada) Limited Partnership, BGO Capital (Canada) Inc. or Sun Life Capital Management (Canada) Inc. BGO Capital (Canada) Inc. is a Canadian registered portfolio manager and exempt market dealer and is registered as an investment fund manager in British Columbia, Ontario and Quebec. 

InfraRed Capital Partners is an international investment manager focused on infrastructure. Operating worldwide, InfraRed manages equity capital in multiple private and listed funds, primarily for institutional investors across the globe. InfraRed Capital Partners Ltd. is authorized and regulated in the UK by the Financial Conduct Authority. 

Crescent Capital Group is a global alternative credit investment asset manager registered with the U.S. Securities and Exchange Commission as an investment adviser. Crescent provides private credit financing (including senior, unitranche and junior debt) to middle-market companies in the U.S. and Europe, and invests in high-yield bonds and broadly syndicated loans. 

AAM is an independent U.S. retail distribution firm that provides a range of solutions and products to financial advisors at wirehouses, registered investment advisors and independent broker-dealers. 

The information provided is intended for informational purposes only and represents the views and opinion of the author(s), which may differ from those of other investment teams at SLC Management and its affiliates. 

The material does not consider the suitability or needs of any person or entity, and is not a recommendation in any asset class or strategy. Diversification and asset allocation do not protect against loss nor guarantee returns. 

Any financial indices referenced as benchmarks are provided for illustrative purposes only. The use of benchmarks has limitations because portfolio holdings and characteristics will differ from those of the benchmark(s), and such differences may be material. You cannot make a direct investment in an index. All referenced indexes are shown for illustrative purposes only. Factors affecting portfolio performance that do not affect benchmark performance may include portfolio rebalancing, the timing of cash flows, credit quality, diversification, and differences in volatility. In addition, financial indices do not reflect the impact of fees, applicable taxes or trading costs which reduce returns. No representation is being made that any investor will or is likely to achieve profits or losses in any asset class described or based on any benchmark. Past performance is not necessarily indicative of future results. 

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Efforts have been made to ensure that the information contained in this report is obtained from sources believed to be reliable and accurate at the time of publication. However, SLC Management does not guarantee its accuracy or completeness. All, opinions, commentary and information are subject to change and SLC Management accepts no responsibility for any losses arising from any use of or reliance on the information provided herein. SLC Management does not provide tax, legal or investment advice and the information within does not consider the reader's investment objectives or needs. Investors should consult a professional based on their unique situation. All opinions and commentary are subject to change without notice and are provided in good faith without legal responsibility.