In an era of high interest rates, Israel’s banks are recording incredible profits. Many investors would like a piece of the credit provision pie, rather than purchasing shares or bonds in the public market. To this end, large investment funds like Apollo Global Management and others have built private investment mechanisms that compete with the other alternatives.
Jonathon Orr, Managing Director responsible for client portfolio management across international wealth at Apollo, among the world’s largest and leading investment firms, explained at the Globes Alternative Investments Conference, held in partnership with the Phoenix Group and Apollo, that the growth of this market is good for all markets, as it creates alternatives. He also stated that the start of interest rate cuts on the part of the US Federal Reserve, didn’t change the fact that private debt funds by firms such as Apollo remain attractive as a source of yield, as compared with other income alternatives.
"The private credit investment market is currently estimated at $1.5 trillion," says Orr, but adds, "It’s hard to know the exact number because there’s no data available. In practice, this market includes infrastructure debt, venture debt, and a variety of other things. When people talk about the private credit market, they’re often talking about direct lending whose size is estimated at $750 billion. I think the correct thing is to compare it to other types of credits. For example, the leveraged public debt market (public high yield), which has a $1.5 trillion volume, syndicated loans provision (by several lenders) which has a similar volume. They grew at a slower pace in recent years, and the private credit market stepped in and grew more."
"More investors get access to the additional yield"
"The private credit market has grown, and to some extent it has taken a share of the leveraged (public) debt market. I don't see this as a negative thing. In my opinion, it means that more investors get access to the additional yield. It's also an alternative channel for borrowers, which is a good thing for markets more broadly. This gives borrowers more than one option," adds Orr.
Orr explains that the approach offered by the private debt market, from Apollo Credit investment funds and other entities, which provides credit to borrowers, is important. This is because, he maintains, "These options could at times dry up." He refers to the situation in 2022, a year in which global inflation suddenly reared its head, and the US central bank, followed by central banks around the world, raised interest rates sharply. Orr points out that the private debt market created more alternatives for companies and economic entities.
What caused the growth of the private debt market?
Orr: "For many years, growth in the private credit market was primarily driven by institutions only via locked-up funds for periods of 6-7 years, drawdown structures with high minimums. Today, this market is much bigger, thanks to a combination of broader access and investors being more aware of the additional yield they can get. Education on the asset class is key but the access point is also important: Drawdown funds continue to exist but we also see new, semi-liquid investment vehicles that are accessible to more private wealth investors, for example, private bank clients, family offices and even smaller institutions."
Orr describes a new landscape, with alternative sources of financing for companies. Asset managers are offering the ability for companies to get loans, which are not issued by a bank. Orr says that the funds offering access to these loans, offer some liquidity to investors typically on a quarterly basis up to a maximum percentage of fund NAV. These are still loans that are considered illiquid, so having some degree of liquidity is important but you shouldn’t allow for full liquidity to protect the funds and the remaining investors. But according to Orr, lower minimums, availability in multiple currencies, this has increased the ability for investors to access an asset class which offers excess return per unit of risk, offers significant yield pick-up over the public market and provides easier access on various distribution platforms. He adds that "education" has also become an important factor. A lot of investment managers today spend a lot of time helping to explain to investors what private markets are, "Separating myth from reality," he says. "All in yields both in an absolute and relative sense are still incredibly attractive in private credit."
US Federal Reserve Chair Jerome Powell reduced the interest rate on the dollar by 0.5% in September to 5%. How does this measure affect the private debt market?
Orr notes with a smile that we can talk about this topic all day, as the interest rate cut can have many consequences for a market that is ultimately engaged in having debt. "The simple answer to this question is that the all-in yield, in the absolute and relative sense, is still very attractive in private credit. If the Federal Reserve cuts the interest rate another 0.5% by the end of the year, we will end 2024 with interest rates north of 4%. This has not happened, aside from the last two years, since 2007. This means that today even after the interest rate cut, you are getting a significantly higher yield than you were able to get in the recent history in credit investments. If you add the private credit market spread , about 5%-5.5%, and the initial issue discount, you can still get an all-in unlevered yield of over 10% to investors. It's very attractive on an absolute basis."
According to Orr, this is also still attractive on a relative basis. If you compare it with the broader syndicated loan market (that’s a yield pick-up of 2% above the Fed interest rate) or the public high yield (pick-up of 3% above the Fed interest rate). He adds that "the rates on the money market funds are dropping rapidly. I think that the return opportunities in private market continue to be very attractive. Another way to think about interest rate reductions is on the risk side. Lower interest rates mean lower financing costs. This is good for the investments within the fund (reducing the risk that the companies will go bankrupt). I think this supports the attractiveness of the private debt market in general.
Default rates are rising. How does that affect you?
Orr points out that since the end of last year, this has seen a rise in non-accruals (which means the loan is no longer paying cash and cannot be accrued into the NAV of the fund). "It's not surprising. We often talk about the importance of vintage. I divide the market into two parts, the one before 2022 and the market since then. What did the market look like before 2022? Zero interest rates and an increase in inflation that we thought would disappear quickly. Before 2022, there were over leveraged business models. Loans were given to businesses that could justify themselves in a zero-interest environment, but not when the interest rate was much higher.
Interest rates did climb that year, leading to an increase in leverage and pressure on many companies already leveraged at that time. Since 2022, the environment has changed a lot. Loans were then given with a horizon for where the interest rate would be going (upwards). Loans were given in a much more conservative manner in the context of higher rates being anticipated.
What’s the best way for an investor to choose the right fund in your area?
Orr points out that with new entrants, the supply of funds has greatly increased, along with demand from investors. "You need to find investment managers who have done this for many years, where this is a core part of their business. We have half a trillion dollars. When it comes to providing private credit, we are the largest asset manager in private credit in the world. I would check historical performance. In addition, I would check the default (insolvency) rates. Our history goes back to 2008 and we take a defensive posture. You also need to decide where you want to be in terms of size of company. We focus on loans to large cap companies, whereas most of the private credit managers are in the business of providing loans to small to medium-sized companies. We focus on large entities with an EBITDA of over $100 million and aim to avoid defaults."
Full disclosure: The conference was held in partnership with Phoenix and Apollo Global.
Published by Globes, Israel business news - en.globes.co.il - on October 10, 2024.
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