The case for adding private debt to an institutional investor’s asset mix

Insurance companies have been investing in the asset class — private investment-grade debt — for their own accounts for many years.

A group of managers — the most notable of which is Integrated Asset Management — are in the same business: they raise capital from institutions and then invest in investment grade senior secured loans. And over the past couple of years, insurance companies, notably Sun Life, have started offering private debt investments to pension fund clients.

It’s a growing business made more attractive because of the opportunity to achieve higher yields than otherwise — an important feature when measured against the backdrop of the continued low interest rates on offer in the public market.

And through a careful selection of investments, the manager can achieve a greater level of diversification compared with what’s available with the traditional Canadian bond indexes, which tend to be dominated by banking and energy issuers.

Among the banks, which are among the country’s largest money managers, TD Asset Management has established a beachhead in the private debt world. Two years back it set up such a group and hired Bruce MacKinnon to find the staff and run the operation that caters to institutional investors. The goal was to generate an annual return of 100 basis points — 150 basis points over the Canada Universe over a four-year rolling period.

On Thursday, in Toronto TDAM — as part of its annual Sharing of Learning Series — made a presentation on private debt. It’s an area that’s more than theoretical: in the time that TDAM’s seven person team has been operational (it officially opened in March 2016), MacKinnon has looked at almost 120 possible investments in North America and has invested more than $400 million in 11 of them.

And he says he has considerable firepower left as the institutions have committed about $1 billion of capital for such investments. When the operation was set up, TDAM estimated that about $8 billion of private debt deals were done in Canada each year. (In contrast about $60.3 billion of corporate debt was raised in the public markets in Canada last year, according to FP Data Group.)

As the name suggest private debt is different from public debt — even if it shares many of the same characteristics: for starters, it’s not publicly traded (though TDAM offers some liquidity features); it’s generally not rated (though TDAM does its own by integrating the borrower’s financials); it’s not included in the benchmarks and the terms are the result of often lengthy negotiations with the issuer. (While there are always negotiations with a public market borrower, the issuer often has outstanding bonds, or comparable rated borrowers, which can help with the pricing.)

Indeed it’s through those extensive negotiations that MacKinnon said the investor can become a price maker and not a price taker. As the lead negotiator and sole investor, TDAM “seeks to provide returns in excess of the defined benchmark by capturing the illiquidity premium associated with private debt.”

In short, the idea is to invest in such a way as to generate yield enhancement, to achieve greater safety (through covenants that are stronger than in public market deals and through buying amortizing bonds which produce regular interest and principal repayments) and through diversification.

So how is it working out? According to its web site, TD’s Emerald Private Debt Pooled Fund Trust is up (before fees) by 1.83 per cent this year — about 60 basis points above the 1.24 per cent enjoyed by the benchmark. Its Emerald Long Private Debt Pooled Fund Trust is ahead by 2.08 per cent this year vs. 1.88 per cent for the benchmark.

Financial Post

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