The Potential of Private Debt Investments

Private assets are booming, as has been demonstrated in recent years inflows into the asset class. Assets under management in private markets will experience exponential growth and, according to a recent report by the consultancy firm Bain & Company, will reach levels close to $60-65 trillion by 2032, almost a third of total assets under management.

Sandrine Richard, head of private debt at Generali AM, part of the Generali Investments ecosystem argues that one of the segments within private assets with the most potential is private debt.

Don't miss the interview with Sandrine Richard, in which she discusses the outlook for private assets and private debt. Find out why the current environment could benefit investment in private markets.

We are at the threshold of a new era for investment opportunities in private debt. Current unfavourable macroeconomic conditions, the continued withdrawal of the banking sector, and the trend towards increased regulation should continue to favour private debt as an attractive credit source of choice, especially for SMEs that may suffer the most from these circumstances.

Thanks to the illiquid nature of private debt, investors are mainly attracted by the decorrelation with the volatility of public markets. Lower volatility combined with stable returns and a certain degree of protection against inflation due to the variable rate component of these debts and rising interest rates make these instruments suitable for those investors who seek long term performances.  

And also:

• Diversification:  Private and SME, not accessible on the public market and limited number so lenders avoiding overlap exposure for an Investor investing in several PD funds
• Attractive risk return ratio thanks to the illiquid premium and higher lender protection
• Low capital charge for insurers
• Support the appropriation of ESG practices by SME 
• Contribute to foster SME to become the large companies of tomorrow.

Investing in this asset class requires high competence and it’s aimed at institutional investors, able to operate on instruments that are private and confidential, compared to listed markets. This means that acquiring information and assessing the risk profiles of potential investments is not always linear, and therefore it is necessary to have specific skills and an adequate and consistent investment horizon and risk appetite.

How do you see the private debt market and its main trends?

According to Preqin 2024 Global Report, investor demand for private credit surged after the Global Financial Crisis of 2008, as investors sought higher returns in a low-interest-rate environment.

This trend is expected to continue, with private credit assets under management (AUM) projected to reach $2.8 trillion by 2028, almost double the 2022 figure of $1.5 trillion.

Nevertheless, to assess the next moves that will drive private debt investing, we must also look at the impact of interest rates on private debt strategies.

In fact, the increase in interest rates raises the cost of financing, impacting cash flow generation. However, this scenario also opens up new investment opportunities as companies seek to reduce leverage.

Conversely, a potential decrease in interest rates would free up cash flow for investments and operations. The variable rate component of private debt ensures that returns are partially preserved, even in a declining interest rate environment. This adaptability makes private debt a resilient asset class amidst fluctuating economic conditions.

How can interest rates scenario can impact the private debt strategies? 

Let's make a preamble: the whole private assets sector is mainly aimed at Investors operating in the private debt market find the opportunity for yields on average higher than liquid assets with the “similar” risk / higher recovery rate - the so-called 'illiquidity premium'. For this reason, even in the current market phase characterized by inflation, volatility and geopolitical tensions, private debt continues to represent good portfolio diversification for some types of investors, such as Generali.

With the increase of rate, the cost of financing increases the consumption of cash flow generation leading to new investment opportunities to reduce the leverage. The decrease of leverage compared to the high level of leverage reached before the Ukraine war and increase of rate tend to reinforce the credit profile of the company. New launch funds investing in deals with the leverage ratio revealing these new financing conditions benefits from the absence of legacy.

If rates will go down?

On the other way, the decrease of rate will reduce the cash flow generation allocated to interest payment, enabling to free- up cash flow generation for investments and operations.

As the return of PD is encompassed variable component (Euribor/SOFAR) and a fixed margin, the expected return of a PD investment will be partially preserved with the fixed margin.

Which are the advantages of allocating to direct private debt?

Allocating to direct private debt within a broader asset allocation provides several benefits:

• Stable and Predictable Income: Private debt offers a shield against market volatility, providing stable returns.
• Illiquidity Premium: The illiquid nature of private debt is mitigated by an attractive premium, appealing to long-term investors.
• Floating Rate Advantage: With floating rate characteristics, investors benefit from a natural hedge against interest rate volatility.

At Generali Investments, our focus on senior secured loans offers robust downside protection alongside attractive current returns of 7-9%. By filling the financing gap for future industry leaders, private debt provides unparalleled diversification for investor portfolios.

In conclusion, private debt investment is set to play a pivotal role in the evolving financial landscape, offering stability, diversification, and attractive returns. As the market adapts to changing economic conditions, private debt remains a resilient and appealing asset class for institutional investors. At Generali Asset Management, part of Generali Investments, we are committed to leveraging our expertise to support the growth of European SMEs and deliver sustainable returns for our investors.