Page 19 - FOGlet 4

By Jonathan Russell

rivate equity is a huge global comfortably cope with material leverage. In
industry able to assemble vast Europe, this approach has stood the test of
financial power to acquire multi time as even during the GFC all CLOs
Pbillion-dollar companies all over the survived and some continued to make equity
world. The growth of this sector is on the payments. Today average distributions are
back of delivering attractive returns to its circa 14 per cent though some managers,
investors and the industry’s ability to evolve including Spire, deliver closer to 20 per cent.
its model in changing and demanding times. On a risk adjusted basis, it is very attractive.
But for the astute investor there are more There is much talk at the moment about
ways to benefit from investing in private where we are in the credit cycle. It is always
companies, and at top of that list is private hard to say with any confidence but at
credit. This modest cousin of the private present there is no sign in Europe of a
equity industry has just as good a track downturn, defaults remain low and the
record, is more transparent, has a floating performance of the underlying companies
rate yield and typically delivers its returns in that issue these loans is generally healthy
cash every quarter, and yet many investors (bar a few exceptions). Most sectors are
have little or no exposure to it in their enjoying some stability with the possible
alternative asset allocations. exception of mainstream high street retail. In
The investment grade corporate credit the US the situation is a little different. Here,
space is enormous and is well represented in there is a lot of concern about the quantum
most portfolios but private credit, which is of BBB corporate loans and bonds which
typically non-investment grade (ie below have seen massive issuance in recent years,
BBB) is less appreciated, particularly here in currently there is $2.47 trillion of this US
Europe. The European market is €800 corporate debt. This does need to be carefully
billion with approximately €140 billion of watched because of its sheer scale. BBB
new issuance each year. These are loans and loans are investment grade but are the lowest
bonds that are issued by some of Europe’s rating that the traditional funds can hold. It
largest private companies. At Spire we invest does not take much underperformance in the
in loans and bonds in over 150 European underlying businesses to drive a re-rating at
companies where the average EBITDA is which point most of the existing holders of
over €350 million. These are substantial, these assets will be forced to sell them
robust companies typically, but not because they will no longer be investment
exclusively, owned by a private equity house. grade and therefore outside of their mandate.
All sectors are represented, and most are This could trigger a wholesale sell off with all
headquartered in Northern Europe. They the usual destabilising effects. So, US
issue the loans and bonds to fund a investors, the Fed and regulators are right to
leveraged buyout or an expansion plan. watch this space.
These loans have proven to be extremely However, it is not so significant over here!
robust, with average default rates of circa In our arena of the non-investment grade
two per cent since 2010 after averaging only credit, we do not face these pressures. The
six per cent 2007-2011 which were the market is much more modest in scale at
dark days of the global financial crisis (GFC). around 20 per cent of the US market, is
This is no surprise given the scale of the broadly in balance and stable and does not
underlying business and the support of a face this type of potential structural shock.
highly engaged shareholder. The loans also This market and the CLOs that invest in it
benefit from first ranking security over the have a good future so long as we maintain
assets of the borrowing company and as our focus on the credit quality of the
result when disaster does occur there is underlying companies that we lend to.
generally a good recovery of value for the European non-investment grade credit
loan holders. The long-term average recovery has delivered first class returns to its
rate for senior secured loans is circa 75-80 investors and there is no reason to suppose
per cent. that it will not continue to do so. Most
A substantial proportion of these loans are investors should take a good look at it.
bought by CLOs, (Collateralised Loan Jonathan Russell is Managing Partner of
Obligation). These are Spire Partners LLP, the independent
leveraged vehicles that build fund management team
a highly diversified portfolio of https://spirellp.com/
around 100 different loans and
are typically about €400
million in size. The strength of
the underlying issuing companies
allied to the portfolio diversification
means that these funds can

Foglet 4th Edition www.gpfo.co.uk 17