By Daniel Lanyon on Monday 30 January 2017
Stéphane Blanchoz, CIO for Alternative Debt Management at BNP Paribas Investment Partners, explores why allocations to alternative debt and other direct lending strategies could be attractive for investors in 2017 as the segment grows.
Investors should see an increasing opportunity in SME private credit in 2017, according to Stéphane Blanchoz, chief investment officer for alternative debt management at BNP Paribas Investment Partners.
A confluence of factors has prompted rapid growth in non-bank lending as an investable asset class with a swelling universe of funds offering exposure to Alternative credit in recent years.
The drivers of the growth in this market segment are bank disintermediation and regulatory support from policymakers in combination with an ever-intensifying search for yield from investors. In addition, investors are having to adapt to an increasingly volatile outlook for vanilla fixed income as well as a low interest-rate environment and mature bull-runs in equity markets.
Blanchoz says, however, alternative credit investments and other direct lending strategies are increasingly attracting investors, especially institutional investors. While these investors were initially focused on larger companies, SMEs are now increasingly attractive as borrowers.
“We believe there is ample scope for the SME credit segment as SMEs tap into different – and often flexible – types of non-bank financing. Investors stand to benefit from the trade-off between liquidity and returns by being able to invest in an additional segment of the European credit markets – alternative debt – with an attractive risk-adjusted return profile,” he said
“The SME segment has so far participated only marginally in the disintermediation trend and is still quasi-exclusively being funded through the banking system. For private investors, financing smaller companies is particularly challenging since this requires time-consuming analysis which might not be economically practicable when investing in smaller loans,” he added.
The direct lending market has become both an additional funding solution for SMEs and an asset class bringing diversification to investors.
A recent Deloitte report, the amount of direct lending fundraising over the 2013-2016 period reached $104.3bn. Over the same period, within Europe, the capital raised by direct lending funds reached $45.2bn
Aside from diversification benefits, he says the characteristics of SME debt typically include a low default risk and a high recovery rate in the case of default.
“In terms of a company’s debt structure, SME debt is usually ranked as senior and the credit protection level is typically ‘secured’. The equivalent credit rating of SME debt, much of which is currently unrated, would be a solid BB.”
Another recent development which he says is definitely positive for SME credit, is the creation of the European Long-Term Investment Fund (ELTIF) label.
“ELTIFs are well suited to investments in long-term and illiquid assets. these funds can grant loans directly to companies, expanding the range of SME direct-lending initiatives. The shift from a concentrated portfolio of sizeable SME loans to a diversified ELTIF of smaller SME loans could well pick up pace in the coming years.”
“However, this will require proximity to origination sources, the development of scoring methodologies and the ability to industrialise credit work through a highly-structured investment process.”