03 June 2019
As the credit cycle enters its latter stages it is more complicated for institutional investors to invest in private credit than in earlier moments of the cycle, according to Apollo Global Management.
Seth Ruthen, managing director for client and product solutions at Apollo, says: “That doesn’t mean there aren’t good opportunities, but you have to be more selective in how you access the market”.
In a low rate environment, private markets have risen in popularity amongst institutional investors, and in particular among insurers.
Entrepreneurs’ ‘increasing ability to raise capital for their businesses via private markets has encouraged a shift from public markets. Raising capital privately carries fewer regulatory burdens and typically allows the entrepreneurs to retain greater control over their businesses.
At the same time, institutional investors are searching for higher yields, and have increased their allocations to private markets.
But insurers tend to seek out the same type of deals, creating crowding in some parts of the market.
“The whole point of the private market is that you can access less crowded trades, that is where there tends to be more value,” Ruthen noted. “And there are some parts of the credit market that have become more crowded than they have been in the past.”
Therefore, insurers have now to find niches with a positive supply/demand tilt.
Ruthen sees opportunities in semi-illiquid assets. These are not traded daily, but they do have some trading, and they are not necessarily hold-to-maturity investments.
Another asset class he thinks has great potential, offering good yields for less risk than can be found in public markets, is unfunded bank revolvers. There are a lot of sellers, and not a lot of obvious buyers for these, he says.
“Banks have to reserve a lot of capital to keep these unfunded facilities open. We think insurers are better holders of that type of facility, and it is a capital efficient trade for insurers,” he says. “There is a time where you can combine illiquidity with capital efficiency: there are things that are illiquid but not capital-efficient [and] there are things that are capital-efficient, but don't yield very much. What revolvers do, is they allow you to have an intersection between capital-efficiency and yield - which is really interesting for insurers.”
Ruthen adds that insurers haven’t been very good at thinking about the amount of time they have to give up when investing in illiquid asset classes.
He says, if the yields on BB-rated or B-rated investments were not much better than yields on riskless investments, investors would not buy B-graded risk. “On the other hand, if one-year to seven-year illiquidity spreads were very flat, people will still buy seven-year illiquidity.”
However, he continues that the majority of the extra yield that investors can enjoy by buying into illiquid investments is to be found at the very front end of the curve. “When people lock things up for five to seven years, they are not always aware that they can get a lot of that premium with a very small fraction of that time.”
Ruthen says insurers “might be able to attack the market in a more effective way, with better return and lower risk,” if they better understood the full suite of investment opportunities in private markets, and had a better grasp on just how much time they needed to sacrifice in an illiquid investment, as a function of the pick-up in yield they get by investing in it.
Ruthen will discuss the benefits and opportunities of private markets in the current environment at the Insurance Asset Risk EMEA 2019 conference in London on 12 June.
Amongst other topics, the conference will also showcase investment leaders discussing investment strategy in the context of emerging risk and expectations for the Solvency II 2020 review.
More information on the conference can be found here.