Conditions within the rapidly growing direct lending market have changed in recent times, opening up prime opportunities for insurers at the more conservative end of the spectrum
Within the direct lending universe, the most attractive opportunities lie within the more conservative end of the mid-market, in our view. We explore why this is likely to be the case, how conditions within the asset class have changed and the benefits of direct lending for insurers' balance sheets, as well as the impact of ESG on the market.
The direct lending market has expanded rapidly over the last few years with Pitchbook now estimating it accounts for around 50% of the wider $1.6 trillion global private credit asset class. The reason for this growth is well known, being largely the retrenchment of public lenders from certain credit segments, owing to capital and regulatory restrictions. However, direct lending is also an asset class which has proven to be dynamic and that continues to evolve. Significant change has occurred in terms of its structure, and emerging factor within this competitive landscape are shaping how investors are navigating this investment opportunity.
There are key considerations when allocating to direct lending for an insurer to take into account. There have been notable recent developments within the asset class, but there are areas where we believe the most attractive opportunities are to be found.
Direct lending benefits for insurers
The floating rate and sub investment grade nature of direct lending means it is unlikely to form part of an insurers' core portfolio composition. However as an allocation to the surplus portfolio, direct lending present an attractive opportunity for insurers.
Firstly, direct lending offers a strong Return on Capital (spread / spread risk capital) for Solvency II insurers, given the underlying assets are unrated. This means the level of Solvency II spread risk capital insurers have to hold against the assets is relatively very attractive in our opinion, when assessed versus the yields the assets are providing. This is in contrast to other asset classes that are held in a classic surplus portfolio such as EMD, private equity or hedge funds – these are generally penalised heavily under Solvency II meaning the Return on Capital is often not as strong. Direct lending also diversifies well against these other surplus asset classes and with the fixed-rate bonds generally held in core portfolios – its floating rate nature protects insurers against rate rises whilst fixed-rate valuations fall.
