AIMA's managing director and head of Canada issues an important reminder about the alternative asset class's vital role
Much has been written in Canada about private credit this past year, though unfortunately not all for positive reasons. AIMA and our Alternative Credit Council (ACC) are dedicated to the sustainable growth of the private credit sector providing core due diligence, operational sound practices as well as compliance resources to their members. We strongly support robust risk management, governance, investor transparency, sound valuation methods, as well as conflict of interest management and fraud prevention. We truly empathize with those affected by the actions of a few and hope that Canadian investors can, in time, recover.
Both in Canada and abroad there is much to be excited about with private credit as an asset class. Institutional and retail investors, eager for yield, diversification, volatility reduction and non-correlated, enhanced returns compared to broad indices have been steadily adding private credit investments for several years.
At over US$1tn globally, private credit is a burgeoning mainstay across portfolios. Preqin reports public pensions and endowments at 2% current allocations (5% target), family offices at 10% allocations (7% target) and wealth managers at 6% current (5.5% target) as of Q4-2021. Beyond current allocations, a recent ACC & With Intelligence survey of over 220 institutional US investors revealed that 40% are planning to add to private credit, citing equity valuation and inflation concerns, strong return expectations, low fixed income yields, new opportunity access and meeting target allocations as part of their reasons for doing so. In particular, 57% of US pensions who responded intended to allocate to private credit this year, followed by 50% of respondent family offices. Investing on behalf of Canadians and local public sector employees, Canada’s own CPP Investments, IMCO and many others too actively invest in private credit.
Private credit fills an important gap in providing essential funding to the real Canadian economy and Canadian businesses. Despite Canada being a banking leader, there are many small-mid-sized businesses who might rely on or even prefer working with an alternative lender. These borrowers benefit from additional access to capital, flexible repayment schedules, greater flexibility in structure or covenants and special expertise or partnerships from the lender. The simplification and regulatory oversight placed on traditional banking business models means that it may not be viable for banks to lend to certain businesses on realistic terms. This may not necessarily be due to the business posing a bad credit risk, but rather them not being a good fit for a bank’s risk appetite or existing exposure.
Private credit is a vital capital lifeline to everyday businesses from main street and beyond, especially through difficult market environments like we’ve seen with the pandemic. According to industry data provider PitchBook, more than US$17bn in private debt was extended since January 2021 amongst over 324 deals in Canada, with more than US$5.4bn in private debt extended by Canadian investment managers specifically amongst over 83 deals locally.
In the US, UK and Europe, governments are actively fostering ‘main street funding main street.’ The newly created Long Term Asset Fund (UK) and the reformed European Long Term Investment Fund (EU) will provide retail investors with greater access private credit and unlock a new source of funding for UK and EU businesses. The US private retail credit market represented mainly by Business Development Companies, now US$163bn and growing, already provides important funding for US businesses that supports their ability to compete on the global stage.
Here too in Canada, we’ve seen more retail-friendly private credit fund structures launch from both boutique and traditional asset managers. This is the sort of product innovation and asset allocation flexibility that Canadian investors need and deserve, especially in a yield-constrained, high-inflation, volatile market environment. This attractive risk-return profile can come with an illiquidity premium, which investors need to understand and be comfortable with when they consider sizing their allocations. While regular liquidity may be a positive feature of some funds, investors need to be mindful that in times of stress or unusual market conditions, funds may restrict redemptions further to ensure the fair treatment of all unitholders and to balance out fund flows amid the underlying investments.
Investors should be prepared and empowered with thorough questions as they review any investment. AIMA and the ACC provide our members and investors with extensive resources on private credit due diligence, including questions retail investors can ask fund managers when considering investments. Questions might include, though are certainly not limited to the following: How are repayment terms on originated loans typically structured? What is the investment manager’s credit assessment and due diligence process? What types of representations, warranties and covenants are the borrowers required to give and what collateral is required? How is this monitored? What is the investment manager’s policy towards impaired/stressed loans or bad debts and what track record does they have? Who are the independent, outsourced service providers of the fund (i.e. auditor, custodian, legal counsel, etc.)? What risk management frameworks are in place (i.e. independent reporting lines, operational risk management policies and procedures, conflicts of interest, etc.)? What is the fund liquidity and does it match the liquidity of the underlying assets? And, many more (please visit AIMA.org and lendingforgrowth.org for more resources).
As we look ahead to Canadian investment and retirement goals, it is critical that investors continue to access the benefits of this valuable asset class and the strategies within it. For Canadian businesses, the need may be even more acute as they look to move past the continued backdrop of the pandemic and thrive once more. Without the option of private credit, investors and business owners alike would be worse off. We have full confidence in the future of the private credit sector and will continue to work hard to build on its success and support sound market practices from Main Street to Bay Street, and beyond.
Claire Van-Wyk Allan is managing director and head of Canada at the Alternative Investment Management Association (AIMA). AIMA is the global association for hedge funds, private credit & digital assets.