Two advisors and one leading private debt manager weigh in on scandal’s impact, and what investors should do to address risks
It’s been roughly eight months since the Bridging Finance scandal made headlines and dealt a blow to trust in Canada’s private debt industry, and until today, the case has yet to come to a definite conclusion. While it hasn’t left a permanent scar, the episode certainly sounded a note of caution for Canadian investors and advisors.
“We really saw distrust in the private debt space peak over the summer months,” Steven Taylor, an Ontario-based investment advisor at Steven Taylor Wealth at National Bank Financial, told Wealth Professional. “Bridging wasn’t a holding for my clients, though I know a few friends and advisors who were affected by it, and I received a few questions from interested clients and contacts who read the news. But I believe most of that negative sentiment has run its course.”
Graham Priest, an investment advisor with BlueShore Financial in British Columbia, said his clients and immediate contacts within the advisor community weren’t impacted by the Bridging Finance affair. But whenever scandals like that break out, he said, it prompts some degree of concern and deeper thinking.
“Investors aren’t always cognizant of the risks that they're taking on, and that's irrespective of fraudulent type activities that may be happening,” Priest said. “People are aware of pensions, endowments, and institutional-level investors looking to the private market, so they want to gain access to it as well.”
There’s no question that private debt can serve an important function within portfolios and in the broader capital markets. With persistently low interest rates forcing investors into areas of higher risk in the public fixed-income markets to match their obligations, Taylor said private debt can offer investment-grade equivalent opportunities. For his part, Priest highlighted how banks’ lending activities have tightened since the 2008 financial crisis, leading many business borrowers to turn to private lenders.
“More than half of the debt in the U.S. is private,” Priest said. “As an asset class, it has in a lot of cases done a good job matching the needs of yield-seeking investors and companies in search of capital to grow.”
While the case for private debt investment is undeniable, that doesn’t mean investors and their advisors should go into it with eyes closed. Taylor said accredited investors can find and vet private investment opportunities through offering memorandum products offered by various Canadian asset managers. Among the different flavours of private debt available, real estate and mortgage investment corporations are his instruments of choice.
“A few years ago, investors may have looked at track record and historical performance as some of the most important due diligence aspects to consider in the private investment space,” he said. “But now, I think you’re much more looking at reputation, compliance, and oversight within these funds.”
To limit their risk exposure, Priest suggested investors shouldn’t devote the entire fixed-income bucket of their portfolios to private debt. Beyond that, he said investors should do their homework and make sure they deal with firms that have strong management.
“The private markets in general can be somewhat inefficient, so strong management is an important differentiator,” he said.
With investors and advisors inclined to ask more questions, it’s safe to say private debt managers have their work cut out for them. But for managers like Ontario-based Cortland Credit, which focuses on lending to small and medium enterprises in the Canadian, U.S., and European spaces, providing answers and reassurance is just business as usual.
“In the world of private debt, prospective investors and portfolio management teams want, and should receive detailed insight into a manager,” Sean Rogister, CEO of Cortland Credit Group Inc., told WP. “That allows them to review the background of the principals, the signing authorities, separation of duties within the firm, who makes decisions, and other information.”
With more than three decades of direct lending expertise behind it – including Rogister, Bruce Sherk (Cortland Credit’s co-founders), and several members of the senior management team – the firm is used to fielding questions and providing extensive documentation to institutional investors regarding its management and the quality of its portfolio.
“No matter what, we have groups that want to see a copy of every legal document for every loan that goes out, long after they make the investments,” Rogister said. “So we have systems set up to support that kind of disclosure and transparency requirement.”
In the wake of the Bridging scandal, the firm also introduced an additional layer of internal governance by establishing an independent review panel. That includes three members with expertise in accounting, regulatory compliance and oversight, and law focused on direct lending, which Rogister stressed is a unique legal domain.
“You have to have some kind of governance model outside of the portfolio manager who can monitor the manager to confirm the written investment and underwriting process is being adhered to,” Rogister said.
Going deeper into the portfolio level, Rogister said the underlying debt securities have to be secured with collateral that the manager can confirm supports the debt. Aside from that, he stressed the importance of strong contracts that can guide the partnership and terms between the firm and the borrower.
“At the end of the day, the manager has to honour investors’ rights to redeem, which means ensuring there’s alignment between the liquidity of assets in the portfolio and the redemption rights of investors,” Rogister added. “We saw that in the asset-backed commercial paper crisis, the credit crisis, and every major debacle in the fixed-income industry. Our structure is set up to mitigate loss in a variety of economic conditions.”