Head of Private Debt explains how the same forces pushing investors into global public assets have his firm seeking new horizons for private credit
Each month at WP we offer a slate of articles and content pieces that go deep on a particular topic. This March we’re focusing on global markets.
The United States remains the largest, most developed, and most sophisticated market for private asset strategies. Private debt lenders, in particular, are overwhelmingly allocated Stateside. The market is well developed, opportunities are varied, and legal frameworks are both strong and creditor friendly. In the private debt space, where the paramount goal is to not lose money, that environment offers the most attractive outlook. That’s why, historically, Nicola Wealth has allocated around 90 per cent of its private credit assets to the United States.
That’s beginning to change, however. A growing range of opportunities in Europe, as well as a changing investor view of US assets, has the Canadian wealth manager starting to slowly explore private credit opportunities across the pond. Jurgen van Vuuren, Nicola’s Head of Private Debt, explains that his firm’s interest in European private debt mirrors the wider public market trend of investors going global.
“Global investors are looking at the US differently than they did before the most recent administration. We always viewed the US as a place with very little political risk, a very safe place to invest. That’s mostly still the case, and obviously governments change. But we want to build a portfolio that’s highly resilient, highly diversified, and can weather challenging environments,” van Vuuren says. “The thesis was similar on the equity side people looked at their currency and geographic exposure and said, “we’re very overweight the US, so diversification is prudent.” I suspect that’s what drove part of the run, with large institutional investors allocating more capital to foreign equities. And in credit, spreads have tightened as investors have allocated more capital to European credit.”
Nicola is taking a “crawl, walk, run” approach to their European private debt allocations, and van Vuuren doesn’t think the US pre-eminence in their portfolio will change anytime soon. Nevertheless, he sees Europe as a natural next step for private credit allocations. Developed European markets show strong rule of law and a tendency towards creditor-friendly legal frameworks. Loans in Europe typically come with a bit more spread, a bit more of an upfront fee, and documentation tends to be better.
An allocation to Europe can also help control for the currency risks inherent in a massive allocation to US assets. There is a growing private credit management industry in Europe, too, which gives Nicola local partners to work with. van Vuuren notes that his firm’s approach is mirroring North American pension investors who are also diversifying their private credit allocations by looking to Europe.
Unlike private equity, which has found far more purchase in global markets, van Vuuren explains that the need for stronger creditor protection has kept private credit allocations limited to North America, and Europe. Australia and Japan are developing as markets, he says, but they remain nascent opportunities.
When working on European private debt deals, van Vuuren says the approach remains similar to deal in North America. His team starts with an assessment of borrower risk, looking at recurring revenues, margin stability, industry cyclicality, and profitability. They asses the strength of the management team and the capitalization of the sponsor buying that business, as well as the loan-to-value on the transaction. In the example of a $2 billion purchase by a private equity firm, van Vuuren says the ideal loan-to-value is around 40 per cent.
Where the process differs from deals in Canada or the United States is in the assessment of local court frameworks and competitive environments. That means finding out where there could be disintermediation for an industry through technological advancements. The nature of Europe’s many markets makes that work more challenging. So does the additional layer of regulatory risk introduced by supranational governance through EU institutions. All of these eccentricities, van Vuuren says, mean that Nicola typically seeks a premium on their European deals compared to loans of similar size and structure in North America.
Crucial in this whole process for Nicola, and any private credit investor, is the setting of appropriate expectations. He says that investors typically take one of two approaches to private credit. The first look at private credit as a source of premium yield compared to public fixed income, which van Vuuren argues is the right outlook. The second category were informed, somewhat, by the experience of 2022 and 2023 when direct lending offered them returns that matched or exceeded equities. The expectation of equity-like returns from private credit, van Vuuren says, will result in disappointment over the long-term. He notes that there have been recent outflows of capital from the private credit space, which he attributes to that second group of investors seeking equity-like returns elsewhere.
For investors in that first category, allocations outside of North America represent more of a diversification play than a search for premiums. While premiums do exist, van Vuuren says that Nicola is now operating in Europe to further diversify its private credit portfolio and deliver on the core motivation for private credit investors: capital protection.
For advisors who don’t have in-house private credit teams to lean on, van Vuuren says the rise of more international opportunity in this space should motivate a similarly process-driven approach. Starting with a self-assessment around what they expect from these investments, advisors can start to parse through this highly nuanced space with the support of industry experts.
“For someone who’s not a credit person, it’s really hard to discern what credit risk a manager is taking,” van Vuuren says. “My advice for advisors: try to lean on as many industry experts as you can, whether that’s a consultant or someone with internal credit experience. That’s been a huge plus for our firm — we’ve managed to avoid every single private credit blow-up in the Canadian market.”
