As interest rates have increased to 5%-5.25% from close to zero last year and volatility in the banking sector has risen, Barings believes that private lending is demonstrating some of the best returns in many years.
Speaking to FSA, Alexander Vaulkhard, client portfolio manager for private credit at Barings, noted that spreads for private lending had widened to up to 600bp from around 400-500bp last year.
As borrowing costs have become more expensive as rates have increased, Vaulkhard thinks borrowers cannot afford as much debt as before and creditors can get higher returns but with potentially reduced risk because leverage is lower and credit quality is better.
“The way we think about this asset class is that you’re locking up your money for a few years because it’s illiquid, so you can’t expect to trade that loan. So you have to lend to a company with a view that that company can survive whatever might be coming, but you don’t know what’s coming,” said Vaulkhard.
He named three key ways to select companies to lend to: focus on less cyclical industries, run diversified portfolios and structure loans conservatively.
Looking at the breakdown, about 50% of Barings’ book is in North America as it is the biggest and deepest market for private debt, followed by northwest Europe, such as the UK, Germany and France.
Meanwhile, only about 10% of its borrowers are Asian companies as it is still a relatively new market.
“North America is the biggest, most established, probably the most competitive market and as a result, pricing can move quicker in North America. Europe is a slightly younger market that is still evolving and generally most deals only have one lender and one borrower only,” said Vaulkhard.
“Over in Asia, apart from being a smaller market and slightly further behind Europe, the borrowers here are actually a bit bigger and potentially have a slightly lower risk.”
He noted that in both the North American and European markets, the capital markets are quite developed so companies would go to there for financing when they grow to a certain size.
Meanwhile, the capital markets in Asia are not as developed so companies stay private even when they get bigger.
“In Asia, where we focus on Australia, New Zealand, Hong Kong and Singapore, we’re getting a similar return to what we get in Europe and North America. But we would argue potentially slightly lower risk just because the companies that we’re lending to are bigger within their markets,” Vaulkhard added.