Wealth Management: Investment Views – The rise of private markets
William Haggard, William Therlin, Amaya Gutiérrez, Raphaela Schröder and Andreas Doepfert, Wealth Management
Managing a direct lending fund
An interview with Rothschild & Co's Merchant Banking business
Rothschild & Co's Edouard Veber, Co-Managing Partner of the Direct Lending Platform of our Merchant Banking division, has multi-decade experience in investing in private debt.
In the following interview, we ask Edouard to share some insights on managing a direct lending fund.
What are the key advantages of direct lending for investors in today's market?
Edouard Veber: Firstly, in today's market interest rates remain near to, or at record lows across the developed world. In an environment where the hunt for yield leads investors to increasingly risky assets, private debt and specifically direct lending offers clients a cash yielding product with regular payments at reasonable risk levels. Whilst potential returns may be lower than in private equity, private debt remains comparatively less risky as an asset class.
Secondly, private debt differs from private equity in that there is no initial drawdown period or J-Curve (Figure 2, page 5). In private debt, fees are generally not charged to the investor until monies are invested and lending is complete. This means clients' returns are net positive from the beginning of the investment cycle.
In your first direct lending fund “FACS” you focused on Junior Debt. In the second vintage “FADL” your team focused on Senior Debt. What lies ahead?
Edouard Veber: Over recent years, the market continues to evolve towards senior lending (unitranche) investment opportunities. For our latest direct lending fund, FADP III, we have decided to optimise the risk/return of the portfolio by investing at least 70% in unitranche positions with the balance invested in junior credit.
For FADP III we will keep our focus on identifying direct lending opportunities in no more than 20 different companies. We limit our portfolio exposure to better understand the companies we lend to and prefer, where possible, to act as a sole lender.
What are some of the key characteristics you look for in the specific companies you lend to?
Edouard Veber: Stability is a key characteristic of companies we lend to. They tend to have strong revenue visibility and regular cash flows. Our goal as private debt lenders is to get our principal repaid and receive interest. As we do not have any equity upside, our focus is to limit risk. This means we tend to favour very stable businesses.
Given where we are in the business cycle, how does the issue of defaults compare to 10 years ago?
Edouard Veber: From the limited number of companies we lend to, we have so far not encountered any defaults. It is important to remember that compared with the 2008-2009 financial crisis, companies are generally less levered, interest rates are lower and the cost of debt remains reasonable. Meanwhile we should not forget recovery rates, even during the last downturn, were around 50% for junior debt and near to 80% for senior debt lending.
Insight into a direct lending company
BIOGROUP LCD (figure 3, page 6) is a leading French clinical laboratory business. We started lending to the business in 2014 when the company had EBITDA 30m Euros. The business comprised of 40 different laboratories with multiple lines of credit and a myriad of legal entities, restricting potential M&A activity.
After streamlining the business structure, Biogroup has grown to generate EBITDA 160m Euros. It is now able to provide critical blood test screening prior to surgery, via a network of laboratories financed in part through a single direct lending line. Over the past decade where bank lending has receded, private debt lending has stepped in to make a tangible impact on businesses and society.
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