Over the last decade, private debt has emerged as a compelling asset class for investors. Investors seeking stable returns and downside protection have added numerous types of assets to their portfolios.
Private debt deals have become so attractive because of the consistent yield they deliver. Plus, they often include a contractual ability to limit potential losses, which lenders love. This offers investors a wide range of opportunities to diversify beyond traditional assets with achieving yield and limiting downside risk.
In this article, we will delve into the concept of private debt. We discuss the various types, and why these assets should be an essential component of any well-diversified investment portfolio.
Understanding Private Debt
Private debt (often referred to as private credit) refers to the financing provided by non-bank entities. Recipients of these funds include corporations, individuals, and ironically enough, other non-bank entities. Unlike public debt, which is raised through bonds, private debt transactions occur directly between the lender and the borrower. These transactions are often customized and negotiated based on the specific needs and circumstances of both parties.
The Appeal of Debt as an Asset Class
Private debt investments hold several advantages that make them appealing to investors. Firstly, debt found in private markets offer steady yields. This makes it an attractive option for income-oriented investors seeking reliable cash flows. Much of the yield comes from illiquidity risk, or the inability to exit positions. Additionally, business debt investments typically come with contractual agreements that prioritize the lender’s interests. This provides a structured framework to limit downside risks, with some additional upside if negotiated correctly.
Types of Debt in Private Markets
Private debt encompasses a wide range of investment options, each with its own risk-reward profile. Let’s explore some of the common types of non-public debt investments.
Merchant Loans
Also known as merchant cash advances, involve providing short-term financing to businesses. In exchange, business remit a percentage of their future sales up to a fixed payback. These loans are often utilized by small and medium-sized enterprises (SMEs) to address immediate cash flow needs for any reason. Merchant loans offer lenders the potential for attractive returns while giving businesses the flexibility to access capital quickly. Merchant advances are niche in the debt world, accounting for roughly $1.8bn in 2022. The credit risk here is in the merchants business.
Corporate Payables
Corporate payables are also known as accounts receivables to the non-paying party, and involves purchasing the right to collect on the note. The most recent figures have this sub-asset class at $150bn. This form of debt allows the lender (or “factors”) to earn interest or fees on the outstanding invoices. Corporate payables are an efficient way for businesses to optimize their working capital and strengthen their financial position. Most payables financed have credit risk in top tier payors.
Direct Corporate Lending
As of 2023, this is a roughly $600bn market, and involves providing loans directly to companies. Funds can be used for specific purposes such as funding acquisitions, capital expenditures, or refinancing existing debt. These loans are typically structured with customized terms and covenants based on the borrower’s creditworthiness and the lender’s risk appetite. Direct corporate lending offers investors the opportunity to earn attractive risk-adjusted returns through tailored financing solutions.
Other types of private debt include mezzanine debt, distressed debt, real estate debt, private mortgages, peer-to-peer lending, and infrastructure debt. Babylon is laser focused on the first three options above.
The Rise of Private Debt as an Asset Class
In recent years, private debt has experienced exponential growth as an asset class. Especially in the aftermath of the banking crisis of 2008, and now again, in 2023. The limitations faced by traditional banks have led borrowers to seek other options. Private funds like Babylon have stepped in to fill this void, offering solutions for borrowers, and attractive returns to investors.
The growth of this asset class can be attributed to several factors. Firstly, the demand for non-bank financing has surged as companies look beyond traditional banking channels for flexible and tailored funding. Furthermore, the prolonged low-interest-rate environment has compelled investors to search for alternative sources of yield. This has driven capital towards non-public debt investments. Consequentially, the track record of these alternative investments in delivering consistent returns is unmatched. Justifiably so, the asset class has gained attention from institutional investors and high-net-worth individuals alike.
Babylon’s Thoughts on Privately Negotiated Debt
Overall, private credit (i.e. debt) has emerged as a viable investment option, providing investors with steady yields and contractual safeguards. We’re laser focused on adding numerous types of non-public debt to our portfolio, specifically, merchant and business financing debts.
As demonstrated by the diverse range of non-public debt opportunities, investors have ample choices to tailor their investments. They can choose according to their risk appetite and return objectives. Along with the opportunity to diversify across asset type, level of capital stack, time horizon, etc.
Contact us today if you’d like to learn more about private debt as an asset class.