Navigating the spectrum of private credit strategies

Published on March 11, 2024 by Prashant Gupta

In the dynamic landscape of private credit, investors are presented with a spectrum of strategies that cater to varying risk appetites and return objectives. Understanding these strategies is crucial for constructing a well-balanced portfolio that aligns with an investor's financial goals. Here, we explore three core private credit strategies: capital preservation, return maximisation and opportunistic or niche investments, including their respective sub-strategies.

Capital preservation: securing the foundation with senior debt and direct lending

At the conservative end of the private credit spectrum lies the capital preservation strategy. This approach prioritises the security of the principal investment, focusing on senior debt and direct lending opportunities.

• Senior debt, often secured by collateral, sits atop the capital structure, offering investors a first claim on the borrower's assets in the event of default. This positioning reduces risk and provides a measure of protection against losses.

• Direct lending, on the other hand, involves providing loans directly to middle-market companies that may not have access to traditional bank financing. These loans are typically structured with covenants that give lenders greater control over the borrower's financial health, further safeguarding the investment.

Investors who prioritise stability and consistent income generation may find the capital preservation strategy particularly appealing. It offers a steady stream of interest payments and is less susceptible to market volatility, making it a cornerstone for risk-averse portfolios.

Return maximisation: navigating strategies for higher returns

For investors seeking higher returns, the return maximisation strategy offers exposure to assets with greater risk but the potential for enhanced yields. This strategy includes investments in distressed and stressed debt, subordinated debt, mezzanine debt and convertible securities.

• Distressed debt: Investing in the debt of companies that are experiencing financial difficulties or are in bankruptcy. These investments can offer high returns if the company successfully restructures or improves its financial position.

• Stressed debt: Similar to distressed debt but involves companies that are underperforming rather than those in severe financial distress. The risk is somewhat lower than for distressed debt, but the potential for higher returns than those from more stable investments remains.

• Subordinated debt: This type of debt is lower in the capital structure than senior debt, meaning that it gets paid out after senior debt in the event of liquidation. The increased risk is compensated for by higher interest rates, which could lead to higher returns for investors.

• Mezzanine debt: Mezzanine financing is a hybrid of debt and equity, often used in the context of leveraged buyouts or growth financing. It typically includes warrants or conversion features that can provide equity upside, justifying the higher yields due to its subordinated position.

• Convertible securities: These are bonds or preferred shares that can be converted into a predetermined number of common shares. The convertible feature provides potential for equity-like returns if the issuing company's stock price appreciates, while the fixed-income component offers some downside protection.

Opportunistic or niche investments: exploring specialised areas for distinctive opportunities

The most dynamic and diverse strategy within private credit is the pursuit of opportunistic or niche investments. This "go-anywhere" strategy is characterised by its flexibility and innovation, as it involves delving into specialised areas that require a deep understanding of specific market segments

• Special-situation/credit opportunities: These are typically event-driven and may involve complex situations such as debtor-in-possession financing, bridge financing and restructuring. They are opportunistic because they aim to capitalise on unique time-sensitive circumstances.

• Capital and liquidity solutions: Providing capital to stressed or distressed companies requires a specialised approach to assessing and managing higher risks. These solutions are opportunistic, as they often involve quick decision-making and bespoke financing structures.

• Asset-based lending and structured credit: This involves lending against specific assets or structuring credit products that are backed by pools of assets. It is a niche strategy because it requires expertise in valuing and managing different types of collateral, such as real estate or receivables.

• Tactical performing credit: This strategy involves taking advantage of primary and secondary dislocations in the credit markets, which requires a proactive and flexible approach to quickly capitalise on opportunities as they arise.

• Speciality finance: This sub-strategy focuses on providing capital to commercial and consumer borrowers inadequately served by mainstream banking channels. Examples include aviation finance or financing against music/healthcare royalties and rediscount lending.

Investors drawn to opportunistic or niche strategies are typically those in search of diversification and the potential for outsized returns. These strategies can be particularly rewarding during times of market dislocation when unique opportunities arise.

Conclusion

The private credit market offers a rich tapestry of investment strategies, each with its own risk-return profile. By understanding the nuances of capital preservation, return maximisation and opportunistic or niche investments, including their sub-strategies, investors can make informed decisions that align with their investment philosophy and objectives. As the market evolves, staying educated and adaptable is key to capitalising on the opportunities that private credit provides.

How Acuity Knowledge Partners can help

We streamline our private credit services to align with our clients' diverse investment objectives. We support a range of investment strategies designed to meet diverse client needs, seamlessly blending capital preservation, capital appreciation and opportunistic or niche investments to create a robust portfolio poised for growth and resilience.

As an integral part of a client’s credit team, we provide end-to-end support – from opportunity screening and in-depth research to execution support and fund operations management. Our expertise in the private credit sector equips us to handle operational complexities, deliver customised reporting and ensure compliance with regulatory standards. We are dedicated to surpassing client expectations through operational excellence and innovative solutions. Partnering with us grants you access to a skilled team able to navigate the nuances of private credit investment, driving positive outcomes and empowering you to invest with confidence.

Sources

Private Credit: An Introduction | Hamilton Lane

Private Credit Investing: Current Opportunities And Risks (forbes.com)

Private Credit Strategies: An Introduction – Cambridge Associates

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