Alternative Investments 2.0 - Группа авторов

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the lender of record (e.g., through co-investments or managed accounts) further strengthens the position of investors. The lender of record owns the loan, has a direct relationship with the borrower, and reserves the right to enforce, settle, compromise, amend the loan, or sell a participation. Participants, on the other hand, have no direct rights under the loan agreement; they can neither enforce the loan nor proceed against the collateral. In most instances, the borrower does not even know the participant exists.[11] The ability to control and drive negotiations with underperforming companies determines the final recovery.

      When investors evaluate GPs’ performance and track records, they often look at the managers’ gross and net IRR. However, it is equally important to assess the deployment rate at that IRR, as this dictates the absolute cash return to the investor. Simply put, if a GP cannot identify enough transactions, an investor’s capital sits idle in a bank account where it provides low or even negative returns.

      As can be seen in exhibit 13, having the ability to put capital to work sooner leads to significant differences in the cumulative US-dollars-earned amount over the relevant period. These differences mostly stem from different implementation strategies. The chart compares the US-dollars earned on capital committed under three different investment scenarios: an evergreen vehicle, a closed-end vehicle and a single fund.

      Exhibit 13: Cumulative US-dollars-earned Comparison

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      Source: the estimates for the evergreen platform and the closed-end platform are based on StepStone vehicles and on Preqin data for the single fund

      Investors should consider an investment structure that provides the flexibility to shift allocations from one GP to another. This cannot be achieved with investments in funds but requires a Separately Managed Account (SMA) with individually negotiated terms. The need for flexibility may be driven by return, risk, regional focus or capital deployment considerations.

      Investing through a flexible SMA platform on which LPs’ commitments can be shifted between GPs allows investors to manage their portfolio based on exposure rather than commitments. By targeting an optimal deployment level, investors can avoid opportunity costs faced in a traditional fund rollover strategy across vintages, as demonstrated in exhibit 7.

      Direct lending investors typically seek stable returns at a defined target level, looking for neither excess returns nor excessive losses. As in public markets, diversification is the simplest and cheapest way to reduce risk within a portfolio. This is even more important for investments such as private debt. Only a handful of managers have track records that precede the GFC, which makes it hard to assess how well a given GP may perform throughout the economic cycle.

      In light of private debt’s general illiquidity, using variance of returns to illustrate this point is hardly sensible. To estimate the asset class’s diversification benefits, loss rate and its associated variance are far better metrics. Similar to the public market, the more loans within your private debt portfolio, the lower the loss rate variance for a given target return.

      To illustrate the diversification benefits based on the loss rate variance, we used our proprietary database to simulate loss distributions for different portfolio sizes, based on a resampling method like the one used to illustrate section 3.1.3. As one can observe in exhibit 14, the greater the number of loans, the narrower the distribution becomes. The tail risk also diminishes as the number of loans in the portfolio increases.

      Exhibit 14: Loss Rate Distribution as a Function of the Number of Loans within a Portfolio

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      Source: StepStone Private Debt Internal Database

      Irrespective of the number of loans within the portfolio, the expected loss remains the same. However, the 99th percentile of the loss distribution falls significantly with the number of loans. This is one more example of the importance of diversification and the benefit of investing with multiple GPs. Indeed, having access to transactions sourced by various managers enables investors to participate in enough deals and build a well-diversified portfolio.

      The COVID-19 pandemic provides another example of the importance of diversification. The lockdown and social distancing measures imposed by most governments had a dramatic effect on some businesses such as restaurants, leisure or retail shops whereas others benefited from the situation. Had it been a computer virus instead of a biological one, the affected sectors would have been very different. Diversification remains the cheapest and most effective hedge against these types of risk. StepStone recommend using investment guidelines (see section 4.2) to ensure a proper sector diversification in the portfolio.

      Investors need to undertake detailed due diligence on the GP’s workout capabilities and experience during previous cyclical downturns. Workout expertise is critical to maximizing recovery. GPs serving as either the sole or lead arranger are often in a better position to succeed in such a situation than a club of lenders. In addition, our analysis from our proprietary database shows that sole and lead arrangers achieved loss-adjusted returns 80 bps higher than participants in club deals with five or more lenders. We believe this is due to their enhanced negotiating power vis-à-vis the borrowers.

      Investors have the ability to improve their negotiating power with GPs and reduce fees through economies of scale. They can do this, for instance, by investing through a platform that aggregates their capital.

      Few investors have sufficient capital and market knowledge to implement the success factors described in the previous chapter on their own. Having the flexibility to switch commitments between managers and strategies is essential to implementing a high-conviction view based on data analysis and manager selection. We are convinced that investment guidelines are the best instruments to avoid situations that could jeopardize the sustainable growth of the asset class through multiple cycles. Because of the rapid growth of private debt in recent years, smaller investors have encountered more difficulties in discussing customised investment solutions with GPs.

      Nevertheless, we strongly discourage investors from compromising on quality and returns because of their size. We believe that investors will collaborate more closely with business partners to regroup commitments. Hence, they will be able to access prime managers, implement their vision, allocate capital more efficiently and, most importantly, diversify their exposure.

      Fang, L./Ivashina, V./Lerner, J. (2015), The disintermediation of financial markets: Direct investing in private equity, in: Journal of Financial Economics 116/1, 160-178.

      Jones Waldo Holbrook & McDonough (2013), Loan Participation or Assignment; What's the Difference?, https://www.martindale.com/banking-financial-services/article_Jones-Waldo-Holbrook-McDonough-A_1971368.htm, access: 7 October 2020.

      StepStone (2014), Co-Investments: Good for Your Portfolio’s Health?, https://www.stepstoneglobal.com/news-press/co-investments-good-for-your-portfolios-health/,

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