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A confluence of factors following the COVID-19 pandemic created a complex global economic scenario that has stoked inflation and driven interest rates to two-decade highs.
A combination of supply chain disruptions, labour shortages, pent-up consumer demand and shifting consumption patterns, followed by fiscal stimulus packages and energy price shocks created a sticky inflationary environment and a cost-of-living crisis, posing challenges for central banks and investors.
“In the hunt for absolute returns in this environment, investors typically default to conventional strategies, allocating capital to equities, inflation-protected securities, and debt instruments, with sub-allocations to cash, bonds and fixed income in the traditional 60/40 portfolio split,” explains Dino Zuccollo, Head of Investor Solutions at South African alternative asset manager Westbrooke Alternative Asset Management.
“When markets start to run again, investors typically recycle capital into equities, which materially increases the risk profile of a portfolio. Investors need to ask whether this conventional approach is still the right way to invest in the face of structural changes in the market, stubborn inflation, and low to moderate growth.”
Globally, investors are increasing allocations to alternative investments, with private credit emerging as the dominant theme on the back of the attractive yields delivered in the high interest rate environment.
For instance, in 2023, the Westbrooke Alternative Asset Management Yield Plus secured private debt fund enjoyed its strongest performance since inception, with a net investor return of 9.2% in British Pounds Sterling (GBP), offering an even stronger return in rands.
This open-ended Jersey Expert Fund provides investors with a high-yielding, fixed-income alternative investment through a diversified portfolio of approximately 50 predominantly floating-rate private debt transactions mainly in the UK, with a total gross asset value of GBP152 million.
“The fund provides a unique investment advantage driven by an asymmetric risk/return profile, achieved by providing loans to lower and middle-market UK companies and real estate sponsors in a significantly underserved UK market segment,” explains Zuccollo.
In the context of a high interest rate environment, fund investors benefit from a target annual return of cash plus 4-6% per annum in GBP.
“Achieving yields of this level in hard currency demonstrates the value of looking beyond equity and bond exposures and highlights the value of including alternatives in a well-diversified investment portfolio.”
According to Zuccollo, private credit offers the largest opportunity set for investors not already invested in alternatives to cut their teeth.
“When compared to the bond markets, these investments offer a higher degree of predictability in returns, with lower risks.”
Moreover, demand for private credit is at all-time highs, topping $2.1 trillion globally in assets and committed capital in 2023 according to IMF data, as traditional funding lines through banks and listed instruments dry up in the high risk, high interest rate environment.
“Private credit providers are not regulated in the same way banks are, which supports more nimble lending. This flexibility allows us to cater to the massive demand for access to capital in global markets, especially in a bear market,” continues Zuccollo.
“These characteristics, coupled with high levels of capital availability in private markets, have supported the emergence of private credit as one of the fastest growing alternative asset classes globally.”
In addition, well-constructed private debt funds, like the Westbrooke Yield Plus fund, are positioned to continue performing when the interest rate cycle finally turns.
Despite initially modelling transaction flow for the high interest rate environment, with 90% of transactions at inception linked to the Bank of England’s floating rate, Westbrooke has recently written longer-dated loans with fixed rates over the last 12 months. The fund is now balanced 50/50 between the two loan structures.
“Where possible, we also implement an interest rate floor on floating rate loans, which will maintain the spread above a certain pre-determined threshold to meet the fund’s cash+ mandate,” adds Zuccollo.
“While no one knows for sure when developed markets will start their rate-cutting cycle given the uncertainty in the inflationary outlook when it eventually happens, the fund is suitably protected.”
Zuccollo explains that Westbrooke only writes investments that they consider great transactions with appropriate equity buffers to generate meaningful returns in relation to the risk.
“Whether rates go up or down, investors will continue to benefit from risk-adjusted cash+ returns that beat the inflation and interest rate hurdle, which should reaffirm the role that private credit can play in suitably diversified portfolios tailored for the prevailing market conditions,” he concludes.
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