Most companies finance their operations and expansion through a combination of equity and debt. Publicly traded companies issue corporate bonds (debt) that are publicly traded. We can call this public debt. Private debt, sometimes known-as alternative debt/credit, refers to the debt that is issued by privately owned companies. As an investment vehicle, access to private debt markets is offered primarily by private debt funds. While individual investments can and will vary, some of the common advantages of private debt can include higher yields compared to the public variety as well as less risk than private equity.
Private Debt History
Private debt as an investment vehicle is a relatively new phenomenon. It only became widespread after the 2008 Financial Crisis when regulators restricted the lending practices of banks, hampering their ability to make higher risk loans. This forced companies, particularly in the small and middle-market range, to seek out loans from private lenders.
Between 2008 and 2018, the assets under management in the private debt markets grew from US$238 billion to US$768 billion, according to a 2019 report from the Alternative Credit Council. The Council predicted that number to double by 2023. Private debt currently accounts for between 10% and 15% of total assets under management in the private markets.
Kinds of Private Debt:
Real estate debt
Advantages Of Private Debt
In a low-interest environment, where public market options like government and corporate bonds provide ever-decreasing yield, private debt offers the potential to be a higher yield fixed-income asset. A report from Bloomberg notes that loans in the private credit market typically yield in the range of 7% to 9% - sometimes much more – while “safer” investment-grade corporate bonds typically yield about 3%. Yet, depending on market conditions, private debt may offer portfolio diversification opportunities with relatively low risk.
As a general rule, private debt is less risky than private equity. One reason for this is that debt, in general, has a priority claim on a company’s cash flows and assets. This means that, in the event of liquidation, debt claims are paid back first. Further, private debt has a higher recovery rate than public debt. In the private debt markets, almost all loans are secured, meaning they are backed by assets that can be resold to pay back investors in the event of default. In the public bond markets, however, around 95% of issuance is unsecured. The result is that when a public company fails, less than 50% of debts are repaid to investors (recovered). For private corporate bonds, by contrast, the recovery rate is over 80%.
Recovery levels for public debt (grey bars) versus private debt (blue bars)
Increased Flexibility And Control
Since private debt is negotiated between the borrower (company) and a small group of investors, there is a greater degree of flexibility in loan negotiation compared to public corporate debt. This means investors can structure loans to precisely meet their portfolio needs. At the same time, private lenders have the flexibility to renegotiate loans towards the mutual benefit of the lender and borrower. For example, if the company is in danger of failing, private lenders can nimbly offer additional funds with attached conditions. Finally, in some cases, private lenders have a mandate to take an active role in the company they are lending to. Since private debt is often financed by private equity firms, those firms can leverage their other portfolio companies and connections to support a company that is struggling with its debt.
Drawbacks Of Private Debt
As with most investment vehicles in the private markets, a key trade-off for private debt has traditionally been reduced liquidity. While investment-grade corporate bonds, for instance, can be traded instantly on public markets, private debt typically has fixed terms that lock investors in for several years. Of course, the trade-off has investors being compensated for the lack of liquidity with potential for higher overall yields.
How Does iSTOX Democratise Private Debt?
iSTOX is an investment platform that lowers the barriers to entry to private debt and other alternative investments while addressing many of their traditional drawbacks, such as lack of liquidity and transparency. Investors can start with as little as S$1,000.
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Singapore-based iSTOX is the world’s first integrated platform for digital securities. Regulated by the Monetary Authority of Singapore (MAS), iSTOX uses proprietary technology to directly connect buyers and sellers. In so doing, iSTOX provides accredited investors with access to previously out-of-reach investment opportunities, including private equity, hedge funds, private debt and more.