Myth-busting: Private credit liquidity

Below, we explain some of the dynamics of liquidity in investment grade private credit, hopefully dispelling some 'illiquidity' myths.

Janine Melnitz: “Do you believe in UFOs, astral projections, mental telepathy, ESP, clairvoyance, spirit photography, telekinetic movement, full trance mediums, the Loch Ness monster and the theory of Atlantis?”

Winston Zeddemore: “Ah, if there's a steady paycheck in it, I'll believe anything you say”.

(Ghostbusters, 1984)

You can perhaps add 'the illiquidity of private credit' to the list above.

They say myths which are believed in tend to become true – this seems to be the case with the supposed illiquidity of investment grade ('IG') private credit. So, let’s bust some myths (‘cos bustin’ makes me feel good).

The fact an IG private debt investment (think underlying investment rather than share of a fund) is typically unlisted does not alone make it illiquid. We believe the idea is overstated and may suggest investors are conflating IG with other parts of the private credit universe.

The appearance of illiquidity is, in part, driven by the long-term buy-and-hold nature of the insurance companies that dominate the IG market. IG private credit – particularly debt issued on the private placement ('PP') format – is reasonably liquid, allowing for a degree of active management and shifts in strategy. Even though we purchase private assets through secondary channels, there remains an asymmetry – the issue is not selling high quality private assets; it’s trying to get your hands on them!

What does 'illiquid' mean, anyway?

We’re not suggesting that the IG private credit markets are suddenly as liquid as IG public bonds. Generally speaking, they are not.

However, if we define liquidity as, “the ability to sell an asset, at a not material discount to held value – assuming the asset is ‘marked-to-market’ – in broadly non-distressed market conditions, within a couple of months, if not a couple of weeks,” then IG private credit often fits the bill.

Myth-busting

Over the past couple of months, we have sold a number of private credit assets. For clarity, there was nothing wrong with credit quality or performance – simply, one client required a portfolio sectoral tilt, and another was looking at buyout (and offloading private credit investments).

The sales were all undertaken in a matter of weeks, at prices commensurate with held value, with the assets regularly valued during their life to reflect estimated market value.

Some may have expected this sales process to take months. But, with a select distribution group, sales were undertaken in 2-3 weeks, including the sale of two more supposedly 'complex' project finance infrastructure investments. Interestingly, the buyout-focused client’s assets were bid by a manager who would have happily taken the assets in specie as part of a buyout, creating another avenue of liquidity.

Market data is available to justify our findings. One of the leading brokers in the PP space – which is part of the wider private credit universe – estimates the secondary market is currently $3-4bn p.a., but with appetite many multiples of this.

Generally speaking, round lots of $10-30m are most liquid. Smaller lots require finding an existing holder while larger lots may need to be managed in pieces or go to only the largest investors.

Market familiarity, number of holders of an existing credit, credit quality, price, sector, covenants, jurisdiction, currency and relative position size are among the drivers of liquidity.

Some trades can be executed quickly (within a matter of hours or days – usually involving existing investors) while others may need to be worked by the broker over a period of up to 60 days (if being sold to a new investor).

The secondary market is still predominately IG. Saying this, at times liquidity can actually improve for more deeply distressed credits as certain distressed and credit opportunities strategies value the control covenants can provide. Additionally, as a workout becomes more likely, there is greater agnosticism regarding the instrument that will generate a creditor claim.

Trading costs can range from as little as five basis points to high teens, on a spread basis – fundamentally, a factor of how easy the asset is to trade – and size and tenor of the trade.

“Who ya gonna call?”

Many clients perceive 'liquidity' as being able to trade daily, but, in reality, that level of liquidity is not required for IG private credit, and a timeframe of a few weeks is more than adequate for, say, planning for buyout.  We also need perspective; a large proportion of public bonds, particularly those outside of the top few thousand issuers, are less liquid than people think. And for some private names that sit in the bite-size sweet-spot, price may not be affected by the sales process.

We should note that all asset classes are not equal. Commercial real estate lending is one example where there is less a secondary trading of debt rather than a primary refinancing of existing debt. As such, even though appetite is strong, the process might take longer.

Overall, however, private credit can be more liquid than one might think. The potential attractiveness of high-quality credit to investors, both in primary and secondary markets, needs to be acknowledged and it is sure to grow, with widespread focus on diversified deployment through privates and increase in long duration demands of investors like UK insurers.

When it comes to selling an asset, you may be wondering “who ya gonna call?”. In reality, there are probably more people than you think ready to pick up the phone.

Key risks:

Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.