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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.<\/span><\/p>\n The whole rationale for investing in private rather than public market debt is that you can launder volatility given the absence of marks it is supposed to offer an illiquidity premium. Harvesting this illiquidity premium, the theory goes, should translate into higher risk-adjusted returns. But empirical data on the illiquidity premium is elusive. We found some, and thought we\u2019d share it.<\/p>\n In yesteryear, companies wanting to borrow less than several hundred million dollars in one dollop had little option but to do so from a bank. More recently, they\u2019ve also been able to approach insurers, asset managers, or some messy combination of the two. These entities collectively control trillions of dollars of capital. And exposure to direct lending\/ private debt\/ private credit is exactly what they\u2019re looking for.<\/p>\n What\u2019s the big attraction of private debt? For a given set of credit metrics, investors are supposed<\/em> to be able to get better terms (some mixture of pricing and covenants) by lending directly to a company than by buying a lookalike bond. The difference between the interest rate you\u2019ll get paid on your pretty much unsellable loan and your easily sellable bond is the illiquidity premium.<\/p>\n For something so central to the whole rationale for investment in private debt \u2014 and something that comes up in pretty much every private debt sales pitch \u2014 empirical data on the illiquidity premium is oddly elusive.<\/p>\n But to their credit, Aviva Investors\u2019 private markets team has been publishing a chart for a number of quarters that tries to put evidence on the concept. Feast your eyes on the resultant glorious mess:<\/p>\n What you\u2019re seeing is the result of the team\u2019s attempt to systematically quantify on a deal-by-deal basis the investment-grade private debt illiquidity premium. <\/p>\n Many of you are as pedantic as we are \u2014 if not more so. So rather than just slap the chart up and have done with it, we got in touch David Hedalen and Nick Fisher \u2014 Head of Real Assets Research, and the Research Director, respectively, who lead private debt work at Aviva Investors \u2014 to understand exactly what each dot on the chart is saying.<\/p>\n The research team examined just over 2,000 individual euro- and sterling-denominated private debt transactions, the overwhelming majority of which they say were originated by Aviva themselves.<\/p>\n They then looked at the difference in spread between these private debt deals and the spread of an ICE BofAML public bond index \u2014 matching the currency, sector and broad rating band.<\/p>\n So for instance, if a sterling private infrastructure debt deal with a rating of Baa1\/BBB+ has a spread of +160bps and the index-level spread on the ICE BofA BBB Sterling Utility Index (UU40) is +140bps, the illiquidity premium on that deal is marked at +20bps. <\/p>\n This means \u2014 for the purpose of the chart \u2014 the deals aren\u2019t rating-notch<\/em> matched. Nor is any account made for maturity. Or indeed whether the deals are fixed or floating rate. And it goes without saying that credit worthiness can vary vastly across different issuers that have the same credit ratings. As such, a Baa3 three-year deal and a Baa1 12-year deal in the dataset will both be compared to the currency\/ sector-matched overall Baa\/BBB index spread at the moment of origination. This hack is going to throw up some weird numbers.<\/p>\n As Fisher explains:<\/p>\n in practise, when we look underwrite a transaction, we\u2019ll make sure it is duration matched. And we\u2019ve got the best available public comparators to price it against. But for the purpose of exercise, doing 2000 transactions in bulk load, we\u2019ve had to make some simplifications <\/p>\n And we\u2019ve got some sympathy with the view that peeling the onion ad infinitum could leave you with a cohort of comparators so thin that it would also be pretty screwy.<\/p>\n For context, the real estate deals tend to have maturities at origination of between around seven and 15 years, infra debt more usually over 15 years, and the private corporate debt and structure finance deals can be pretty much any maturity.<\/p>\n Aviva Investors show annual averages by sector in its version of the chart, but in a quest for something a little wigglier, we\u2019ve made our own version showing the dots\u2019 three month moving averages:<\/p>\n This captures \u00a335.1bn of private debt deals that Aviva has internally originated over the past 10 years. So not a rinky-dink pool of transactions. And the simplified illiquidity premium attached to these deals has averaged 59-72 basis points depending on the sector. But the premium can really move around.<\/p>\n We\u2019ve written many posts looking at the growing appetite for private debt from insurers, investors and Business Development Companies. Rob Armstrong speculated a few weeks ago in MainFT that the humungous private credit finance initiative in which Meta is reported to be engaging points to the illiquidity premium turning negative. What has Aviva seen in the European investment grade private debt market? Nick Fisher:<\/p>\n in terms of pricing, we have seen spreads compress over the last couple of years. I think it\u2019s not just necessarily BDCs [who are less active in investment grade] and insurers\u2009.\u2009.\u2009. we\u2019ve noticed the banks being more active. They\u2019ve loosened their lending standards and so they\u2019re more active in the market and that has led to some spread compression\u2009.\u2009.\u2009. over the course of 2024, we saw more competition come into the market, and that led to a compression in both spreads and illiquidity premium.<\/p>\n They reckon this increasing demand has taken the illiquidity premium back to long-term averages of 50-75 basis points rather than taken it negative. But it\u2019s not the constant static number that they describe investors expecting a priori<\/em>.<\/p>\n So there we have it. The data isn\u2019t super-clean \u2014 but it\u2019s pretty much the best we\u2019ve seen out there.<\/p>\n","protected":false},"excerpt":{"rendered":" Unlock the Editor\u2019s Digest for free Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter. The whole rationale for investing in private rather than public market debt is that you can launder volatility given the absence of marks it is supposed to offer an illiquidity premium. Harvesting this illiquidity premium,<\/p>\n","protected":false},"author":1,"featured_media":11501,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[49],"tags":[4888,4889,4890],"class_list":{"0":"post-11500","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-business","8":"tag-elusive","9":"tag-illiquidity","10":"tag-premium"},"_links":{"self":[{"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/posts\/11500","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=11500"}],"version-history":[{"count":0,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/posts\/11500\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=\/wp\/v2\/media\/11501"}],"wp:attachment":[{"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=11500"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=11500"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/naijaglobalnews.org\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=11500"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}