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Uncovering alternative credit opportunities


December 12, 2018

This paper discusses why asset owners should go beyond the mainstream credit sources and consider alternative credit.

We have found that acceptable returns from traditional investments are increasingly hard to find. Equities may promise strong returns, but based on our experience, the price is high risk and elevated volatility. Bonds have delivered for many years, but that era may be over. Alternative credit has the potential to deliver equity-like returns at much lower risk levels.

An asset class worth a closer look

Credit is vital for business to survive and for economies to thrive, yet since the global financial crisis regulators have made it harder for traditional lenders, like banks, to supply credit. Borers still need to bor though, and institutional investors can bridge the gap and make good returns doing so. This is one of the biggest developments in credit markets since the financial crisis and the asset class has gn too big to ignore, yet many investors in Asia don’t hold it yet. Most asset owners should at least form a view on this opportunity.

Alternative credit still has a strong tailwind from the global financial crisis, as banks remain under pressure to rebuild capital and reduce their risks. We believe that this leaves a sizeable ongoing opportunity for institutional investors to step into the breach and potentially become profitable lenders.

Alternative credit as an asset class encompasses a wide range of lending opportunities. Taking a nar approach is too risky. Applying a broad approach can result in a more robust portfolio.

Why should asset owners go beyond the mainstream credit sources and consider alternative credit? We will explain the following key reasons:

  • More opportunities to boost their returns — elevating their bond returns to equity levels and potentially profit from the retreat of lending banks.
  • Adding diversity but not more risk to a credit portfolio — lending to many borers, with their loan secured on almost any assets and benefit from potential uncorrelated returns.
  • Taking advantage of being a long-term investor — make a virtue of their ability to be less liquid than other investors and potentially benefit from higher returns.
Alternative credit includes listed debt that is not investment-grade quality and all unlisted debt. It includes corporate, securitized, structured credit rated below investment-grade, and both sovereign and corporate issued by emerging market borers that are not strong enough to have an investment grade credit rating. It also includes private credit, whether on bank balance sheets, in funds or in other formats.


More opportunities to boost your returns

We estimate there is now more than twice as much alternative credit as mainstream credit (see Figure 1).  The asset class is ging and broadening at a rapid pace since the global financial crisis, providing more potential opportunities and giving rise to diverse strategies.

Figure 1. Market size in US$ trillion

Source: Willis Towers Watson, data as of 31 December 2016

Many credit investors focus solely on high-yield bonds and bank loan markets as alternative credit sources. However, we have found that listed high-yield corporate credit tends to be a poor stand-alone solution for alternative credit exposure because it is an index-led cded market and brings little diversity. Also, this is limiting and ignores other investable credit opportunities, which can offer attractive risk-adjusted returns and may have a substantially positive impact on your portfolio.

We find these opportunities reside in alternative credit markets, which used to be dominated by banks and were largely inaccessible to investors. As the banks retreated, they left a gap for institutional investors to step in and potentially generate returns. This part of the market is attractive because it is more illiquid, more inefficient, and more under-researched by the mainstream investment community.

By investing in alternative credit, we believe you are lending to the real economy. As with all lending, you receive the promise of income from interest, coupons and fees, which should more than compensate you for the risks that your capital is not fully repaid when it is due. We observe a well-diversified alternative credit portfolio can offer attractive yields to many investors today.

"A well-diversified alternative credit portfolio can offer attractive yields to many investors today.”

Alternative credit is different from mainstream credit, such as investment-grade bonds. Potentially it has a much higher expected return, more like the returns you hope for on your equity investments. This is thanks to its higher income. And yet, its volatility and risk potential may be much lower than that of equity — equity holders start to lose value from their investment in a company long before the company is in danger of defaulting on its debt.

Add diversity but not more risk to a credit portfolio

One of the strengths of alternative credit is its diversity. We advocate a broad strategic allocation across the full range of risks shown in Figure 2.

Figure 2. Credit universe

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