The private debt asset class has grown in recent years as an increasing number of asset managers have launched dedicated commingled funds, founded business development companies, and raised separately managed accounts to meet investor demand.
This report discusses directly originated loans that are made to corporate borrowers. These loans are primarily cash flow based, but may occasionally have an asset coverage component to them. These direct loans are often held by one or a handful of lenders as opposed to the broadly syndicated loan market, where there are typically dozens of holders of a single issuance.
Navigating this asset class can be daunting simply because of the sheer number of private debt managers marketing products and the lack of transparent data around the asset class. Guggenheim Investments has over 20 years of experience as an originator of and investor in private debt and is well-positioned to help investors pursue their investment objectives in the private debt market.
Report Highlights
- We believe the current environment for private debt offers the opportunity for compelling risk-adjusted returns in addition to attractive pricing, leverage, and documentation.
- Private debt has the potential to provide higher current income and returns than comparable below investment-grade fixed-income alternatives by taking advantage of the illiquidity premium, or the potential for excess return for investing in assets that cannot easily be converted into cash.
- The two pillars of successful private debt investing are sourcing and underwriting, both at closing and ongoing through monitoring.
- Guggenheim Investments (Guggenheim) has invested over $25 billion in over 450 middle market loans, and over this time have sought to originate direct loans with improved economics, relative credit strength, improved structural protections1, and enhanced control vs. liquid credit alternatives.
- Our private debt platform has historically generated a broad funnel of lending opportunities that can lead to differentiated portfolios of private debt assets, which are managed by our large, integrated investment team.
1 Structural protections generally refer to mechanics negotiated into a loan document that can include but are not limited to covenants, security/collateral, obligor reporting requirements/lender information rights, etc. Protections neither assures a profit nor eliminates the risk of experiencing investment losses.
Introduction to Private Debt
The private debt asset class has experienced significant growth in recent years as an increasing number of asset managers have launched dedicated commingled funds, founded business development companies, and raised separately managed accounts. This growth has been fueled by investors that have recognized the potential for enhanced risk-adjusted return that private debt can bring to their portfolios relative to corporate bonds.
Private debt can include direct lending, real estate, infrastructure, mezzanine, venture, distressed, and asset-based lending. The focus of this report is on directly originated loans that are made to corporate borrowers. These loans are primarily cash flow based, but may occasionally have an asset coverage component. These direct loans are often held by one or a handful of lenders as opposed to the syndicated loan market, where there are typically dozens of holders of a single issuance.
Direct lending has been present in some form for decades. Commercial banks and other local lenders used to dominate the market for loans to businesses that were too small to warrant financing from large institutional markets. As companies grew and their need for financing increased, banks provided additional debt capital, often by syndicating the debt to large institutional clients. And as banks’ business models evolved, generating fees through the syndication of debt became much more lucrative than holding loans on their balance sheets.
The increased capital formation that private debt has experienced has left some to worry about the market being overheated. In reality, private equity capital formation has far surpassed that of private debt, and private equity remains the most significant driver in private credit deal activity. In addition, the increase of capital flowing to private debt managers has increased the opportunity set that private debt lenders can address, as transactions that were once too large can now become achievable. Furthermore, while there have been new entrants on the smaller end of the market, the upper end of the market has not added many (if any) new players, despite experiencing considerable growth in assets under management.
Fund vehicles like BDCs and SBICs have leverage levels capped based on regulatory restrictions. For BDCs, that amount is 2:1, while for SBICs it is also 2:1, but with no restrictions on the underlying composition of the assets (e.g. lien, security, covenants, etc.). During the Global Financial Crisis (GFC), a number of BDCs and SBICs ran into trouble due to the high amount of leverage they were utilizing because of markdowns on the asset values in their portfolios (despite BDC leverage being capped at 1:1 during this time). Some were forced to shut down while others sold their assets at a discount to managers who had been more prudent in their underwriting and use of leverage.
Leverage is a useful tool, but we do not believe that leverage should drive portfolio construction. Instead, it should act simply as an enabler of the portfolio to meet the investment objectives of the investor. We believe leverage should be employed conservatively and only in instances when it can provide investors with greater flexibility and optionality. For example, the use of leverage may allow a fund to broaden its investable universe by investing in less risky but lower yielding assets while meeting its target return.
The Keys to Successful Investing in Private Debt
We believe two key pillars of successful private debt investing are sourcing and underwriting (both at closing and ongoing through monitoring). These two activities can vary in importance over the course of the credit cycle. As finding private debt investments gets more difficult and sourcing increases in prominence, underwriting standards can weaken with competition and with the expectation that a benign credit environment will continue. However, as the credit cycle turns and pressure mounts on weaker borrowers, underwriting will show itself to be the determining factor in driving returns in the asset class.
Sourcing private debt investments is typically broken out into two categories: sponsored and non-sponsored. Sponsored transactions are done in partnership with a private equity firm, financing a leveraged buyout, growth equity investment, or dividend recapitalization. Non-sponsored transactions can vary in size and sophistication from a family business with no audits and a few million dollars in revenue to a public company with a several hundred million dollar market capitalization. The common theme in these transactions is that the borrower is typically not a sophisticated financial investor. Non-sponsored transactions can often be more complex due to lack of transparent financials, and can take longer to execute on as borrowers may not have a pressing need for capital. The rewards can be significant, however, as non-sponsored transactions typically come with higher pricing, better structural protections1, and greater incumbency value.
The underwriting process will vary depending on whether a transaction is sponsored or non-sponsored and by the type of investor. But most private debt managers have a similar process where teams are staffed with deal leads who run diligence and negotiate documentation and are supported by junior analysts who focus on due diligence efforts. Potential deals are presented to an investment committee comprising senior team members and a decision is made on whether to invest.
The Guggenheim Difference
For more than 20 years, Guggenheim has invested over $25 billion in over 450 middle market loans, and over this time have sought to originate direct loans with improved economics, relative credit strength, improved structural protections1, and enhanced control vs. liquid credit alternatives. Since we began investing in private debt, Guggenheim has had a consistent market presence with a selective approach, and our sourcing capabilities, underwriting expertise, and size allow us to be disciplined and patient but also drive outcomes through responsiveness and negotiation. The significant size of our capital base and our large team of 55 analysts covering the United States and Europe enable us to be important partners for potential borrowers, while the pace of fundraising and the size of our client base allow us the ability to be more selective in our investments relative to other market participants.
As with all our investments, we manage private debt sourcing and investment according to our investment process, which incorporates an integrated team approach to investing across the capital structure, with rigorous bottom-up credit research, deep industry expertise, and strong valuation conviction. Any investment or loan is subject to extensive due diligence, which includes a thorough exploration of any contracts or covenants by our specialized legal team of five internal lawyers.
Investment or loan decisions are not executed without unanimous approval by our Investment Committee, and positions and portfolios are monitored daily to assess whether any of the factors that led to the allocation of capital have changed.
Our private debt platform has historically generated a broad funnel of lending opportunities that can lead to differentiated portfolios of upper middle market private debt assets, which are managed by our large, integrated investment team along with more than 10 dedicated origination professionals. Our significant investment in resources allows us to be active in both sponsored and non-sponsored transactions. Overall, over 100 professionals are involved in the direct lending process, and we currently have over 75 private debt issuers and over 500 syndicated loan issuers on our platform.
We have dedicated sourcing and underwriting teams in both the United States and Europe, with investment decisions approved by a central Investment Committee. With $9 billion of direct lending assets across the Guggenheim platform, we are an important partner for private equity firms, deal brokers, and investment banks across these geographies, and are well-positioned to help private debt investors pursue their objectives.
Important Notices and Disclosures
Guggenheim Investments (“Guggenheim”) represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC (“GPIM”), Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC (“GCF”), Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.
This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.
Any opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Investing involves risk, including the possible loss of principal. In general, the value of a fixed-income security falls when interest rates rise and rises when interest rates fall. The private debt assets and strategies discussed herein are not suitable for all investors. An investment in private debt assets is speculative and involves a high degree of risk. No investor in a private debt strategy should have any need for any monies invested in the strategy to meet current needs or ongoing financial requirements and an investment in the strategy should only be made after consultation with independent qualified sources of investment and tax advice. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate. Exposure to high yield assets can subject an investment to greater volatility. Some assets may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices very volatile and they are subject to liquidity risk. There often in no secondary market for an investor’s interest in private debt assets and one is not expected to develop. A conflict of interest will often arise when Guggenheim or any of its affiliates participate in loan arrangements for which it is providing investment management services, investment banking services or other transaction related services and in which the strategy also invests.
Index Definitions
Indexes are unmanaged. Index data does not reflect the deduction of fees or expenses which would reduce returns. Investors cannot invest directly in an index.
The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, USD-denominated, fixed-rate taxable bond market. The index includes Treasurys, government-related and corporate securities, MBS (Agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (Agency and non-Agency).
The Bloomberg U.S. Aggregate ABS Index tracks the ABS component of the Bloomberg US Aggregate Bond Index.
The Bloomberg U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market.
The Bloomberg U.S. High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.
The Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fee performance of U.S. middle market corporate loans, as represented by the asset-weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.
The Morningstar LSTA U.S. Leveraged Loan Index is designed to measure the performance of the U.S. leveraged loan market based upon market weightings, spreads, and interest payments.
The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.
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Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
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Investing involves risk, including the possible loss of principal.
*Assets under management is as of 9.30.2024 and includes leverage of $14.8bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Guggenheim Wealth Solutions, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors.
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