Welcome to the My Private Network Podcast!
Interested in learning about private market investing concepts and opportunities available to you?
This week's episode features our co-founder and host, Bob Simpson, who gives you, the investor, a chance to hear from industry experts about why you should consider investing in private debt.
Our expert panelists with "boots on the ground" experience in the private markets:
Paul Tyers, FCPA, FCA, CFP, CIM
Managing Director, High Net Worth Advisor
Wealth Stewards Inc & Canadian Life Settlements
Sean Rogister
Chief Executive Officer
Cortland Credit Group Inc.
Vikram Rajagopalan
Senior Managing Director, Capital Strategy and Distribution
Trez Capital
Rob Anton
President & Partner
Next Edge Capital
Michael Scott
Managing Director
SAF Group
Today's Questions of Interest
2:27 What is private debt?
4:19 Why is private debt important to Canada’s economy?
6:07 What are some benefits of private debt investing to Canadian investors?
8:25 Why have pension funds been increasing allocations to private debt?
9:36 Why have individual investors been so slow in accepting private debt investments in their portfolios?
10:45 Why are Canadian borrowers turning to private lenders instead of traditional borrowers like banks?
13:48 Compare investing in private debt to investing in GIC’s or bond funds?
15:48 How should an investor deal with liquidity?
18:17 What kind of price or return volatility should an investor expect in a private debt investment?
20:06 What are the major risks of private debt investing?
23:00 How should an investor use private debt in a portfolio?
Transcript
Bob Simpson: I'm Bob Simpson, your host and co founder of privatedebtandequity.ca. A website to educate investors about concepts and opportunities in exciting new asset classes. Today, we shift the focus to our first in a series of podcasts to answer the question, why? Why allocate funds to private debt? Starting with the question, what exactly is private debt?
To do so, I am going to, for the very first time, open doors to people who I know, like, and trust. People in my private network. People who were pioneers in laying the foundation for this new asset class in Canada. People who quit jobs because they saw an opportunity and swapped a fancy office for a basement or garage desk; or people who took the risk to take a job in one of these startups.
Now, don't get me wrong. This wasn't yesterday. One of our guests just celebrated his firm's 10th. Year anniversary, and now has a team of 33 people, another who has dedicated a big part of his life to fighting bureaucratic corporations to help Canadians have similar rights to people south of the border.
Another who is my go to guy for information about what's happening with people and companies in private markets. Another brings disruptive thinking to spot opportunities for investors. And another is a 25 year veteran who's been teaching due diligence on hedge funds. Now, what else is cool is that all of these people also have names.
Joining me today are Sean Rogister, Paul Tyers, Vikram Rajagopalan, Michael Scott, and Rob Anton. Today is a rapid fire question, short answer format, mostly to give you the opportunity to put a voice or a face to a name. Now you'll get a chance to see all of these guests on future episodes for longer and more in depth interviews.
The doors to My Private Network are opening. Let's see what we can learn today. So I'm going to start with my first guest. My first guest today is Vikram. Private debt is a really new concept for most people. Can you just spend a few minutes with us and talk about what exactly is private debt?
Vikram Rajagopalan: Private debt in its most simplistic definition is financing that occurs in our markets through the non bank public markets.
It is a market that is quite large, which a lot of, I don't think investors understand. It exists both in real estate and in company to company lending. I know a lot of my colleagues here will talk more about that. But to give, um, investors an understanding of the private debt market here in real estate, it's really financing that anyone who is a real estate developer or someone in the real estate development game that, that cannot go into the banks to get conventional financing, accesses it through the private markets, and that is the definition of private debt.
And the sources of that private debt are really investors like the people on this call, you know, major institutional funds. Anything again that is not really driven by deposits in the bank. And the reason why that private debt market really exists, and I'm sure we'll talk about it some more, is because ultimately that market is always looking for a little bit of a higher return than what you would do at the bank. So therefore are able to take on a little bit more nuance, a little bit more risk with some of those deals. As long as those are mitigated through quote unquote, the managers of those deals. Some of who are on this, on this podcast as well.
So simplistically private debt is financing through the non bank channels and in what you would call the quote unquote, private markets.
Bob Simpson: Now, turning my attention to Rob, and this is an important question, I think, for our viewers, private debt plays a major role in financing companies in Canada. Can you just explain to us why is private debt so important in today's Canadian economy?
Rob Anton: Yeah, good question. You know, private lending, which is really just lending that occurs outside the traditional bank network, is definitely a critical part of financing the economy. Banks are significant lenders, obviously. However, they tend to be very cookie cutter in nature, whereby their models do not really fit in providing debt capital to many of the new as well as existing businesses, you know, in our country.
And as I speak to many entrepreneurs, uh, as part of my day to day life or people that have run businesses in the past, you know, in this country over the last number of decades. It's very common for them to state how banks were not that adaptable in providing them with the lending capital required for their businesses and that many of them had to actually go outside the bank network, such as to private lenders in order to get the capital to support their growth and their business plans.
So, having a thriving non bank lending industry in Canada is really a key piece to the future growth and innovation of our country. Just recently, I saw a report that came out from the Alternative Credit Council who published an annual report called Financing the Economy. And, you know, it mentioned that, uh, just to show you how big the size of this, uh, non bank lending market is, it, uh, estimated the size of, uh, private credit.
Lending managers globally, it was estimated at 320 billion U. S. And it just shows you how much lending was a vital source for finance and liquidity in both small and mid sized and even to some degree larger companies globally, as well as in Canada.
Bob Simpson: Paul, everything has benefits. You know, we're, we're now looking at private debt investing.
Just tell me, What are some benefits of private investing for Canadian investors today?
Paul Tyers: Bob, I'm going to answer your question with three points. Number one, diversification. Number two, certainty of income. And number three, taxation. I don't believe traditional portfolios of 60 percent equities, 40 percent traditional fixed income works any longer for many private investors.
Let's face it, bonds did extremely well as long as interest rates are coming down over the decades of declining inflation and declining interest rates. But when they hit all time lows during COVID, there was no further down movement possible. The flip side of that is when they started to go up, traditional fixed income goes the other direction and doesn't do very well.
And I think many people were deeply surprised and disappointed when they looked at their traditional fixed income returns. On the other hand, equity markets did great, about six and a half percent over the last 20 25 years, but they encountered four periods where they declined over 10 percent, and two of those periods declined actually over 40 percent.
Serious volatility. Private debt allows people to avoid that level of volatility. And when you look at many private debt options, there's certainty in a certain approach that's being taken by a company. And I believe that retirees want certainty. They need regular income, especially if they're relying on their Portfolio for a good portion.
So my second point really want to reinforce is certainty of income. And the third point is all affluent Canadian investors should be concerned about taxation. The beauty of some of the private debt offerings is they've been structured in a manner to avoid high taxation, which is the norm. When it comes to the traditional fixed income market.
Bob Simpson: Sean, there's a lot of talk and marketing material about how and why Canada's major pension plans like Canada pension plan have shifted large portions of their portfolio away from investing entirely in public investments and it made the shift to private.
Now you've been on the pension fund side for much of your life. Why do you think pension funds have been increasing allocations to private debt?
Sean Rogister: You know, when I was looking at this from the point of view of a pension plan, it's interesting in my entire team, every one of the portfolio managers always has to look for value and they're really looking for how to diversify in areas that have good risk adjusted returns.
And what we found when I was sitting in that pension plan was in the fixed income markets globally, especially in North America, short term senior secured private debt had the best risk adjusted returns available in the capital markets. And it's interesting because most of them are floating and that's a great diversifier from traditional fixed income, which is fixed coupon.
And so in the last year when fixed income traditional strategies had terrible performance, the floating rates really improved because their returns are tied to that rising floating rate, and it really helped them outperform. Pension funds are very good at doing debt analysis and the diversification works for them because they can do a deep dive into the strategies they're looking at.
Bob Simpson: Pension funds have been making this shift all along. Why have individual investors been so slow in accepting private debt investments in their portfolios.
Sean Rogister: Well, the problem with private debt is a little more complicated. There's no third party or armed link group that is opining on the quality of the debt that a rating agency will do on public bonds.
So private debt investors have to do some of their own due diligence and they look to their advisors to do that work with them. So you need to have a good advisor that's familiar with private debt. And as I said there are [00:10:00] levels of due diligence that the institutional managers will dive into because they have expertise on legals, on back office, on risk analytics. And really you're looking for making sure you understand the principal protection that is available in the private debt and that is an area you can look to your advisors to dive into.
It's good to have a manager that has a lot of institutional investors allocating to them, because that'll give you some comfort that other people have done that due diligence.
Bob Simpson: Michael, why are Canadian borrowers turning to private lenders? So we've looked at why investors have been slow. I think we've seen much more action where borrowers have been turning to private lenders like your firm, instead of using only the more traditional borrowers, like the banks.
Michael Scott: It's an excellent question, Bob, is I think investors often mistakenly assume that borrowers look to private debt solutions only in higher leverage or higher risk situations, which is not the case. To be fair, historically speaking, there have been more borrowers that would have fallen into this category.
Although within the Canadian landscape particularly, more and more prime borrowers today are trained private lenders simply for access to capital to support growth and expansion of their businesses. As background, it's important to recognize that for most Canadian mid market borrowers, the Canadian banks are generally their only option for debt financing, given the historical lack of alternative financing sources within the Canadian market.
Unfortunately, this dependency on the Canadian banks hasn't created much competitive tension within the banking system, which on its own has served to restrict access to capital from Canadian borrowers. But I would argue the key factor in an increasing shift by borrowers towards private debt solutions can be attributed to a structural shift within the regulatory environment in Canada.
While this is an entire topic in itself, the punchline being that Canadian banks are just starting to feel the impact of increasing capital requirements, which is making capital more scarce and more expensive for them. When you consider that banks have to allocate capital against each and every loan they make, in a capital constrained world, the Canadian banks have become incredibly focused on their deepest and most profitable for relationships.
This is creating a gap within the market for prime or what we like to call, "bank like borrowers", who are seeking debt financing from private lenders. Given they may not be able to provide the same profit or return potential to be attracted to the banks in today's environment.
In addition to this regulatory aspect, there are a couple of other factors motivating borrowers to pursue private debt solutions. One being private lenders can often provide more of a spoke credit solution, whereas Canadian bank solutions tend to be very standardized or off the shelf, so to speak. This is simply because a private lender has the ability to invest more time with the borrower, to understand the unique needs of their business and provide a debt structure that is more customized to their specific requirements or circumstances.
And lastly, speed of execution also plays a role here. While our due diligence process is very comprehensive, we do not have the administrative burden of a bank. So credit decisions can be made very efficiently, which can permit borrowers to pursue acquisitions or other growth opportunities that may be more time sensitive.
So while not only an exhaustive list of all the advantages, the summary here is we are seeing increased demand from Canadian borrowers for private debt solutions as the banks navigate a more capital constrained world. Without a doubt, private debt funds are becoming an increasingly important source of funding for Canadian businesses.
Bob Simpson: Sean, private debt is considered to be a fixed income alternative investment. Compare investing in private debt to investing in GICs or bond funds.
Sean Rogister: It's a perfect question to understand the key components of fixed income. What is the return characteristics? What is the liquidity characteristics? And what is the principal protection that you're going to get with that?
From the point of view of private debt, It probably offers the best return among the three, but its liquidity is not as good as public bonds, a little bit better than GICs, but its principal protection is very good, but not as good as GICs. GICs are guaranteed by the government of Ontario. Private debt, if it's an asset based lending strategy, which I'm the most familiar with, then we look to the collateral and we do all our due diligence on that.
If you look at GICs, they're usually one year or longer instruments. You don't have any liquidity in the meantime on that. But as long as you're comfortable that you can leave the cash with them, it's going to be backed by that government guarantee. Public bonds, they're tremendous liquidity. It's daily valuations and t plus three or three day liquidity. But their returns have been volatile.
They move up and down the opposite direction of interest rates, but they are definitely more exposed to rising rates. And if you think interest rates are going to fall they may be a good allocation, but their returns otherwise will not be as good as private debt and they are unsecured. They may be rated well, but they don't give specific claims on collateral that private debt does.
So they're not as well secured. It's really your assessment of how much tolerance you have for the risks under principal protection, uh, how much return you need and how much liquidity you need. And that's a great question because it covers those trade offs.
Bob Simpson: Back to Michael. How should an investor deal with liquidity issues related to private investments?
Private debt investments are much less liquid than traditional fixed income. How should the individual investor deal with that drop in liquidity?
Michael Scott: Sure. I think what you're pointing out is that the underlying investments within a private debt portfolio often do not trade within the public markets, like traditional fixed income instruments, such as bonds.
The reality is it's important for investors to understand that unlike a potential trade opportunity to save public bonds, private debt investments are structured to generate consistent, risk adjusted returns across economic cycles. So investors should be thinking longer term when allocating to private debt strategies.
There just isn't the concept of timing the market. when investing in private debt. That being said, private debt funds do provide liquidity to investors as there are several sources of liquidity within a fund. The first source is principal and interest payments. Borrowers pay cash interest on underlying loans and also typically make monthly or quarterly principal repayments.
No different than a homeowner would make regular principal interest payments under their mortgage, for example. These payments generate cash flow within a fund and are available to provide liquidity to investors. Secondly, there are periodic loan prepayments as the underlying businesses are sold or the loans are refinanced.
Well, the capital from these types of prepayments in the normal course would generally be redeployed into new loans. These prepayments do create liquidity opportunities within any loan program. And then lastly, loans within a private debt fund typically are shorter duration loans. Call it two to three years.
As you ladder the maturity date of these loans within a portfolio, there becomes a natural cadence of maturities and refinancings. Again, creating liquidity opportunities within a fund. So, while the underlying investments themselves are not as liquid as, say, a publicly traded equity investment, there are a number of levers available to a private debt manager to create liquidity.
It's also worth noting that there are investment funds out there which are structured to include a liquidity sleeve. Uh, which can provide an additional liquidity enhancement for investors.
Bob Simpson: And, you know, Vikram, everybody's always interested in price, their interest in return. And in a lot of cases, the way financial markets have been, especially the S&P since over, you know, the last three or four years, markets have been very volatile. If we look at investing in private debt investments, what kind of price volatility should an investor expect when they are investing in this kind of investment?
Vikram Rajagopalan: It's an interesting question because a singular private debt investment, anything can happen.
I mean, if you were to make one loan to a company or real estate deal, that loan can go bad and therefore the volatility of your return can be quite high. I mean, in terms of one loan, you're lending to someone at a prescribed rate, let's say that's 10 percent and that person can't pay that loan, then obviously your 10 is now zero when it comes to a rate of return, your principal is quite protected.
But really, if you are in any investment, again, most of us are here at firms that really prescribed to a diversified base of private debt investments and a fund structure, your price and volatility should be very minimal because ultimately, if you're managing, uh, 50 to a hundred loans in a diversified portfolio, then what that does, it mitigates any risk of one of those loans going bad.
You obviously can manage through that. But you shouldn't really be in a private debt diversified investment. You shouldn't really be expecting much in terms of price volatility. Definitely, you should not be expecting much in terms of return volatility, because ultimately if you're managing that you shouldn't have too much on the downside.
On the other side of the spectrum, though, on private debt investments, there's not much in terms of upside above what is the prescribed rate. So if you're in a private debt investment where the prescribed manager lends in the seven or 8 percent range, there's not a lot of chance that that becomes 13 percent for no reason.
You're just always going to be investing in that bandwidth. So really investors in private debt are here for consistency and the lack of price volatility.
Bob Simpson: Also, we always have to look at risk, right? What would you say are some of the major risks of investing in private debt?
Rob Anton: I think it's good to start or to mention that private lending should not be all painted with the same brush.
There's numerous styles, strategies, and areas of focus within private credit and with various degrees of risk reward. Some strategies can be very conservative in nature. And others might be a little bit more aggressive. So I think that matching style in a structure that suits your risk tolerance and time horizon is very key. Along with that, some considerations that I would bring up, although there's probably more than this when assessing the risk in private credit investing can be as follows. The seniority of the loan. Is the loan first, second, or third with regards to their claim on value of a company, you know, in the company's capital stack?
Um, obviously having a first lien in the company means you have more priority to the assets or any value in the company. Then as you go down that capital stack, you know, is that loan secured or is it unsecured? Is the loan backed by assets or is it backed by just the general financial health of the company?
Such as their cashflow. I think you need to be cognizant of liquidity factors. These private loans are not traded. So tend to be less liquid in nature, although it can range anywhere between very, very short term, meaning 30 to 60 to 90 days out to as long as five to seven years or longer. So understanding the liquidity and the fact that they're less liquid in nature and keeping that in mind when making an investment and matching your liquidity timeframe to the liquidity of both the fund and the underlying liquidity in the portfolio, I think is, uh, is quite, uh, important.
Understanding the fact that these private loans do not transact, they do not trade. So, you know, they don't price in an open market. And understanding the company's valuation policy, it's quite easy to, in general, to price a performing loan, although it's important to understand for loans that maybe are not performing, what's their philosophy and policy towards pricing those loans?
And lastly, although private lending in general has incredible risk reward attributes towards it, I would say that, it has great attributes toward it when done properly. In order to do this properly. You can't just put a sign up and be in the business and spec to do this. Well, you need to really find a team with vast experience in the space that they're operating in.
And that's just a key part of, uh, I think in order to generate proper returns and risk reward profile when investing in the space.
Bob Simpson: And final question for our panel today. I'm going to turn back to Paul. You know, it's nice to choose investments. And one of the things that I've always said is that, you know, in building an investment portfolio, what you're really doing is you're trying to find good quality assets for your portfolio.
Now thinking about private debt, how should an investor really use private debt in their investment portfolio?
Paul Tyers: Today's panelists oversee private debt portfolios for pension funds, corporations, and private investors. Our starting point is diligent research, primarily scrutinizing the track record of private debt managers.
Managing manager risk is key in the private debt market. Private debt has become our alternative to conventional bond strategies, with a strong emphasis on diversification to avoid over committing to an individual strategy. Bond portfolio management is straightforward, centered on credit quality and term. Selecting bonds from reliable issuers like the Ontario government and deciding on the term is the key in traditional bond management.
When selecting private debt, always assess the yield spread compared to traditional fixed income. For instance, if GICs offer 5%, an approve it private fund boasts a 5 year track record, [00:24:00] only as two negative months, but has a current yield of 9%, it becomes a compelling alternative to both equities and bonds.
Ultimately, your confidence is in our ability to manage the managers and to look at their track record and make sure their names that should be in your portfolio.
Bob Simpson: Now, I'd like to extend a big thank you to all our guests today. Sean Rogister, Paul Tyers, Vikram Rajagopalan, Michael Scott and Rob Anton for engaging in today's panel discussion.
Now, as an investor, hearing directly from people who make the investment decisions like those people on our panel today should always be part of your investment decision process. Now, I've spent a lifetime developing my private network, and it truly is my pleasure to open doors to you to hear from people like those on today's panel.
Now, please stay tuned for our next episode where we're going
to talk about allocating your assets
into private real estate. Also, don't forget to follow us on your favorite
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episodes. If you want to learn more, all of today's panelists have channels on
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link to us and we'll be there to answer your questions. I'm Bob Simpson
empowering you to become a knowledgeable investor, enabling you to make
informed, high quality investment choices and guiding you towards realizing
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Until next time, have a great day.
