Canadian Investment Review

Going Private

Written by Nushi Kazemian on Thursday, April 23rd, 2015 at 7:09 am

story_images_bridgestructureIn today’s low interest rate environment, plan sponsors are looking at alternative fixed income exposures to add yield to their portfolios without undue increases in credit risk.

Private fixed income (PFI) involves any fixed income transaction not subject to a prospectus in the public markets. A broad category, PFI investments can include project financing (e.g., power generation), infrastructure financing (e.g., roads, hospitals), mid-market or large corporate lending, and other financing structures such as credit tenant lease financing, and private securitization finance (where a well-diversified pool of individual consumer leases are secured by pools of assets and additional credit enhancements in the form of cash reserves).

Borrowers pay more for the flexibility from PFI for four key reasons:

• Borrowers can’t always access the unique set of specialized expertise required for customization in public markets, which offer common templates of financing to suit a wide array of investors.

• In addition, there are few lenders in a private debt transaction. This provides borrowers with the ability to reach out to the lender(s) directly and discuss issues during the term of the loan and to accommodate needs in real time.

• There is no public disclosure. Private debt eliminates the need for public reporting such as prospectus and regulatory filings. This attracts companies whose financial information is proprietary and strategic.

• PFI also broadens the sources of capital for larger companies with ongoing needs for large volumes of debt financing.

Historically, private debt offers lower losses and higher recoveries than a comparable portfolio of public debt. And it offers investors access to a unique set of investment opportunities not generally available in public markets. PFI allows investors to diversify their portfolios into different sectors and with different borrowers than that available in a solely public bond portfolio.

Plan sponsors must, however, understand the importance of credit underwriting, risk analysis, legal and operational expertise as well as knowledge of different sectors and geographies. PFI transactions are illiquid so investors need to consider the risks over the life of the investment. Doing this involves ensuring strong downside protection mechanisms are in place through covenants, terms and structure. At the same time, in the PFI space investors also have the opportunity to negotiate more rigorous covenants, terms and reporting requirements than offered in public financing.

Nushi Kazemian is Managing Director and Portfolio Manager, Private Fixed Income, Sun Life Investment Management

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