In the dynamic landscape of private credit investment, investors have a variety of choices when allocating capital. There are many managers to choose from, who focus on different segments of the market, different types of borrowers and different parts of the capital structure. Each manager brings their own expertise and unique perspective on their target market. While investors have a range of factors to consider, one question seems to frequently arise: Does size matter?
For investors, there is the allure of larger, well-known global firms which can be enticing and on “face value”, the lowest risk decision. However, there is a counter-intuitive alternative to consider: the mid-market specialists.
In this article, we will explore why the size of a fund may not be the most relevant determinant of risk-adjusted returns, particularly in the context of investing in Australasian Private Credit. Specifically, we will delve into the advantages of partnering with mid-market specialists like Global Credit Investments (GCI) and why we believe we deliver superior risk-adjusted returns and a unique investment proposition.
Understanding GCI’s Approach
Before we delve into the discussion on the significance of fund size, it’s essential to understand GCI and why, despite our founders’ prior experience working in larger investment firms, they opted to focus on the mid-market for their own capital allocation when they started GCI in 2015.
At GCI, the mid-market encompasses transactions ranging from $5-50 million, within three core strategies:
- Asset Backed Finance: Loans backed by physical and financial assets.
- Real Estate: Property finance strategy backed by “hard” real estate assets.
- Strategic Capital: Asymmetric credit facilities with contractual debt returns and embedded upside mechanisms, backed by liquid or semi-liquid assets.
So, why the mid-market? We believe this sector of the lending market is often underserved as it is deemed too challenging by banks or large institutions.
Companies in this sector are often changing significantly and the credit they require by its nature cannot be “cookie cutter’’. They cannot be underwritten with a simple box ticking exercise which makes it very difficult for banks to lend to as there is often not enough company or director real estate that is offered as collateral. The loans require a deep understanding of the businesses, the changes that are coming and potentially looking beyond any negative history.
The Perception of ‘Scale is Better’ in Larger Firms
It’s important to acknowledge that larger firms bring their own strengths to the table. They can leverage their scale to effectively address issues in portfolio companies thanks to substantial resources and global reach, this can be advantageous in specific scenarios.
Nonetheless, their size and return expectations can potentially constrain their investment options. They are essentially confined to a particular category due to their scale and return targets. These large funds are primarily focused on the large leverage buyout (LBO) or high-yield markets.
For instance, if you’re managing a $10 billion credit fund, your smallest deal might still be around $200 million, which is about 2% of the fund. In Australasia, such deals are scarce. Even on a global scale, the larger funds are compelled to operate in the ultra-competitive, ultra banked and highly regulated LBO market to meet their deployment and return objectives.
It’s also important to note that decision-making processes in large firms can be slow, especially in distressed situations. The credit committee in distress is a sluggish, non-aligned decision-making structure, leading to elongated decisions and worse outcomes for recovery. In contrast, mid-market companies often align closely with their single lenders like GCI, leading to more rapid responses in all circumstances -good or bad.
Differentiators Between GCI and Large Funds
In contrast to the larger funds, mid-market specialists like GCI, offer a different investment experience. We have outlined a few key considerations investors should consider when contemplating their mid-market focused Australasian Private Credit investments:
- No Leverage: GCI operates without leverage, delivering returns that are not amplified and accordingly a lower level of risk. As larger institutions are not allocating capital to smaller deals, the reduced level of competition leads to more attractive pricing for mid-market specialists and hence leverage is not required to meet investor return hurdles.
- Flexibility and Expertise: Mid-market deals are characterised by complexity and hence reduced competition. These investments necessitate a deep dive during due diligence. They demand a highly flexible, nimble and pragmatic approach throughout the loan’s lifecycle. This level of monitoring and focus is only possible without the bureaucracy of a larger organisation, further aided by the fact that there is typically not a syndicate of lenders.
- Bilateral Deals: By concentrating on smaller deals and collaborating directly with companies, mid-market specialists can uncover hidden gems that larger firms might overlook due to their scale. GCI engages in bilateral deals, cultivating close relationships with every company it lends to. This direct approach ensures a more personalised experience for borrowers, streamlined decision-making processes, and a lower risk profile for investors, as we remain closely connected to the operations of our portfolio companies.
- Market Sensitivity: Unlike larger funds that often prioritise larger, leveraged transactions, GCI’s mid-market focus typically offers stability in unpredictable environments. Smaller transactions are less sensitive to broader market fluctuations, reducing overall portfolio risk.
- Asset Backing: GCI emphasises asset-backed lending across all of our strategies. While cash flow is essential, our facilities rely on debt coverage by liquid or semi-liquid assets that can be quickly monetised if needed. This approach minimises exposure to market turbulence or company specific issues. Borrowers from larger funds in larger transactions almost never have sufficient hard assets to cover the size of the loan.
Conclusion: Finding the Right Fit
As discussed above, investors often lean towards bigger private credit firms. These firms are seen as having an edge due to their size, creating the impression of lower risk, both in terms of investment performance and manager reliability. However, there is a caveat. These larger funds have raised an estimated $600 billion that they still need to put to work. This intense competition and the pressure to invest quickly can end up hurting returns for investors while increasing risk.
Ultimately, the decision of where to invest should align with the specific goals and risk tolerance of each investor. By diversifying across size, asset classes, geography, and investment strategies, investors can construct a resilient portfolio that stands strong in varying market conditions. Size might matter, but it is only one piece of the puzzle and strategy remains key. In the world of Australasian Private Credit, we would argue it’s even more important to invest with the funds correctly sized for the market.
Authored by Steven Sher (Managing Director & Co-Founder) and Adam Schwartz (Head of Investor Relations)