Does a lack of data transparency pose a concentration risk?
The issue of data transparency is frequently debated in the private credit sector, with some stakeholders arguing that the industry is not disclosing enough, while others argue that the data available is actually better than that offered in the public markets.
Whether transparency is sufficient to prevent concentration risk is also a matter of debate.
Some industry professionals have told Alternative Credit Investor that investors could be funding the same loans across several different private credit funds, meaning that they have less diversification in their portfolio than they think.
Read more: Private credit experts slam claims that sector does not offer higher returns
And Mikhaelle Schiappacasse, partner at law firm Dechert, affirms that this lack of transparency could be an issue.
“I don’t think there’s enough transparency on the portfolios in order for an investor in multiple funds to have certainty that they are not cross investing in the same asset through more than one fund,” she said.
However, Joe Abrams, partner and head of private debt (Europe) at Mercer, argues that the private credit sector may in fact provide better transparency than the public markets.
Mercer’s private debt team researches opportunities in the sector and builds portfolios for investors.
Abrams said that the team got “great information” from private credit managers at the start of the pandemic in March 2020, receiving ‘red, amber, green’ status sheets regarding the liquidity situation for each portfolio company.
Read more: Emerging ‘bifurcation’ of quality in middle market private credit
“In times of stress, there is a case to say that private credit managers can have a greater degree of transparency about the companies they invest in, compared to managers who invest in high-yield bonds,” he said.
“When looking at the pricing and spreads on high-yield bonds, does that reflect the market’s liquidity or technical analysis?
“Whereas with private credit, the manager receives monthly information about the companies.”
Abrams said that Mercer tries to avoid overlap and concentration risk when building portfolios.
“In credit, concentration risk is what will kill you,” he added. “When we’re building portfolios for our investors we’re not just looking at direct lending, we’re also looking at structured finance, specialty finance, asset-based lending and opportunistic credit.
“Even within direct lending, it could be around 40 to 50 per cent of the portfolio that we try to diversify across geographies and managers. For example, we may have one manager who focuses on the lower mid-market and one who focuses on the upper mid-market, so there’s less risk of overlap.”
Europe vs the US
Dechert’s Schiappacasse argues that there is more of an overlap risk in Europe.
“In Europe, which is a smaller market than the US, there’s more of a risk that large institutional investors could have exposure to the same assets through certain portfolios,” she said.
She also noted that large institutions often ask for more transparency with respect to the underlying portfolio composition, meaning that this is more of a risk for smaller or less sophisticated investors.
“It depends on how broadly they do their credit holdings,” she added. “Some investors might opt to allocate funds to just one or two private credit managers with different strategies, which should enable diversification.”
Read more: Private credit fund managers prepare for stricter EU rules
Conversely to Schiappacasse, Mercer said that the European market tends to be “less club-y than the US” and he sees more of an overlap risk in the latter.
“In the US, the market is much more established with more managers and there can be some overlap,” he added.
“Over the last couple of years, as the syndicated market wasn’t functioning and private credit stepped in, you had a lot of managers entering the upper mid-market space and you did get overlap in transactions. You can also see evidence of overlap among some business development companies.
“If you’re comparing two large upper mid-market managers in the US, there could be up to 10 to 15 per cent overlap, but it would perhaps be five per cent among smaller managers focusing on the mid-market.”
