What investors want: Interview with bfinance’s Kathryn Saklatvala

bfinance has a unique insight into the minds of investors, from pension funds and insurers, to endowments, sovereign wealth funds and wealth managers. Kathryn Saklatvala, bfinance’s head of investment content, tells Alternative Credit Investor what these investors are looking for right now.

Alternative Credit Investor (ACI): Can you tell me about bfinance’s work?

Kathryn Saklatvala (KS): We are an investment consultancy with a very global remit. We have clients in more than 40 countries, we have 10 global offices, but we are still very much a mid-sized firm and that’s reflected in our ethos. We help investors across various aspects of strategy and implementation, with highly customised support on everything from asset allocation and portfolio design to manager research and selection, monitoring, ESG, and impact advisory.

Our growth story was very much about being a disruptor, especially with our unconventional model for manager research and selection. We do still do lot of manager selection for clients, but it’s now a mature business with all of the various functions involved in supporting investors across strategy and implementation.

ACI: What are private credit investors currently looking for?

KS: Diversification in private credit portfolios is an important theme: many institutional investors entered private debt within the past decade and are looking to evolve portfolios to become more resilient and sophisticated, or take advantage of growing specialist sub-sectors that are becoming mature enough for dedicated allocations. That being said, the nature of the agenda around diversification has changed over time, and with a changing interest rate environment. For example, before 2022, we saw a period of greater focus on strategies such as royalties and trade finance. More recently we’re seeing interest in niche direct lending strategies in sectors with attractive supply/demand dynamics, such as healthcare.

The other thing that’s going on that’s interesting is how investors are trying to get better at dealing with capital recycling in this asset class. Unlike in private equity or infrastructure, you have to constantly deal with the challenge of what you do with the need for constant reinvestment. You need to keep applying mental energy to this challenge rather than just reupping into the next funds with the same managers. You need to keep being thoughtful on this. You’ve also got to manage the cashflows and the liquidity aspect, and work out the extent to which you want to deal with managing that liquidity aspect yourself – using relevant asset classes – or use asset manager partners who can handle that with multiple investment strategies.

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The question becomes more challenging as you reach your target allocation. A lot of investors have gone through a phase of being under-allocated and ramping up exposures towards a target level, but once you reach that allocation the challenge becomes greater. This is an issue of how you evolve and develop a robust sustainable portfolio over time and manage the cashflows around it. And a lot of our clients are grappling with that question.

ACI: And how are they solving that problem?

KS: You can use fixed income, for example, whether that’s absolute return bonds or multi-asset credit or something else. Or you might be using something like leveraged loans, where the risk/return profile may be a little closer to private credit. There are a lot of different ways to approach this. Some asset managers will provide us a structure whereby they’re moving assets back and forth between a leveraged loan portfolio and a private credit portfolio, for example. So there are different ways of handling this problem.

ACI: With your investors, do you find that private credit sits in the fixed income portion of their portfolio, or in the alternatives part?

KS: It’s very often a question of legacy structure and silos, and it’s institutionally-specific. Often when you’re introducing new strategies, you’re introducing them in the way that makes sense at the time for the stakeholders or for the team as it exists at the time.

That then can create challenges down the line as you look to evolve. If you have private credit sitting by itself, what risk/return expectations have been attached to it, how have you modelled that? If you have it sitting in an ‘alternatives’ portfolio or a ‘private markets’ portfolio or a ‘yield’ portfolio or a ‘growth’ portfolio, it’s having to sit alongside asset classes that have a particular profile and it’s having to justify its role alongside them, and then there’s the question of what benchmark or target you’re using for the portfolio: how much risk can be tolerated in that context, and how is success being measured? What happens when it doesn’t quite work, either because the market itself has changed or because you want to introduce new strategies and exposures that may be very attractive but don’t fit the existing set-up?

Read more: Private credit spreads expected to tighten

Ultimately, most investments in your portfolio are essentially a type of equity or a type of debt or a mix of both. You’re trying to get exposure to some aspect of the real economy, whether that’s in liquid or illiquid markets. But there’s a reason that you need structures and silos laid on top of that, however artificial they may be in some ways for governance and for modelling. Intuitively, there is a way in which private credit sits alongside fixed income in terms of the yield-generative profile and some of the risk characteristics. That being said, your real assets should also be delivering yield. So where do they sit relative to each other? It’s an ongoing question that investors grapple with from time to time in their own institutions and where change is often necessary.

ACI: How important are high yields to private credit investors? 

KS: Definitely, yields on private credit have been very attractive and that’s very important to investors. The way that direct lending has maintained an attractive spread above bonds, even as interest rates rose, it has shown resilience from that perspective. There has recently been some compression depending on the market segment, but overall this asset class has really shown resilience.

That being said, you have to think carefully about the risk profile – how much risk you’re taking for that yield. Default rates are a very inadequate measure of risk. Even though default numbers have not risen much, there are other signs of elevated stress and various things will happen that do affect returns before you reach the default stage. There’s also a change in the profile of returns, such as greater use of payment-in-kind that ultimately defers returns, to a later stage and also makes them more dependent on a corporate event such as a refinancing or some form of exit.

ACI: What are your expectations for private credit in 2025?

KS: Investors are certainly asking a lot about ongoing interest rate declines and how that may affect the asset class. We also can’t ignore the decline in private equity fundraising, which has declined in a way that private credit fundraising has not, and the effect this may have going forward on the private credit market from a demand perspective.

Read more: Alternative credit interval funds returned 10pc in 2024

I think that there has been a dynamic where there was already quite a bit of private equity dry powder still to be deployed: even when fundraising slowed, you didn’t necessarily see the impact of that for private credit investors seeking deals. Private equity transactions are the lifeblood of the sponsored private credit market. You want private credit managers who really do have very strong sourcing capabilities and have a real edge there. That’s always an important part of due diligence; it’s always an important part of the analysis of a manager. You also want to be very focused on workout capabilities and restructuring, which is not just about resources it’s about having a deep understanding of the sector and the prospective exits for the companies you’re lending to.

ACI: What changes are you seeing in the US and European markets?

KS: There has been a theme in the last few years with non-US investors – European, Asian, and Australian – looking to introduce some US private credit into their portfolios. We’re interested to see what’s going to happen in that respect as to whether the relative attractiveness shifts. For example, we’ve seen European pension funds that started in European direct lending starting to introduce US exposure, and so forth. Asset managers have been very receptive to this; for example, US private debt managers have introduced separate vehicles or feeders that could offer less fund-level leverage that can be more appealing to non-European clients.