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Opinion Direct lending
Private credit in Italy should benefit from a general rotation to alternatives
by Randy Schwimmer
Randy Schwimmer
Vice chairman
Churchill Asset Management
Diversification is driving direct lending allocations in Italy and Canada
In recent visits to Milan and Toronto, we heard how private capital is becoming accepted as a core allocation in institutional investment portfolios. Investors in Italy certainly have an increasing variety of options, including exposure to US private equity. And while specialised strategies have emerged (for example, venture capital), the focus on established buyout funds has prevailed.
Italian credit investors have historically been big buyers of fixed income. While current exposure to private debt is limited, appetite is growing. It follows the same path as private equity, with some nuances dictated by regulators. For instance, insurance companies are one of the largest investor categories in private debt, even though, with US currency exposure, the accounting and Solvency II implications add complexity.
As an asset class, private credit in Italy should benefit from a general rotation to alternatives. Investors look at US private markets with renewed interest. As European private markets programmes grow and expand, the need for diversification becomes critical. This is true even with a trend of investing locally to support the Italian economy, either with equity or debt.
Increasing exposure to Europe and the US
We have seen growth of European exposure as Italian investors believe this to be the natural evolution of their domestic allocation. With more familiarity with the asset class, the demand for US exposure has also been increasing, especially among those investors with more advanced private debt programmes in place.
Conversations with Italian investors recently revealed increasing demand for dedicated US versus European exposure, or global exposure blending both. Currency risk and yield differential between Europe and the US were often mentioned as key concerns. Beyond diversification benefits, the US middle market can be seen as possessing the third-largest GDP in the world, while also offering well-developed business service sectors.
Similar drivers are apparent in Canada, where we have found evidence of solid risk management. A recent Fitch report on Canadian pension funds said investment portfolios “will remain pressured by a challenging market backdrop, as the increased cost of debt and anticipated slower growth weigh on private asset valuations”.
The good news, the report went on, is that “the exceptionally strong liquidity of the funds provides sufficient cushion to absorb investment volatility and gives them flexibility to work through troubled investments as they are not forced sellers”.
This is not to say Canada lacks headline risk. Some retail and wealth investors suffered losses after a handful of private debt shops embarked on dubious ventures. The result was private income funds with private credit or asset-backed lending and bridge loans being gated. Banks and other large platforms accordingly moved to larger managers, while some committee members read about the problems and inferred all private credit is risky.
Canada pushes domestic investment
Real estate, a stalwart for Canadian pension funds, has had a tough slog of late. This has led to the internalisation of some large subsidiaries, in order to reduce costs and increase efficiencies. A move to diversify globally has spurred potential government intervention. The idea is to mandate a domestic investment bias in areas like infrastructure, especially for the “Maple 8” — Canada’s largest public pension plans, including CPPIP, PSP, Caisse Depot, AIMCO and Ontario Teachers — to support the economy.
As has been the case elsewhere, slow private equity realisations have impeded Canadian institutions from using sale proceeds from existing investments to fund other investments. The impact has been especially felt among family offices. These favour large PE allocations, thanks to beneficial capital gains tax treatment.
Consistent with views from attendees at a Toronto conference last month, pension plans are looking at niche private credit strategies to achieve diversified return profiles. Examples include secondaries, NAV financing, ABL, distressed and real estate debt. In part, this is because the sheer number of managers that name private credit as their focus make it challenging to navigate. But if it is true, as one CIO noted, that a reckoning in private credit is coming between “well-managed managers and unnecessary risk-takers”, then investors may benefit from choosing a greater diversity of strategies.
