Credit Investments to Watch: Private Credit, Securitized Credit, and Alpha-Oriented Mandates

Asset owners should dig their heels into renewables financing, bank capital relief trades, and other less ‘vanilla’ strategies, says Willis Towers Watson.

Private credit, securitized credit, and alpha-oriented mandates are all strategies that investors should dig deeper into, as they search harder than ever in a low-interest era for attractive yield in the credit markets, says Willis Towers Watson.

Among opportunities investors should consider in the private credit markets are direct lending strategies, renewables financing, and bank capital relief trades, according to a report, released Monday from the consulting firm, called “Covid and Credit — One Year Later.”

Willis’ analysts did not find direct lending strategies attractive before the pandemic, but the sector has improved since then, they said. The illiquid investments have been slower to price in changes than the public markets.

“You have to make sure that you’re identifying the right strategies because you are locking up capital for the long term, but we find a lot of investors probably have a little bit more liquidity than they actually need,” said Mike Fontaine, director of investment research at Willis. “And so right now is a good time to take a step back, see how much liquidity you actually need, and then potentially added some private credit-type strategies in the portfolio.”

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Another opportunity in private credit: renewables financing, which the firm calls the “rare” strategy that offers investors competitive returns and also allows them to integrate environmental, social, and governance (ESG) elements into their portfolios.

Another niche private credit strategy that has been generating buzz? Bank capital relief trades. The asset class helps banks unlock some relief from the regulatory pressures requiring they maintain higher levels of capital on their balance sheets.

It’s been criticized by regulators in the past for appearing too much like the structured products that came to grief in the financial crisis. But the asset class has also gained wider acceptance on Wall Street in the years since the 2008 recession.

“This is a strategy that, for an investor, may not have really existed as an option, say, 20, 30 years ago, and now it does, and offers you what we think is pretty competitive returns for the risk you’re actually taking,” Fontaine said. “That’s why we like it.”

In lower quality securitized credit, questions remain for investors regarding commercial mortgage-backed securities (MBS), even with the rollout of the vaccine and the general improved outlook of the economy one year into the pandemic. Nevertheless, investors can still find value in offices, hotels, and housing if they partner with skilled active managers that have the resources and expertise to snap up the right properties.

Within alpha-oriented mandates, the consulting firm is changing up its high-yield sleeve. It’s hiring three or four managers with 30 or 40 issuer portfolios to place more concentrated bets across the firms the managers have the highest conviction in. Willis is aiming for better alpha, instead of index-like performance.

It’s also adding specialist managers to track emerging market debt, particularly in Latin America, Africa, and Asia, for on-the-ground expertise.