For over a decade, private debt was the hot sector for wealthy investors.
Investors poured money into funds that loaned directly to companies, fuelled by a simple narrative from the likes of Bridging Finance chief executive officer David Sharpe. His pitch went like this: The big, bad banks are cutting back on loans in the wake of the global financial crisis, while funds like ours are smart enough, and brave enough, to extend capital when traditional lenders balk.
In 2012, the year after Bridging was launched, private-debt funds oversaw about US$400-billion worldwide, and delivered a stellar 15-per-cent annual return, according to data service Preqin.
Here’s the funny thing about boom times in niche markets such as private debt. Rivals jump in, and returns plummet. If you’re an upstart like Bridging, it gets far more difficult to feast on the banks’ leftovers. Over the past year, a once-hot sector turned distinctly chilly.
By last September, Preqin said there was US$975-billion committed to private lending, including US$336-billion of dry powder, money that is looking for a home. Industrywide, private-debt fund returns were down by 2.4 per cent in the year ending Sept. 30, according to Preqin.
In response, many fund managers began taking more risks. Preqin analyst Grant Murgatroyd said: “Over the past couple of years, debt funds have sought to add some juice to these lacklustre returns, either by leveraging the fund itself or by taking on broader exposure through the capital structure.”
Now, according to Bridging’s press releases, the fund manager sailed smoothly through last year’s stormy market. Bridging Income Fund LP posted a 7.86-per-cent return in 2020. The company says its flagship fund turned in consistent returns of 7 to 9 per cent in each of the past seven years.
We’re now finding out, to absolutely no one’s surprise, that the banks are actually pretty good at avoiding bad loans, while funds like Bridging operate in a largely unregulated space, where things can go very wrong, very quickly.
Bridging, if you missed this week’s headlines, is now in receivership, at the request of the Ontario Securities Commission. The company oversees about $2-billion for clients. Regulators allege Mr. Sharpe misused millions of dollars entrusted to him, diverting client capital for his personal use.
Bridging attracted a following among wealthy families and high-net-worth individuals, who were attracted to the promise of steady income from its loan portfolio. Their money is now frozen, and a significant portion of it may be gone.
Mr. Sharpe wasn’t the only entrepreneur who grabbed clients from those ponderous, process-bound banks over the past decade, only to come unstuck in recent months. In 2011, former Australian farmer Lex Greensill launched a British finance business, Greensill Capital, that loaned against its corporate customers’ accounts receivable. Mr. Greensill claimed superior technology allowed his company to seize opportunities the banks missed. As recently as two years ago, Greensill Capital was valued at US$3.5-billion.
Greensill Capital collapsed in March, filing for bankruptcy and leaving customers scrambling. Its failure achieved what many would have said was impossible: It further tarnished the reputation of former British prime minster David Cameron, an adviser to the company and the architect of the Brexit referendum.
Bridging and Greensill Capital were undone by internal problems. Going forward, even the best-run private-debt funds will struggle to match the performance they delivered in the past, as rising interest rates undermine results. Howard Marks, founder of US$150-billion credit fund Oaktree Capital Management and author of a widely followed newsletter, warned two months ago: “Today’s high asset prices may be justified at today’s interest rates, but that’s clearly a source of vulnerability if rates were to rise.”
Investors in private-debt funds are trying to squeeze extra income out of their portfolios, and in doing so, they shoulder additional risk. “I have trouble seeing this as a time to aggressively chase high returns,” said Mr. Marks. “Moreover, the surer one is that rates will soon rise meaningfully, the more cautious one should be today.”
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