European private debt: Interview with Sandrine Richard, Head of Private Debt at Generali Investments Partners

The private debt strategy you manage focuses on European SMEs aiming to improve their ESG approach. What are the key trends and opportunities in this segment?

We’re continuing to see remarkable traction in alternative financing, and private debt is growing in popularity for various corporate needs such as capital transmission, acquisitions, and capital expenditures. The aftermath of the pandemic, coupled with disruptions in the mid-market banking sector and higher interest rates, has prompted companies and private equity firms to reconsider their financing strategies.

CFOs are now actively exploring private debt financing alongside traditional bank loans, creating a wealth of opportunities for strategies like ours to contribute to the growth of European SMEs.

To what extent is Europe a growth market for private debt?

Europe, with its diverse economic drivers and specialized industry segments in each country, presents a unique growth market for private debt. Italy's artisanal expertise in luxury and accessories and Germany's industrial prowess are just a few examples. This offers private debt funds an unparalleled opportunity for portfolio diversification.

Additionally, the SME segment in Italy, France, Spain, and Germany comprises over 12 million companies, representing over half of Europe’s GDP. This rich tapestry of opportunities allows for both diversification and selectivity. We see huge potential in partnering with banks to support European SMEs who are willing to improve their ESG profiles.

To what extent can private debt investors impact a company’s ESG approach?

While lenders have limited influence over a company's strategy, we adopt a proactive approach. We initiate a comprehensive assessment of the company's current ESG standing, strengths, areas for improvement, and short to medium-term goals, as the first step in understanding the company's ESG landscape.

Moreover, we engage with portfolio companies once invested, fostering an ongoing dialogue on their ESG initiatives, opportunities, and potential threats. This not only enhances the companies' awareness of their ESG strategies but also facilitates an exchange of ideas to drive business development.

We also incorporate a ratchet mechanism in our debt agreements. This incentivizes companies to achieve set ESG indicators by offering a reduction in debt costs. Conversely, failure to meet these targets results in penalties, creating a mutually beneficial arrangement for companies, shareholders, and lenders.

What sets your origination and sourcing process apart from other private debt funds?

Our senior investment team’s diverse experience across banking, private debt and equity, and debt advisories really sets apart and strengthens our sourcing capabilities. We currently have eight professionals across Europe, with Italian, French, German and Spanish nationalities. As for me, I joined General Investments Partners 18 months ago to lead the direct private debt activity. I’ve been in the European private debt sector for over 25 years, previously at Muzinich and before that at Axa AM and Exane.

We also benefit from the well-established brand and considerable history of Generali’s indirect private debt and private equity networks. This enables us to engage with banks, private equity firms, and debt advisories in a rather unique manner, facilitating a comprehensive approach to identifying and securing investment opportunities.

How are rising long-term interest rates and higher oil prices impacting the private debt of European companies?

The rise in interest rates and energy costs has compelled many companies to reduce leverage to absorb increased financing costs. This is no bad thing because it minimizes the risk of non-payment, which aligns with our conservative focus on capital preservation.

Inflation and escalating energy prices are doubtlessly putting strain on the profitability of companies, and it’s a very tough environment to be a business owner. At the same time, there are positive aspects for private debt funds, as the increase in Euro rates, coupled with the benefits of floating-rate instruments, is attracting more investors seeking higher returns with reduced leverage risks.

Are you expecting a recession, and if so, has your investment process changed?

The slowdown looks likely to extend into 2024. While the extent of the recession remains uncertain, our process remains focused on rigorous due diligence with a long-term mind-set: we approach each investment opportunity with caution, conducting meticulous assessments of business plans and negotiating lender-friendly terms. We remain focused on providing stable income and delivering value to our clients, regardless of the market environment.

What are the key considerations for private debt investors as we head into a more difficult macro environment?

Considering industry, issuer, and geographic diversification, along with a careful evaluation of leverage and returns, is pivotal. We encourage investors to scrutinize each transaction on a standalone basis, considering the inherent risks and opportunities specific to the company.

What makes you constructive about the future of private debt?

We believe that the increased interest from LPs, coupled with the inherent illiquidity premium and lower volatility, makes private debt an increasingly valuable asset class. The evolving dynamics in the SME sector in particular, driven by lower financing from banks, present an opportunity for private debt funds to fill the financing gap. Challenging macro environments also present opportunities for strong companies to grow further, by acquiring competitors at a lower price for example.

Finally, being part of a company like Generali puts us in a promising position. We have over €300 million earmarked for investment in our strategy, and we’re still in the early stages of the investment period, having started in February. As a result, there's no urgency to hastily deploy capital. We have the luxury of time, which allows us to be discerning and focus on delivering strong deals and outcomes for our investors. This is particularly notable given other funds in the market right now are facing constraints due to dwindling available opportunities or the imminent conclusion of their investment periods. For us, this presents a real alignment of stars – we have ample capital, a strategic timeline, and robust support from our organization, with well-established infrastructure across investment teams, legal, compliance, and back-office functions. So we possess all the essential ingredients to do our very best to deliver on our commitments to our LPs.