Exploring the Potential of Private Debt Investment

By Sandrine Richard , Head of Direct Private Debt at Generali Asset Management (part of Generali Investments)

In the ever-evolving landscape of financial markets, with the current macroeconomic conditions, the continued withdrawal of the banking sector, and an increasing trend towards regulation, private debt has emerged as an attractive alternative source of credit, particularly for small and medium-sized enterprises (SMEs).

Why are investors attracted to private debt?

One of the primary reasons investors are drawn to private debt is its illiquid nature, which provides a unique advantage in the form of reduced correlation with the volatility of public markets and an attractive illiquid premium over risk ratio.

In an era where market fluctuations can significantly impact returns, private debt offers a more stable and predictable income stream. This stability is further enhanced by the variable rate component of these debts, which provides a degree of protection against inflation and rising interest rates with a fixed cash margin.

Key Benefits of Private Debt Investment

1. Diversification: Private debt provides access to opportunities that are not available in public markets, particularly in the SME sector. This allows investors to diversify their portfolios and avoid overlap exposure.
2. Attractive Risk-Return Ratio: The illiquidity premium associated with private debt and higher lender protection makes it an appealing investment with favorable risk-adjusted returns.
3. Low Capital Charge for Insurers: Insurance companies benefit from the lower capital requirements associated with private debt investments.
4. Support for ESG Practices: Private debt can encourage SMEs to adopt and enhance their Environmental, Social, and Governance (ESG) practices, contributing to their long-term growth and sustainability.
5. Fostering Future Large Companies: By providing essential financing to SMEs, private debt plays a crucial role in nurturing the potential large companies of tomorrow.

Which are the main trends in the Private Debt Market?

According to Preqin 2024 Global Report, investor demand for private credit surged after the Global Financial Crisis of 2008, as investors sought higher returns in a low-interest-rate environment.

This trend is expected to continue, with private credit assets under management (AUM) projected to reach $2.8 trillion by 2028, almost double the 2022 figure of $1.5 trillion.

Nevertheless, to assess the next moves that will drive private debt investing, we must also look at the impact of interest rates on private debt strategies.

In fact, the increase in interest rates raises the cost of financing, impacting cash flow generation. However, this scenario also opens up new investment opportunities as companies seek to reduce leverage.

Conversely, a potential decrease in interest rates would free up cash flow for investments and operations. The variable rate component of private debt ensures that returns are partially preserved, even in a declining interest rate environment. This adaptability makes private debt a resilient asset class amidst fluctuating economic conditions.

Which are the advantages of allocating to direct private debt?

Allocating to direct private debt within a broader asset allocation provides several benefits:

• Stable and Predictable Income: Private debt offers a shield against market volatility, providing stable returns.
• Illiquidity Premium: The illiquid nature of private debt is mitigated by an attractive premium, appealing to long-term investors.
• Floating Rate Advantage: With floating rate characteristics, investors benefit from a natural hedge against interest rate volatility.

At Generali Investments, our focus on senior secured loans offers robust downside protection alongside attractive current returns of 7-9%. By filling the financing gap for future industry leaders, private debt provides unparalleled diversification for investor portfolios.

In conclusion, private debt investment is set to play a pivotal role in the evolving financial landscape, offering stability, diversification, and attractive returns. As the market adapts to changing economic conditions, private debt remains a resilient and appealing asset class for institutional investors. At Generali Asset Management, part of Generali Investments, we are committed to leveraging our expertise to support the growth of European SMEs and deliver sustainable returns for our investors.