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Private debt is generally seen as interest-rate or inflation-hedge investments; more than 80% of the loans are linked to base rates: Dino Zuccollo, Westbrooke Alternative Asset Management.

SIMON BROWN: I’m chatting now with Dino Zuccollo from Westbrooke Alternative Asset Management. Dino, I always appreciate the early morning time. Private debt [is] much like private equity, but of course it is debt within it. This has become quite a popular asset class and, particularly in this inflationary environment, frankly offers some decent yields.

DINO ZUCCOLLO: Good morning, Simon, and thank you for making the time. You’re correct. Private debt has become one of the world’s fastest-growing alternative asset classes. To give you some statistics at the moment, private debt assets have grown at a mid-teens annual growth rate and currently, in terms of at least a global view, comprise $1.4 trillion of investments around the world.

It’s anticipated that private debt will become the world’s second-largest alternative asset class by next year.

I suppose the question is, what has driven this? A lot of it at the moment, Simon, has to do with the tough macroeconomic environment that we find ourselves in. Obviously, with interest rates rising steeply around the globe, there’s an associated set of impacts that are quite difficult for investors to handle.

The first, of course, is that there’s a lot of volatility in the fixed-income markets, especially in bonds where, for example, if you have a fixed-rate bond and interest rates go up, they tend to lose value.

Absolute yields on cash are still quite low around the world, and unfortunately there’s a statistical relationship between rising interest rates and falling equities.

So I suppose in that environment investors are [asking], ‘Well, inflation is high, we need to invest in something. The traditional markets aren’t perhaps giving us what we need – what can we turn to that’s different? What can we turn to that’s uncorrelated? What can we turn to that is tax-efficient and that can give us higher yields?’ I think private debt from many of those aspects is ticking the boxes.

SIMON BROWN: Who are you lending to? I don’t know. I’m thinking corporates; I’m thinking Reits and the like, who perhaps need, I don’t know, [a shorter] duration. What is your typical client?

DINO ZUCCOLLO: It’s a good question. It depends on the geographies in which you operate in. So we at Westbrooke operate in the UK and in South Africa in the private debt markets. Both of those markets are fundamentally different. The UK has a market where the traditional lenders don’t really like to operate at loan tickets of less than £20 million. This is because the costs of implementation are simply too high for them relative to the reward. And so in the UK we are tending to lend a lot against real estates, where security is a bond against the property at a smaller ticket size and for a shorter duration.

If you contrast that, Simon, to South Africa, in South Africa the big banks are pretty good at fishing in a small pond. And so in real estate, it’s a lot harder to extract higher returns than the level of risk you need to take.

And so in South Africa we’ve taken a slightly different focus from a niche perspective looking at specific industries.

Those industries include things like lending to businesses which inherently themselves are lenders. The banks don’t like to lend to a competitor in South Africa.

We also focus in South Africa on real-estate holding companies and a little bit of niche real estate where there’s too much complexity for the incumbent lenders to handle.

SIMON BROWN: [On] your point around the security, obviously if I invest into the fund, there are going to be multiple loans within it, so I’m not taking single loan risk. But there is credit risk. I imagine you and your team are much like bankers running those numbers, and you mentioned getting security in terms of property – you’re never going to reduce risk to zero – to reduce the potential risks.

DINO ZUCCOLLO: Well, that’s a hundred percent right. And I think it’s one of the fundamentals of any investment, specifically in alternatives, that you need to back an experienced investment team who have done this for a period of time and understand how to structure debts, how to enforce security, and how to ensure that in an event where things do go wrong, one is able to act in a manner that protects capital.

There’s a variety of ways you can do that. One of the best, as you mentioned, is to invest through a fund where you have exposure to dozens of different underlying loads.

And then the second is to back an experienced team where you have the ability to enforce security. Obviously enforcing security isn’t an overnight procedure. It takes time and it takes experience and it requires a manager who’s done it for a period of time.

SIMON BROWN: Your returns in sterling, your sterling fund [Westbrooke Yield Plus Plc yields] 9% to 10%, your ZAR fund [Westbrooke Income Plus yields] 13% to 14% pa. Will these, as normality returns – and I don’t know if that’s next year or in five years’ [time] – and interest rates start coming down and the like, will these have a lag effect but obviously also start to edge lower?

DINO ZUCCOLLO: Correct. It’s one of the big advantages of alternatives in the sense that specifically private debt is generally seen as interest-rate or inflation-hedge investments. So in both instances more than 80% of the loans are linked to base rates. In South Africa, it’s referenced to prime. In the UK it’s referenced to the Bank of England base rates. As a result the loans float.

But the advantage I suppose, Simon, is that they float at a yield far in excess of what one can get. I don’t think of private debt. You must talk about trade-offs. There’s no free lunch in life. You don’t ever get anything for free. This is why I say it’s not a case of either/or.

One doesn’t invest only in private debt or in the traditional bond and fixed-income funds. It might be a bit of both. And the reason for that is that the trade-off when making a private-debt investment is that you’re locked in for a period of time.

So in the case of the UK you’ve got to invest for 18 months, you can’t get your money out for that period of time. In South Africa it’s 12 months. And then in both instances you can give six months’ notice to get your cash out. So the give is that you lock in your money for a period of time, but the take is that, to your point, in the UK 9% to 10% in sterling, if you compare that to a two-year fixed deposit, that’ll get you 3.5% to 4% in sterling. And so the return is more than double. In SA a 24-month fixed deposit is probably at 8.5% to 9% in rands, whereas in private debt investment you are now 14%.

And there are other advantages as well, things like lack of correlation to the traditional markets. There isn’t that volatility that you see specifically in listed bonds. And, by playing in clever niches of markets, what you can also do, number one, is reduce your risk profile or at least make it different from what you’re getting in the listed markets. And you can get clever with things like tax as well.

SIMON BROWN: I’ll take that… In the whole private investing space, equity debt, it’s that ‘uncorrelation’ and that lower volatility which is hugely important. But I also like your point that there’s give and take. You give up a bit, but then you get that yield.

We’ll leave it there. Dino Zuccollo at Westbrooke Alternative Asset Management, I appreciate the early morning insight.

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