CI GAM on private credit: a risky perception but a manageable reality
This article was produced in partnership with CI Global Asset Management
The perception of private credit as a high-risk investment often surfaces in discussions among investors. However, Geofrey Marshall, Senior Vice-President, Head of Fixed Income and Lead – Private Markets at CI Global Asset Management, (CI GAM) emphasizes that while private credit is indeed complex, it is not inherently more risky than other investment classes. The key, he suggests, lies in how that risk is managed.
Progressing through 2024, the landscape of private markets is poised for significant shifts, influenced by central bank activities and monetary policies. The macroeconomic consensus has solidified around the notion that interest rates and inflation will remain higher for longer.
Despite the U.S.’s resilience, prolonged restrictive measures increase the likelihood of a weaker economic outcome. Some analysts argue that the ‘liquidity premium’ private credit products once enjoyed over public fixed income has diminished, making them potentially less attractive to institutions. However, Marshall believes that private credit allocations remain beneficial for institutional asset managers due to their unique return profiles, bespoke nature, and promising long-term growth and yield prospects.
Private credit remains attractive despite diminished liquidity premiums
Marshall, notes, “The private markets have been both more resilient and a little bit more sticky than the public markets.” This stickiness is particularly evident in private equity, where deal activity has slowed. However, Marshall remains optimistic, stating, “With interest rate cuts from central banks, particularly the Fed, we believe this will spark IPOs and more deal activity, including leveraged buyouts.”
Marshall does not shy away from acknowledging the challenges of private credit. “Private credit is difficult; there's always the situation of what if something goes wrong—are you willing to own this asset, liquidate it, or work through a restructuring process?” he explains. This complexity, however, is not a reason to avoid private credit but rather a call for careful and strategic management.
In any environment where double-digit yields are being underwritten, it is crucial to have a contingency plan. “You cannot get credibly into this asset class without a plan and the resources and experiences for managing covenant waivers and restructurings. Risk management starts with underwriting”, Marshall states. Just as in high-yield bonds, where defaults are a primary risk, private credit requires a similar focus on risk management.
For those investors who were initially optimistic but have grown hesitant, Marshall maintains, “There's a lot of capital in private credit, and I think this market has a great opportunity to prove itself,” he says. He acknowledges the challenges in scaling private credit but underscores its potential to disintermediate traditional banking channels, particularly among US regional banks.
The ability of these regional banks to extend credit and how large pools of private credit can disintermediate these channels is crucial. There's a significant amount of capital in private credit, but it’s challenging to originate and scale direct lending, typically done in ten to twenty million-dollar increments.
The importance of contingency planning and diversified strategies in mitigating risks
One of the fundamental ways Marshall manages the inherent risks in private credit is through diversification. “We’re not exposed to just one private credit manager right now,” he says. CI Private Markets employs a multi-manager approach, currently working with four strategies across three managers, with a fifth manager being added in the next twelve months. This strategy ensures that the portfolio is not reliant on the underwriting process of a single manager, thereby spreading the risk across different methodologies and approaches.
This diversified strategy is crucial in mitigating the risks associated with private credit. “By not being beholden to any one manager, we can better manage the risks and ensure a more stable return profile,” Marshall emphasizes. This approach contrasts sharply with a more concentrated strategy, where the failure of a single manager’s underwriting process could have a disproportionate impact on the portfolio.
Marshall co-manages the CI Private Markets Growth and CI Private Markets Income funds with CIO Marc-André Lewis, with a focus on optimizing portfolios across three axes: returns, volatility, and liquidity. Marshall details, “If we were solely optimizing for returns, the portfolio would heavily feature private equity and venture capital. For volatility, we might lean towards infrastructure. If liquidity were the main concern, the portfolio would likely consist mostly of private credit.
“For the Private Markets Growth fund, we include private credit, infrastructure, venture capital, and real estate. The Income Fund has a similar structure but with a stronger focus on income, and it doesn't include venture capital.”
Marshall provides insights into the investment approach for infrastructure, real estate, and venture capital. The team invests in closed-end funds with 5 to 10-year investment horizons, he explains. CI enhances liquidity with a 10% public markets liquidity sleeve, and by incorporating mature investments and/or open-ended funds, such as those managed by HarbourVest Adams Street and Apollo Realty Income Solution, which offer quarterly liquidity.
Marshall also points out the disconnect between institutional and retail investors in Canada. “The top 100 Canadian institutional investors have an average allocation of 30% to private markets, whereas retail investors have essentially zero,” he notes. This represents a significant opportunity for retail investors willing to take on some illiquidity risk.
Partnering with industry leaders
For Marshall, partnering with industry leaders is particularly exciting, as it allows him to dissect returns and analyse attribution—understanding how those returns are generated. The team reflects on the recent period where it was possible to buy a company, leverage it with significant debt, refinance that debt at increasingly lower rates as interest rates fell, and direct the incremental cash flow to shareholders. Then, they could sell the company at the same multiple it was purchased at. However, Marshall recognizes that this isn't true value creation; it's what the industry refers to as financial engineering—merely leveraging cheaper debt.
His focus is on finding value creators—seeking out managers with the right skill set who understand that while their strategy works well with a $4 billion fund every two years, raising $10 billion might dilute returns because it would be too much capital to deploy effectively. The team is honing in on disciplined GPs who excel at what they do.
A recent partnership with private equity firm 26North underscores CI GAM’s commitment to finding value-creating managers. "These new partners complement our existing portfolio and enhance our ability to generate returns for investors,” Marshall reassures.
