In the first article (available here) of this two-part series we introduced the third factor, complexity, to expand beyond the risk / reward assessment of any investment. In this article, we take a deeper look at how Keyview leverages complexity in opportunistic transactions to drive returns and how we actively manage risks so that we can achieve capital preservation.
Keeping risk low
The complexity that is a hallmark of opportunistic credit doesn’t require us to take additional risk. In fact, our risk profile is often lower than traditional lenders. Our loan to value ratios are modest and often below most peers – we lend with a wide margin of safety – and we have a sophisticated, detailed understanding of the risk of each investment.
We assess and structure for the business risks but then remain closely involved with our counterparties to stay across any changes in the business and to mitigate risks via active, hands-on management of any issues that arise. Risk in opportunistic private credit investments can be kept low thanks to:
1. Quality, non-distressed assets: given we are looking at misunderstood, ‘tricky’, or overlooked opportunities, we have our pick of deals. We can be highly selective about the deals we take and sit high up the capital structure.
2. Tailored security packages: we negotiate strong investor protections and covenants to safeguard capital. The borrower gives us a plan for the next 24-36 months, and provides us with regular updates that helps their business stay on track and enables us to spot any potential issues ahead of time, so they can be addressed. Our approach is different to many lenders who are light on covenants and ongoing involvement, leaving the lender with little opportunity to take proactive remediation or to step in to assist when issues unexpectedly arise.
3. Ongoing active management: this in turn helps identify and mitigate risks throughout the term of the investment. We take a hands-on approach to monitoring performance, providing guidance and re-adjusting where needed, allowing for more controlled risk management and contributing to the success of the investments.
4. Idiosyncratic risk: meaning no sector concentration risk and less exposure to market movements as each of our investments has had the risk priced in and structured for. We understand the idiosyncratic risks specific to each investment and are not making investments based on a macro or industry view, instead deciding on the merits of each underlying investment opportunity.
Protecting capital above all
Despite all due diligence, it is possible for an investment’s performance to start to deteriorate due to poor management, unforeseeable shocks, unfavourable market conditions or industry environment.
We never enter an investment where we can envision a scenario in which we would lose capital. We have a track record with no losses on our books and want to keep it that way. However, each investment has to deliver more than just capital preservation, it also has to have the potential to deliver maximum value.
Our hands-on approach means we are able to identify early signs of deterioration and actively help the business adjust plans or right size. While less hands-on lenders might go straight to a sale to recover what they can, our experience means we can successfully manage an investment over time so we are never at the mercy of market offers.
The golden goose
So, high returns with low risks are possible – by allocating to opportunistic deals and actively managing them. For a long time, private credit investment was only available to institutional investors. But as traditional lenders’ risk appetites shrink and liquidity dries up, they leave a gap for more nimble lenders – good news for individual investors, as equity-like returns become accessible, especially in ‘special situation’ opportunities. Investors are increasingly drawn to this asset class for the opportunities outlined above. Some things investors should consider when comparing funds are:
1. Portfolio concentration: a strong fund should have strong diversity – across sectors, asset types, borrower types and return types (fixed or floating).
5. Well-spread returns: an attractive fund should not only target strong returns and have a track record of success, but also achieve them consistently across investments and time. Even if the overall return is good, it is a concern if it has been achieved via exceptional returns on a few deals but losses elsewhere. Investors should analyse how returns have been generated by deal. It’s also worth understanding whether the returns have been consistent month-to-month across a multi-year period. ‘Lumpy’ return records are also cause for concern.
6. Skin in the game: The investment professionals at the fund manager should be invested in their own funds. They should be “eating their own cooking”. This is an important indicator that everyone’s interests are aligned and the managers have personal conviction in their fund’s strategy and fundamentals.
By understanding complexity, a key characteristic of opportunistic credit, and having the ability to manage it means that our investors can enjoy high returns without the commensurate increase in risk.... which is a long way of saying yes, it is possible to have high returns without high risk.
