November 2021: Private Debt and Digital Lending Digest
by Aleksandra Yurchenko
Welcome to the monthly digest about Private Debt and investing in Digital Lending providers. We have hand-picked thought pieces and new information relevant to the topic from the past month. Please, feel free to reach out in case of questions or feedback.
1. Capitalising on private credit investments in Asia
2. Global private credit market focusing on sustainability
3. Diversified private markets: A source of illiquidity premiums
4. Alternative Assets Hit $9 Trillion This Year. Here’s What Investors Should Be Worried About
5. Incorporating Life Settlements and Private Debt in Financial Plans
6. How Much Money Would You Make by Investing in Different Assets?
Big shifts such as consolidations among asset managers will likely happen in the burgeoning private debt markets in Asia. Some of the most prominent trends in the Asian private credit market:
The AUM has been on the rise even though the number of investment managers has not increased as much. Most asset owners tend to turn to global private debt players with a pan-Asia strategy;
In the next two to three years, more local asset managers will be entering the private debt space;
Market harmonisation or consolidation will likely take place, with some of the small local managers joining forces through joint venture arrangements or co-investments in order to compete against the global ones;
A new type of asset managers in this area is emerging - family offices.
Some of the primary concerns of the asset owners are:
Legal framework/legal risk, as private debt investors are concerned with collateral and level of security;
Currency swings and the lack of stability and predictability in these local currencies.
Global private credit market is increasingly focusing on sustainability. According to the new research, 74% of private credit managers already integrate ESG into their investment strategies and consider it to be a core part of their approach to due diligence, borrower engagement and investor reporting. 28% of firms reported offering ESG-focused private credit products that incentivise businesses to become more sustainable, for example by linking the interest rate to ESG-related criteria. Still the industry is in the early stages of development when it comes to methodologies, loan documentation and engagement practises.
Negative cash flows, pressure to diversify risk exposures, stricter investment regulations – institutional investors are facing many issues. These are also making holding listed equities harder, while low bond yields add to the challenges of sourcing adequate returns. Capturing the credit and/or equity illiquidity premiums by investing in diversified private debt and private equity portfolios improves the risk/return profile of institutional portfolios. Private markets offer the following advantages over their listed equivalents:
Higher returns, captured through an illiquidity premium
Lower volatility and a lower market beta (which for insurance companies under risk-based capital regulation is crucial)
Potentially more targeted environmental, social and governance (ESG) oriented investments (based, for example, on line-by-line selection of well-defined projects)
Lower immediate liquidity as most of these assets are valued once a month or once a quarter and are usually held to maturity to avoid liquidation costs.
As capital continues to flood into the industry, Moody’s raises concerns about leverage and illiquidity. Moody’s highlights three potential hurdles alternatives investors may face in the near future:
Rising systemic credit risk as a result of increased allocation to the leveraged assets. As this activity has moved into the private domain, there’s less visibility and transparency and perhaps more aggressive terms;
“Lower-rated” companies borrowing more capital. With lower rates, weaker creditors have been buying more, but if rates rise, they may not be able to support the debt;
The illiquidity that comes with investments in alternative asset classes may put future stress on portfolios.
Some 98% of institutional investors recently told Preqin they plan to maintain or increase their allocation to private credit, a subclass of private debt that includes distressed credit, mezzanine investing, direct lending, and specialty finance. Private credit allocations are typically meant to serve as a portfolio diversifier by reducing correlation to traditional investments, but not all of the strategies within the subclass deliver the same level of non-correlation. The specialty finance area of private credit, which includes life settlements, litigation finance, healthcare royalties, catastrophe bonds, structured settlements, and aviation finance, is a bit different. The biggest components of risk/drivers of returns in life settlements – getting mortality rates wrong or regulatory issues – have little connection to financial markets and can be effectively controlled by a skillful and experienced manager. Consequently, life settlement investing has historically delivered compelling returns with low correlations, giving them the ability to fill the gaps between traditional allocations.
Kilde’s CEO, Radek Jezbera, looked into key performance metrics of the four assets: Dow Jones Industrial Index (equity), PIMCO High-Yield Debt ETF (bonds), Gold (commodity), and Robocash debt note issued at Kilde’s investment platform (private bond). If invested $100 back in January 2021, today, an investor would have $117 from Dow Jones Index investment, $103.3 from PIMCO’s ETF, $94.2 from Gold, and $109 from Robocash’s note. That is, if we look at return purely.
Once we consider volatility (measured by standard deviation), it becomes obvious that the Dow Jones Index provided the highest return but while doing so exposed investors to high volatility of 11.4%. The worst performer was gold on which investors lost more than 5% while riding up and down with 15% volatility.
Finally, Radek calculated Sharpe ratio for each of the investments - a measure that brings returns and volatility together. Suddenly, investment into Dow Jones Index does not appear to be the most attractive option anymore as it is outperformed by both PIMCO High-Yield Debt ETF and Robocash’s debt note.
1. Fintech Adoption Surges in Southeast Asia, Led by Digital Payments and Online Lending
2. 'Buy now, pay later' fad could have redeeming qualities — with proper use and regulation
3. Amsterdam’s fintech unicorn Bunq becomes the first digital bank in Europe to offer mortgages
4. How the ‘New Normal’ is Driving Change in Small Business Lending
Usage of digital financial services is witnessing strong growth in Southeast Asia this year, a trend mostly driven by digital payments and digital lending adoption, according to the annual report, produced by Google, Temasek and Bain & Company. Digital payments reached mainstream consumer adoption, which has pushed merchants to follow suit with now over 90% of digital merchants accepting payments digitally. Usage of A2A (account-to-account) transactions, meanwhile, has been propelled by infrastructure development and real-time payment systems. In Singapore, instant payments grew 58% over the last year.
The appetite for digital lending rebounded this year, with about 30% of digital merchants stating they would likely increase usage of supply chain financing and BNPL offerings. Competition is now heating up with pure players, e-commerce platforms and banks all looking to get a piece of the pie. Banking incumbent Standard Chartered recently ventured into the space, partnering with BNPL players Atome Financial from Singapore and Kredivo from Indonesia.
BNPL has enabled millions of Gen Zs and millennials to take on the kind of debt which has no benefit other than immediate gratification of a spending itch. Instead of replacing credit card debt, #BNPL may be creating new burdens on the cash flows of young households. The UK, Australia, and California have started tightening regulation. At the same time, credit cards are too complex and costly. Properly regulated, BNPL might evolve into a cleaner alternative. BNPL has no redeeming features if used properly. Young people are drawn to BNPL for a number of reasons:
the simplicity of its features;
the nature of their obligation is transparent and straightforward;
there is typically no interest if they pay according to terms.
Early and better financial education could help young people in understanding financial behaviours that will cost them money and impede their ability to build wealth in the future.
The Dutch fintech will offer mortgages to its users from early next year, as it seeks to challenge traditional banks’ grip on the home-lending market. By taking the first steps into mortgage lending, bunq wants to be at the forefront of innovation in digital banking. The mortgages will initially be available in the Netherlands. Approximately two-thirds of bunq’s home loans on its balance sheet will be covered by the Dutch government’s insurance scheme, which guarantees homes up to €355,000 (amounts for 2022) in the event the borrower defaults.
Across the board, most of the bankers are focused on diversifying their loan portfolios. Diversifying into different industries and types of loans means facing one of the major challenges, - fixed costs: they use the same processes to underwrite a $50,000 loan as for a $5,000,000 one. As a result, many banks are looking for partners and technology solutions to support their efforts to efficiently offer new commercial lending products.
Digital lending platforms and loan origination solutions are seen as an enabler of portfolio diversification within these banks. Still, many banks worry about the complexity of commercial lending and the importance of banker interaction with the client. They don’t want to lose the human touch in a self-service world. But everyone agrees paper is not their friend. The move to digital can be scary for traditional banks. That’s why many banks adopt a staged approach, beginning with smaller dollar loans to existing customers, and then expanding to larger dollar loans to existing customers followed by new customers.
Kilde is a regulated investment platform for alternatives. We operate as a two-sided platform connecting institutions / HNWI with securitised private investments. Our main alternative asset classes are private debt, venture debt, and recurring revenue financing. Kilde has partnered with leading non-banking consumer & SME lending firms to give investors safe and controlled access to consumer lending assets. Our unfair advantage is vast accumulated data on consumer & SME assets performance as well as scalable investment and securitisation tech platform. Thanks to Kilde’s license for dealing in securities, we securitize alternative investments into digital securities.
Our methodology and loan tape assessment techniques allow us to obtain a deep understanding of the loan portfolio through analysing each loan that has been issued by the borrower, its performance, risk of default and predict its behavior for the next 12 months. In this short video Yujia Li talks about the analysis we do on the loan tape and the way we present the outcomes in the dashboard.
In this piece we compare the performance of four investment assets in the turbulent year 2021: Dow Jones Industrial Index (equity), PIMCO High-Yield Debt ETF (bonds), Gold (commodity), and Robocash debt note (issued at Kilde). We calculate returns, volatility and Sharpe ratio for each of the assets and arrive to some interesting conclusions.
BNPL providers offer interest-free instalments to their customers but then how do they make money? In this piece we tap into the remuneration and cost structure of the BNPL companies and discover additional value these players are bringing to merchants by bringing new customers to discover their products.
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