Credit markets attract yield-hungry global investors
Central bank stimulus aimed at countering the effects of COVID-19 has sent global capital hunting for yield, as investors in developed markets contemplate near-zero or negative interest rates and worry how they will meet their long-term return targets.
Attractive yields are still available to those investors willing to look beyond traditional markets in developed economies. Some of the most attractive high-yield opportunities at present can be found in private or unlisted credit, and specifically in frontier markets. These assets also present real opportunities for investors to make a difference in raising environmental, social and governance (ESG) standards in developing economies.
Features of private credit
Apart from yield, private credit offers particular advantages. It is uncorrelated to traditional asset classes, can be counter-cyclical, and these instruments deliver stable, predictable returns. Private credit is appropriate for investors with a long-term horizon or those with liability-driven objectives, as it less liquid than traditional fixed income assets.
Private credit can be issued by corporates or the public sector, and it is particularly well suited to an infrastructure rollout, impact and ESG investing. STANLIB expects the global private credit market will top US$1 trillion during 2020/21 as more investors allocate to private credit offerings.
STANLIB Credit Alternatives Portfolio Manager Thuli Kumalo says there’s been a global surge in private credit issuances in 2020 compared with previous years, as corporates concerned about liquidity during the COVID-19 lockdowns issued paper to increase their cash resources.
This trend was also seen in SA where listed issuances fell compared with the record levels of 2017-19 as corporate treasurers were concerned about failed auctions and widening spreads, as well as about negative market sentiment arising from SOE defaults.
Kumalo says that investors can access moderate or high-risk instruments, depending on their risk profile, or blend different instruments to achieve their desired outcome. For example, senior secured infrastructure and real estate debt offers moderate risk, but it can be blended with senior unsecured paper, subordinated or mezzanine debt to add greater risk and return in a portfolio.
Although emerging market credit risk is higher than in developed markets, it can be managed with the input of specialist asset managers with local understanding. The listed debt and unlisted credit markets across Africa, including SA, cover assets that include senior, high yield, property and infrastructure finance. The yields, at many multiples of their counterparts in the developed world, are often disproportionate to the risks.
Johan Marnewick, head of STANLIB Credit Alternatives says when combined with hard currency listed credit in a portfolio, private credit can deliver yields of 7-8% in USD terms, whereas achieving similar returns in developed markets would require venturing into mid-market leveraged debt funds, potentially with liquidity constraints and lengthy lock-ups. Many corporates operating in Africa will tend to have inferior credit ratings, or ratings on the same level as high-yield debt in developed markets. This is often because their ratings are capped by their operating country risk.
“Frontier markets currently present an important value proposition,” added Jonathan De La Pasture, also a Portfolio Manager within the STANLIB Credit Alternatives team. “Pan-African eurodollar debt is one of the most attractive asset classes on a risk adjusted basis in the world right now. The pan-African Eurobond market (beyond SA) has been around since 2006. It is now worth US$180 billion and is regarded as an investible asset class on the radar screen of frontier and emerging market investors.”
Specialised sectors of the credit market
For global and domestic investors, there are different ways to access credit instruments, tapping into various sub-themes, from infrastructure, telecommunications and financials into impact-focused areas such as healthcare and education. ESG screening can be applied across the opportunity set to identify themes that are important to particular investors.
De La Pasture says Africa is not a homogenous market: the dynamics of leading economies such as SA and Egypt will differ significantly from the relatively underdeveloped Uganda, while Kenya and Ghana are reflecting political stability after recent political transitions. Many investors have had their fingers burnt in Africa, particularly on listed entities, and local knowledge is key. Good portfolio construction and diversification can minimise potential downside risks.
Applying the ESG lens
Nicholas Naidoo, Head of Credit at STANLIB Credit Alternatives, says changes in awareness, behaviour and attitudes can be driven by capital allocators, but that it requires a unified approach by the investor community.
There are several impediments to the widespread adoption of ESG-focused investment in the short term. These include the difficulties of quantifying ESG risks, which entails a level of expertise, and the current inconsistency of disclosures, which makes it difficult to compare entities within a peer group. The United Nations Principles for Responsible Investment (UNPRI) and the Task Force on Climate-related Financial Disclosures (TCFD) framework are helping to set high standards and consistency in the way ESG is assessed however more is needed and professional investor bodies can help shape these outcomes.
Two other impediments are that ESG risks in general do not appear to be currently priced into loans, Naidoo said, so borrowers with higher ESG risks pay the same risk premium as those with lower risk. There is also a general lack of oversight and regulation of ESG which also contributes to the inconsistency of disclosure. In time, it is hoped that investors will better differentiate on the basis of ESG features and that it will be reflected in the access to and price of capital.
Investment as a tool for upliftment
“International capital can make an enormous difference in Africa and many investors are motivated to do just that,” De La Pasture says. “There is a need to drive economic inclusion and help the continent to develop, while giving investors measurable and predictable outcomes that reward them for the risks taken.”