By Michel Degosciu, Managing Partner, LPX AG
Over the past few years, the private debt asset class is attracting serious investor attention due to several factors that have had a lasting impact on the credit market environment.
Within the Eurozone, traditional lending via the banking sector has been annihilated due to the legacy from the financial crisis in 2007/08.
Additionally, increased capital requirements due to Basel III legislative framework imply that banks have had little choice but to reduce their lending-volume in certain areas. The resulting gap is being closed by so-called “non-banks”.
These “non-bank” lenders have taken over parts of the traditional lending business of the banks and have also launched investment vehicles that offer investors the opportunity to participate in their private debt portfolio.
The aforementioned distortions in the traditional lending business have led to private debt increasingly being perceived as a separate asset class. This is demonstrated by the investment volume, which has risen steadily over the past few years (figure 1).
Figure 1 This figure shows the cumulative total return of the DLX Direct Lending Index vs. MSCI Financials Index from 31.12.2009 to 13.09.2022 based on daily data in USD (Total Return with dividends reinvested). Source: LPX AG.
According to Preqin, the volume was more than $848 billion in 2020. The volume of private debt funds raised in 2020 was approximately $118 billion. Preqin forecasts that private debt AUM to exceed USD 1.46 trillion by the end of 2025. The majority of the money is managed and invested in the US, where the “non-bank” sector is already an integral part of the overall credit market.
We anticipate that this development will also progress steadily in Europe as a result of developments since the financial crisis in 2007/08.
The Direct Lending Index (DLX)
The remarkable growth of the market compelled us to launch the first direct lending index – a measurement of the listed debt universe, through our DLX index.
The purpose of this was to provide the investment sector with a standard benchmark for the private debt asset class and to track the performance of companies that provide debt capital to unquoted companies.
Why we pioneered a listed direct lending index
Since the global financial crises, private debt has become its own asset class for investors. This has been driven by attractive post-global crisis credit opportunities and as a lucrative alternative to the low yields observed within traditional fixed income and credit markets.
Investors’ access to this market was nigh on impossible previously as it is a notoriously challenging one to track – a niche market without any standard definitions. The DLX Direct Lending Index overcomes this for investors, broadening investor access on a systematic basis that allows them to benefit from this burgeoning asset class.
The index itself, is based on a representative universe of stock market listed debt companies. As of August 31, 2022, a total of 41 companies can be identified worldwide.
And because the performance benchmark is a stock index based on market prices, this also allows for a direct comparison with other indices or benchmarks.
Performance versus the broader maker
Over the entire observation period since the global financial crises, the DLX Direct Lending Index shows an annualized geometric mean return of 10.35% with a standard deviation of 21.34%.
The MSCI Financials returns over the same period was 6.05% with a standard deviation of 19.03% (figure 2).
Figure 2 This figure shows the cumulative total return of the DLX Direct Lending Index vs. MSCI Financials Index from 31.12.2009 to 31.08.2022 based on daily data in USD (Total Return with dividends reinvested). Source: LPX AG.
We may be able to attribute the DLX Direct Lending Index’s outperformance versus the broader market, to certain attractive investment features:
- A high risk-adjusted return on average
- And a low correlation to traditional equity markets
- Stocks listed on the Index also have a comparatively high and stable dividend yield (figure 3 – 93% on average, as measured from 2009-21).
Figure 3 – Dividend yieldThis figure shows the average dividend yield (in percentage) of the DLX Direct Lending Index from 31.12.2009 to 29.12.2020. Source: Bloomberg, Dividend Indicated Yield – Gross (FLD: DV013).
For investors who focus on a steady dividend payment
Empirical results suggest that the integration of private debt into the strategic asset allocation improves the risk and return menu for an investor in stocks and bonds.
The stocks included in the DLX Direct Lending Index have a comparatively high and stable dividend yield. Against this background, we think the asset class is particularly attractive to investors who focus on a steady dividend payment in their asset allocation.
