The coronavirus financial meltdown has changed the way we live and invest. Therefore, most ordinary financial advisors are unprepared for what has already come and what is coming soon. Family offices have been ready and, in fact, taken advantage of the economic transitions to thrive. One such strategy that is not much known in ordinary investment circles is private debt. While other economic sectors are melting, private debt is thriving due to the increased global demand for this product.

Today, we introduce you to a truly amazing series of fund products that focus on private debt and bring returns of 8% and above in USD with a high level of liquidity. It is hard to believe for the ordinary investor, but such returns are average and nothing to brag about for family offices. Indeed, as we will show you below, private debt is safer than secured mortgage debt. This is a high-income, relatively low-risk strategy that only opens to accredited investors and understands the principles involved.

Why can private debt be a good investment for family offices?

Family offices need various elements to work out well. An excellent tax residency to reduce your tax exposure is the first step. A Fort Knox-level trust, so your assets are completely safe, is also vital. And, of course, a second passport to be safe from government persecution, and increase your quality of life if you come from the developing world.

However, if a family office is much more than just guarding your wealth, it’s also about multiplying it. The mere concept of family office implies that it is intergenerational, which means it should be generating more wealth, not stagnating it. Thus, your family office is incomplete until it does not include an investment portfolio to magnify your wealth and establish a strategy according to your needs.

The issue is that most of these investments are highly illiquid. Private equity, structured products, real estate, among others, generally need a medium-to-long-term period before you start seeing earnings and receiving liquidity. That’s not the case with private debt. Plus, you will receive similar returns as with private equity, but with way higher liquidity. All this makes private debt a potential element in your portfolio diversification strategy.

Thus, private debt can become an essential part of your intergenerational wealth strategy. There are many reasons why:

• During COVID-19 times, traditional assets, such as bonds and stocks, have low expected returns. Even for a long-term strategy using S&P 500 and similar vehicles, private assets can be as safe and bring more returns.

• However, private assets are not generally liquid, especially private equity. Generally, the less liquid an investment is, the higher the expected return. However, private debt is both highly liquid and offers high returns, around 8-16% per year. Thus, the most liquid private debt assets offer about the same returns but with higher liquidity.

• Private debt liquidity is high because the investment period is only a few weeks or months.

• Yet, most private debt funds are accessed to close-ended structures with 7–10-year investments. They are focused on short-term direct lending.

• The private debt products come with robust collaterals, guarantees, and insurance, which means they are a moderate risk investment.

• Private debt has predictable performance. It generates positive performance with reduced volatility.

• Private debt generates way superior yields to bonds at the same risk level.

Now that you know some of the advantages let’s start explaining the details.

What is private debt?

Private debt is any debt held or extended by private companies. It comes in dozens of forms by the most common is loans from non-bank institutions to private companies or buying these loans on another market. Private debt funds are a common investment and come in many forms: direct lending, distressed debts, real estate, mortgage, infrastructure, among others.

The company that handles the investment pays back the loan’s full sum and the interest generated. Some private debt funds provide capital to sponsored borrowers, other fund mortgages or infrastructure, real estate developments, and others focusing on distressed assets.

Private debt is at the same time a relatively unknown and relatively prevalent of the private market.

It is about 10-15% of the assets under management with most markets, at least if they are in the mid-range, holding at least a small percentage of private debt.

Private debt funds are on their rise because they bring strong returns, with a relatively low risk of diversifying assets and diving into private funds.

This market grew enormously after the 2008-2009 financial crisis because banks faced new lending restrictions, meaning that many investors and project managers looked for alternative borrowing opportunities. Plus, with high-yield opportunities being scarce in public markets and interest rates at an all-time low, investors wanted new strategies. And private debt funds were one of the chosen paths because they serve as direct lenders to mid-level companies and leveraged buyouts, meaning they could provide a higher yield.

In fact, if you look for the lowest five-year annualized performance since 1992, private debt is one of the best performers; along with developed market buyouts it is the only one with positive returns even in their worst five years, with 5%. High yield bonds, leveraged bonds, energy stocks, venture capital, global equities, real estate, and real estate trusts, all have performed far worse than private debt.

What do private debt funds do?

Private debt funds raise money from investors and then lend them to a pool of companies. On the one hand, it provides borrowers access to alternative lending sources than traditional banks and provides investors access to high-liquidity, high-yield, safe investments. Since the financial crisis, debt funds’ overall value almost tripled globally in just a bit more than a decade.

U.S banks stopped taking on investments they consider risky. Thus, many mid-level companies had a hard time finding funding for their business; they sought private investment, meaning private debt funds grew significantly. 

This form of investment is common among P2P lenders, which cut out the middleman, i.e., the credit institution or bank that usually borrows the money.

Banks aren’t in the process, so borrowers have a higher chance of receiving it, but it also has higher interests, which means it provides a higher yield for investors. Plus, borrowers have the opportunity to receive money from different individuals and companies instead of one institution.

Private debt funds provide and manage loans in a portfolio instead of investing in the debt per se. Plus, they do not invest in any public market, meaning it avoids the unpredictability of investing in stocks. These funds generally manage an entire portfolio of funds, sometimes for specific markets, made by individual investors, whether they are companies, family offices, or individuals. Some of these funds may be worth dozens of millions of dollars, meaning they usually require a minimum investment to gain access to the fund, and this amount can be as high as $1 million.

One of the advantages is that they allow access starting at $150,000, which is a relatively low amount even for small family offices that are just beginning.

Why can private debt be better than private equity?

There are all kinds of investments for all types of investors. There’s no single-best one-size-fits-all investment. However, family offices, which generally look for longer-term investments, might see private debt as an investment that is way safer than a stock, and comes with higher yield and liquidity.

Private equity funds are also a common option for family offices, but how can they compare to them?

• Private equity is less liquid than private debt. According to ordinary wisdom, this would mean it also has a higher yield, but with an adequate private debt strategy, that’s not the case.

• Private debt funds sometimes are open-ended, while equity is almost always close-ended.

• Private debt generates returns from loan interest, while private equity does so by increasing the value of a group of companies.

• Private equities own a portion of several companies. In contrast, private debt covers a loan where the money is lent to a company or individual. The loan is secured against an asset, such as property.

Why choose private debt funds?

All family offices need tailored solutions and diversified portfolios. Sometimes they undergo internal changes, such as tax residency, acquisition or sale of assets and business, intergenerational change, etc. All these situations call for a new strategy and better advisory.

These types of services work well with various family offices, especially Latin American family offices, to offer varied wealth management solutions, adaptability, and long-term strategies.

They are mainly specialized in offering private debt funds as part of the overall strategy but offer a wide array of services, including:

Insurance

• Advice choosing life insurance

• Advice choosing HCM insurance

• Advice choosing travel insurance and family protection insurance

Monitoring and reporting 

• Preparing consolidated reports of bank accounts, real estate and other assets.

• Monitoring the diversification of assets.

Legal, tax, and accounting

• Incorporation and maintenance of companies in an array of jurisdiction

• Immigration and residency assistance

• Accounting and tax advisory, planning a tax optimization strategy

Fiduciary services

• Diagnosing the structure of your patrimony and organizing accordingly

• Serving as trustee and foundation council members and structuring these protection structures

• Custody of legal and accounting documents

Asset management

• Diagnosing your financial situation

• Defining investment goals, risk profile, and strategy

• Allocating assets and designing an investment strategy

• Managing private funds and access to private equity and private debt opportunities.

Private debt funds

There's a wide array of funds established under the SICAV structure (similar to what is known in America as an open-ended mutual fund) as a Luxembourg Reserved Alternative Investment Fund.

The private debt world can be divided into open-ended and closed-ended funds. The open-ended funds are usually more liquid, last less, and bring returns similar to private equities. Some of these are:

• Trade finance

• Factoring

• Real estate bridge loans

• Receivable monetization

• Consumer finance (it is in a middle way between open-ended and close-ended)

Close-ended private debt funds are more illiquid, last longer, and, therefore, are riskier, but also have the possibility of yielding higher returns.

Some examples of these are:

• Mortgages

• Equipment leasing

• Distressed assets

• Venture debt

The key is to focus on short-term, direct lending vehicles with strong collateral, which is the safest area in private debt funds.

Thus, there are four funds in particular:

Global lending opportunities

• Diversified fund focused on liquid private debt

• Monthly liquidity + 45 days’ notice

• No leverage

• Management fee of 1.25%

• Performance fee of 10%

• 8% return per year

Real estate lending fund

• Funding of short-term loans for real estate

• Monthly liquidity + 90 days’ notice

• No leverage

• 1.5% management fee

• 10% performance fee

• 8% yearly return

Factoring fund

• Buying invoice from companies at a discount

• Monthly liquidity + 90 days’ notice

• No leverage

• 1.25% management fee

• 10% performance fee

• 10% yearly return

Litigation finance fund

• Provides funding for claims in financial schemes

• Quarterly liquidity + 180 days’ notice

• No leverage

• 1.6% management fee

• 20% performance fee

• 8-16% return per year

These are sound options, but the Global Lending Opportunities Fund is probably the best for family offices because of the level of diversification it allows, which is one of the most important factors for any family office.

This fund aims to have a high degree of diversification with thousands of positions in different sectors and jurisdictions. It is focused on short-term, high-yield strategies with a cash-on-cash return, meaning they are made with short duration (most of them have a maturity of less than 50 days) and high compound).

The fund targets an 8-10% net return per year with no negative months, monthly liquidity, and an optional 6% dividend per year in four quarterly possibilities.

It is a good option because it basically includes the elements of the other funds available:

Factoring and receivables

• Buying invoices from companies at a discount

• Has guarantees and collateral

• Matures at 180 days tops

• 8-14% return per year

Trade finance:

• Funding transportation of commodities

• Comes with insurance, collateral, and guarantee

• Average duration of three months

• 6-10% returns per year

Credit opportunities

• Opportunistic financing

• Collateral and personal guarantees

• Widely variable duration

• 8-18% return per year

Bridge financing

• Funding short-term real estate financial needs

• Comes with the first lien on real estate and shares of the borrowing company

• Variable duration, 3 to 24 months

• 8-15% return per year

Conclusion

For private clients and wealthy families, bonds have always represented the bulk of any investment portfolio. They protected against inflation, they generated cash flows and they were relatively safe compared to the speculative equity markets. 

Since central banks and governments pushed interest rates lower and lower since the 2008 financial crisis, the amount of debt carried by companies and governments exploded, and yield paid to investors was sent to the floor. This is the textbook case of a bad investment environment. 

When global investors all decided to go for riskier and riskier bonds to satisfy their yield needs, some others turned to public and private equities. The asset management team decided to think outside the box. They explored any other type of debt investment that could provide much better value to investors than bonds. Many options were found: peer to peer lending, single-issuer private bonds, closed-end debt funds, and quickly realized that one niche market offered the best risk-reward ratio: the short term and diversified private debt funds.

Thus, they specialized in the area and went for the best managers worldwide. They interviewed dozens of private debt managers, went through an extensive due diligence process for some, and found the best-in-class PD manager, and invested exclusively with them for private debt.

We're talking about an asset management company targeted at private debt with a global presence in the EU, London, Panama, Switzerland, and Brazil and handle over $800 million in investment funds.

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