Private debt growing at an undiminished rate

Data provider Preqin predicts that this year, private debt will become the second-largest private investment category. In terms of size, private equity remains by far the largest category, but private debt will amply surpass real estate, infrastructure and venture capital. Whereas the latter categories were left treading water in the second half of 2022 and the first few months of this year, private debt continued to expand at an undiminished rate. And the end is not yet in sight. In the past decade, the growth rate averaged 13.5% and between now and 2026 we will see average growth of 17.4%, according to Preqin.

Initially, of course, the big numbers, the big deals and the big funds attract all the attention - hundreds of billions of euros or dollars in new funds per year are involved - but in the shadow of all that display of force the developments in emerging markets are no less compelling. Relevant data are collected by institutions such as the Global Private Capital Association (GPCA), a society of investors in private markets in Asia, Africa and the Middle East, Latin America and Central and Eastern Europe. According to the GPCA, 2022 was a record year, with USD 10.8 billion of new inflow, versus USD 5.7 billion a year earlier, an increase of 89%.

Florian Bankeman, Fund Manager Triodos Financial Inclusion funds

Financial inclusion

In emerging markets this inflow is received with open arms. Because in emerging economies access to financial services (also referred to as financial inclusion) is not exactly a given, especially not for small and medium-sized companies and the self-employed. But these are the companies that are needed to drive the economic dynamics in many countries, says the International Finance Corporation (IFC, part of the World Bank group). This institution estimates that in emerging markets around a third of the total private debt outstanding has been provided to this segment, which has 'huge potential' in terms of economic and social development.

Social economic development

"Especially since the pandemic, the funding requirement is enormous", says Florian Bankeman, fund manager for Triodos Investment Management (Triodos IM). “In fact, greater than we have ever seen before.” Triodos IM launched its first microfinance fund almost 30 years ago. Since then, two additional funds have been launched and together they have invested nearly EUR 900 million in financial inclusion. These investments consist of loans to financial institutions, which in turn provide loans to individual entrepreneurs and small and medium-sized businesses, which would not or not easily have qualified for loans from regular banks. The Triodos IM funds thus indirectly reach more than 20 million borrowers. Triodos IM also provides private loans in emerging markets in other sectors, such as renewable energy and the sustainable food sector.

Even though financial inclusion cannot solve all the problems in emerging markets, it certainly contributes to the social economic development of many people, and thus to their quality of life, says Bankeman. At the same time, this results in greater demand for financial services. Products and services that were previously not accessible (for instance for education and healthcare organisations) now come within reach of those groups and new local investments are required to be able to meet that demand.

Low correlation with financial markets

Does this expansion mean that private debt in emerging markets is becoming an attractive investment category for insurance companies and pension funds? “It already was as an impact investment, without question", says Bankeman. “And that is what we are emphasising; it fits with the mission of Triodos.” And, in addition, the financial return is more than acceptable: since its introduction in 2002, the current financial inclusion strategy has generated a negative return only in one year, in 2020, “due to the pandemic, which hit the real economy hard. The financial crisis in 2007 and 2008, on the other hand, did not impact its return, which was positive in both years.”

The default rates for these loans are traditionally very low, at less than 1%. A team of around 40 Triodos IM investment professionals (with 20 different nationalities) performs the due diligence and maintains close contact with around 100 financial institutions (in over 40 countries) to which loans are provided.

The fact that, furthermore, the correlation between the return on these loans and the price movements on worldwide financial market is low, does not need any further explanation. Bankeman: “People always need to eat, they need to be able to move about, they need education, et cetera. So a taxi company in Peru or an education institution in India, small shops in Mexico or farmers in Serbia: whatever happens, they will keep going, the real economy will continue to operate. That is the domain of these types of private debt.”

This is a translation of the interview published earlier on Investment Officer.