Patient investors will benefit from an exposure to alternative credit
The growth of non-bank lending was among the causes of the financial crisis, but today it should be seen as a positive development overall. Both investors and policymakers should support it.
Some may argue that non-bank lending is not a great idea at a time of aggressive quantitative easing and slow economic recovery. The market is, in fact, sending some troubling signals. Private debt funds have grown dramatically in size since the financial crisis. Institutional investors have flocked to the sector. Loan terms have become looser, leverage is growing, return expectations are falling and the amount of uninvested capital by funds is at its highest.
This is a worryingly familiar scenario, leading many to question the ability of financial markets to allocate capital efficiently within a rapidly changing global economy.
However, from that perspective, non-bank lending is by no means the only sector of the economy that should have investors worried today. Valuations in liquid markets, such as developed market equities and fixed income, are relatively high as well. Inefficient allocation of capital appears to have become a persistent problem that will lead to more frequent crises. But that is a wider question that transcends more immediate ones about the shape of the alternative lending sector.
The perceived risks around the sector relative to others could well be exaggerated. Granted, it has become highly competitive. Current investors may incur losses in the short term, particularly if the market continues to grow at this pace. But that does not mean pension funds should shy away from it. Investors and managers have better awareness of the risks compared with pre-crisis times. Both lenders and investors tend to commit for longer than in the past. In the long term, the sector should stabilise. In Europe especially, institutional investors will play a significantly larger role than they did before the financial crisis.
To avoid losses, investors should be patient, favour lower-risk companies and choose managers with good processes and track records. Policymakers should facilitate cross-border investment but also keep sensible restrictions in place.
Furthermore, investors in alternative lending carry out an important job in the economy by trying to focus on innovative companies that will eventually take over obsolete ones. If done properly, non-bank lending could be transformative, embodying ‘good’ capitalism rather than the ‘evil’ one epitomised by the financial crisis. By supporting the more dynamic sectors of the economy, pension funds will ultimately benefit their members.
Carlo Svaluto Moreolo,
Senior Staff Writer