Five reasons to invest in mid-cap corporate private debt 

For several months, we have been navigating a more complex and uncertain environment, from a macroeconomic perspective:

• How deep will the economic slowdown be?
  
• How quickly will inflation subside?
  
• How far will monetary tightening go?

From a geopolitical perspective, the conflict between Russia and Ukraine has driven up energy prices and created tensions in raw material supply chains. This has fuelled concerns over a potential rise in corporate default rates.
And yet, we believe the midcap corporate private debt segment remains highly attractive for investors.

Here are five reasons why:

1.    Mid-sized companies, often seen as vulnerable, are proving resilient.
2.    Corporate financing needs, which are driven by various strategic imperatives, are significant.
3.    Our management approach is conservative, and our investment policy is characterised by a high level of selectivity.
4.    The asset class has benefited from dual repricing.
5.    Financing is increasingly incorporating non-financial criteria to support companies in their transition towards a more sustainable economy.

1. Mid-sized companies, often seen as vulnerable, are proving resilient

While corporate defaults have risen slightly, they remain below pre-Covid levels.
 
In France, business defaults returned to normal in 2022 and are expected to increase gradually in 2023.
Many businesses were hit hard by the pandemic and were forced to strengthen their business models. They emerged more flexible and agile and have maintained this discipline.
Moreover, the profile of the companies we target in our LBPAM Mid Cap Senior Debt fund provides reassurance against a potential increase in corporate defaults. These companies are typically leaders in their respective sectors. They are growing, demonstrating resilience and generally have solid governance structures, with shareholders capable of supporting them on key challenges such as decarbonisation, digitalisation, cybersecurity and the security and optimisation of supply chains.

2. Corporate financing needs, which are driven by various strategic imperatives, are significant

Many companies pursuing sustainable growth are set to undergo capital restructuring in the coming years. This includes capital transmission transactions (it is estimated that between 250,000 and 700,000 French SMEs, mid-sized businesses and micro-enterprises will see a change in ownership structure within the next decade ). This may involve allowing investments by financial partners, particularly private equity players, through minority stakes, but increasingly majority stakes too, often via deals requiring disintermediated financing. At the same time, human capital is regaining prominence in corporate structures. Many companies are now bringing senior managers into their capital structure, helping to secure loyalty and strengthen long-term growth trajectories.

 Other businesses are refocusing on core activities, resulting in carve-outs of non-strategic assets.

 Additionally, recent crises – the Covid-19 pandemic and the war in Ukraine – have highlighted the vulnerability of some French companies, which have become aware of their over-reliance on imports, particularly within value chains (raw materials, semiconductors, healthcare products, etc.). These new challenges are forcing them to rethink their organisation to make them more efficient and less exposed to geopolitical or health-related uncertainties (diversified, sometimes proprietary, shorter supply chains located closer to production sites). As a result, a growing number of companies are beginning to reshore both industrial and service activities.

Finally, the energy transition is giving rise to new needs and is supporting fundamental challenges for many sectors of the economy (e.g. the need to adopt cleaner processes in industry), in a sustainable way.
This breadth of need creates a rich and varied investment universe, allowing asset managers to be highly selective – a key advantage in building diversified portfolios.

Private equity: a natural source of deal flow 

Private equity funds aim to create value by strengthening the companies they invest in and positioning them for a successful exit.
This process of value creation is highly beneficial for the private debt market, which gains access to high-quality deals. We can therefore expect a robust pipeline of strong mid-cap deals in the coming months. In the past decade, the role of private equity partners has evolved considerably.
From being merely financial partners, they have become the true spearheads of growth, helping to deliver sustainable operational excellence and underpin coherent growth strategies.

3. Our management approach is conservative, and our investment policy is characterised by a high level of selectivity

Our management approach is conservative, and our investment policy is characterised by a high level of selectivity, which has been further strengthened in recent months – offering protection against default risk.
We have reinforced our due diligence processes to address the macroeconomic and geopolitical risks facing companies. This includes market due diligence, incorporating both sector-specific dynamics and broader structural drivers, financial, legal, tax, social and ESG due diligence.

Financing processes are taking longer, mainly due to tighter credit conditions and more in-depth risk analysis by financial institutions.

Access to management teams to discuss identified risk areas is systematic, and investment cases and financial projections are routinely challenged.

Transaction structures and financial projections are tailored to current conditions, incorporating the necessary safeguards to secure financing.

Legal documentation requirements are stricter than ever, with heightened attention to numerous protective clauses, including the implementation of robust security packages and covenants adapted to the issuer’s business cycle and activity, as well as to the transaction itself. Special attention is paid to issuer disclosure obligations, through enhanced reporting. Furthermore, given the current interest rate environment, strict interest rate hedging is mandatory. The result is highly structured, protective legal documentation.

4. The asset class has benefited from dual repricing

Floating-rate strategies like ours benefit directly from rising interest rates, which mechanically increase yield potential.

At the same time, mid-cap corporate private debt has seen a widening of spreads, offering an illiquidity premium relative to listed credit markets.

Another positive factor is that leverage levels are falling. For the companies targeted by our strategy, they are now below 4x, compared with 4.0x to 4.5x in spring and summer 2022.

Finally, our positioning in these transactions allows LBP AM to earn fees, which have risen significantly since the second half of 2022 – further enhancing returns for the Midcap Senior Debt strategy.

5. Financing is increasingly incorporating non-financial criteria to support companies in their transition towards a more sustainable economy

Origination channels and deal introducers, well aware of the importance of ESG issues, are becoming more structured, with some now integrating dedicated ESG experts.
As a result, non-financial criteria are increasingly negotiated and incorporated into legal documentation at closing. This allows for an even more comprehensive understanding of companies and the challenges they face within their sector, and helps support meaningful transition efforts.
This development is perfectly aligned with our ambitious SRI management approach. Our fund qualifies as an SFDR Article 9 product and is committed to sustainable investment objectives aligned with both environmental and social themes.

Today’s market conditions, characterised by:
1-    Lower leverage levels, partly coupled with more stable company valuations,
2-    Wider spreads, associated with a floored floating-rate strategy, and
3-    A tightly structured transactional framework, combine to create, in our view, a compelling opportunity to invest – or strengthen positions – in this asset class.

Disclaimer

Risk factors – corporate debt

General risks: 
•    Neither the management company nor the custodian guarantees the full and timely repayment of sums owed by debtors (with respect to purchased receivables) or by counterparties with respect to any forward financial instruments entered into on behalf of the Fund, nor the proper performance by contracting parties of their obligations under contracts entered into with the Fund.

•    There is no guarantee that the collateral or hedging mechanisms, if any, established for the benefit of the Fund will be sufficient in all circumstances to protect against the risk of debtor default. Unitholders may therefore be exposed to the consequences of defaults by debtors, counterparties to financial instruments, or other contracting parties.

Other risks: 
•    Investor risk assessment
•    Credit risk
•    Currency risk
•    Liquidity risk
•    Interest rate risk
•    Recovery risk
•    Prepayment or early repayment risk
•    Market and economic risk linked to the financing of private sector companies
•    Legal risk
•    Refinancing risk

This promotional document is for information purposes only. It does not constitute an offer or solicitation, nor a personalised recommendation within the meaning of Article D321-1 of the French Monetary and Financial Code. It does not constitute investment research (as defined in Article 314-21 of the AMF General Regulation) nor financial analysis (under Article 3.1.35 of EU Regulation 596/2014 on market abuse), for the purpose of subscribing to LBP AM UCITS. 
This document has been prepared using information and views that La Banque Postale Asset Management considers reliable. The information, opinions and data contained herein are considered by La Banque Postale Asset Management to be well-founded or justified as of the date they were prepared, taking into account the prevailing economic, financial, market and regulatory context. They reflect La Banque Postale Asset Management’s analysis, as of the date of publication of this document, of the relevant markets and their potential future developments.
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