Episode 13: Introducing the MD Platinum™ Global Private Credit Pool

Greg, can you explain what MD Platinum is and what purpose it serves to investors?

Greg Scott [1:02] Sure, I’d be happy to. MD Platinum is the name of a specialised offering of alternative investment solutions that are exclusively available to our MD Private Investment Counsel clients. We introduced our first [MD] Platinum offering, the [MD Platinum] Global Private Equity Pool in 2018, followed by the [MD Platinum] Global Real Estate Pool in 2019. We’re excited to now be starting the subscription period for the introduction of [the MD Platinum Global] Private Credit [Pool].

Alternative investments, which have become an important and growing part of investment portfolios for large institutional investors, provide diversification opportunities beyond the traditional investments of publicly traded, domestic and global stocks and bonds. This is because, when introducing these asset classes into a portfolio, they can have lower correlation than traditional investments. The old adage of when the U.S. sneezes, Canada catches a cold exemplifies that. Although the markets don’t have the same performance, they can be highly correlated, and often move in the same direction. This has become more of the case, over the years, as global macro conditions can affect markets worldwide.

When alternative investments, such as private equity, infrastructure, and real estate are added into a well-diversified portfolio, the performance can be attributed to different factors and or to a different magnitude. When these lower correlated investments are part of a well-diversified portfolio, they can provide potentially higher returns for the same or lower level of volatility.

So, MD is not new to making alternative investments available to our clients. In fact, we’ve been offering this in the form of liquid alternatives, as part of our clients’ portfolios since 2013.

What makes our [MD] Platinum offerings different is that they’re closed, limited partnerships that our clients can subscribe to. Our clients commit a certain dollar amount that will be invested for up to a predetermined timeframe, so for example, 10 years, of which the money is locked-in for that period of time. We provide a 6-month subscription period to determine the total amount of committed capital that’s raised by our clients to be directed to investing into these offerings. When the subscription period closes, the money is then available to be invested as the most optimal opportunities present themselves. This means that our managers will call capital to make investments for the first number of years in the commitment period, and throughout the latter part of the period, sell the investments. Clients will receive cash flow back in a combination of capital gains, return of capital and income throughout the investment period. At the end of the locked-in period, the remaining capital will be returned to investors and the limited partnership will be wound down.

MD has partnered with world class managers such as BlackRock for [MD Platinum Global] Private Equity [Pool] and Metropolitan for [MD Platinum] Global Real Estate [Pool], to give our clients access to their specialised expertise and global reach that would otherwise only be available to institutional investors, or high net worth individuals at a significantly higher entry level.

We believe that introducing our [MD] Platinum Global Private Credit Pool will generate a lot of interest from clients, particularly given the very low interest rate environment.

Can you provide an update on the MD Platinum Global Private Equity Pool and the MD Platinum Global Real Estate Pool?

Wesley Blight [4:29] Absolutely happy to. Thanks Alex. [The MD Platinum Global] Private Equity Pool, it’s performing inline with our long-run expectations. It’s a well-diversified fund. It’s got exposure to a wide range of sectors, asset classes and well-established fund managers. The fund committed more than 80% of the commitments that were received from our clients. And more than 35% of those client commitments have been invested already, through the end of 2020.

In terms of the type of investments, the fund is very much tracking inline with our long-run target allocation that we had expected when we first created the fund. 45% has been invested in primary investments, 13.3% has been invested in secondaries, and 23% have been invested in direct deals. Those are deals that we have funded directly to the private equity company themselves.

Regarding the sector exposure that we have, industry diversification is broad and cyclical businesses remain low as expected, in that we don’t have a material exposure to cyclical businesses like energy companies. We do have an increased allocation to stable information technology companies, industrial companies, and diversified businesses take the majority of our allocation. Through the end of the 3^rd quarter in 2020, the internal rate of return was 14.96%. And the multiple on invested capital was 1.17.

The [MD Platinum] Global Real Estate Pool, it’s similarly on track with our expectations and US$17.3 million has already been invested through the end of 2020. And although the pool is new, the investments that are held have already generated an internal rate of return of 13.3% and a multiple on invested capital of 1.06. That’s all through the end of the 3^rd quarter of 2020.

And we think about what transpired in 2020, with COVID and the pandemic, the economic impact to real estate has really reinforced the value of having a well-defined risk framework in which we target properties that have a low correlation to GDP growth, and seek insulation from cyclical factors, similar to avoiding the cyclical companies that I talked about in the [MD Platinum Global] Private Equity Pool.

In real estate you think of an office and retail properties during the pandemic induced lockdowns versus industrials, where warehouse requirements for e-commerce businesses have increased. So, making sure that we’ve got appropriate diversification and a well-defined framework has really helped us. And despite the negative consequences from the pandemic, the monetary policy response has pushed interest rates down and that’s improved the market value of the properties that are held in the [MD Platinum] Global Real Estate Pool. With more than 75% of committed capital not deployed, we are well positioned to benefit from post COVID pandemic opportunities.

MD Platinum helps investors solve certain problems. What challenges are investors facing today?

Greg Scott [7:35] The co-ordinated very accommodative monetary policies by central banks have driven interest rates to new lows. For over more than three decades, the decline in interest rates has been a positive for bond investors, as they have not only enjoyed previously higher yields, but also the capital appreciation that resulted from the declining rates.

At the current level of interest rates yields are substantially lower than in the past, leading less income being paid out from bonds as well as little opportunity for continued capital appreciation. This means lower forecasted returns from traditional asset classes.

Investors in traditional asset classes are facing two possible decisions. Number one, either increasing the risk within their portfolio to obtain higher total returns. So really, that means increasing their equity allocation. Or two, accept lower returns by continuing to invest in traditional fixed income investments, such as domestic government bonds, or GICs.

This is why investors are looking for alternative solutions to this conundrum.

We’ve launched the MD Platinum Global Private Credit Pool and its subscription period runs until September 1^st. What is private credit and how can it help investors?

Wesley Blight [8:54] Fantastic question. It’s an exciting asset class. It covers a wide range of investment opportunities that are broadly defined as non-bank lending. And importantly, the asset class’ investments do not trade on the public market. The asset class isn’t new, but it’s increased in both available opportunities and popularity with institutional investors.

And what happened was – the increased opportunities are really the result of updated bank regulation that happened in both the U.S. and Europe after the global financial crisis. And that made it more expensive for banks and traditional lenders to make and hold private loans. Private companies, however, still needed capital in order to fund their ongoing business activities, like new projects, other growth opportunities, needed loans to fund leveraged buyouts. And that vacuum was created by the lack of capital being supplied by traditional lenders like banks and the ongoing demand from private businesses contributed to the growth of private lending. At the start of the 2000s, banks made up roughly 60% of private loans, whereas financial companies and institutional investors were less than 30%. Today, institutional investors represent 80% and banks less than 10%.

The other side of this is demand. So demand from institutional investors – and this is very much aligned with what Greg was talking about – that demand has been growing largely as a result of falling interest rates and falling bond yields, and in turn a lower expected return for the future performance of traditional portfolios. We’ve all heard of the search for yield and private credit offers this solution by consistently delivering elevated income along with a focus on capital preservation. That’s true in what it’s been able to deliver in the past and that is the reason why we’re targeting an allocation to private credit for our clients.

Loans are originated by an asset manager, sometimes known as a general partner and there are also a variety of other sources that are out there looking to originate private loans. For our product, we’re seeking private equity sponsors, debt consultants and borrowing companies – they will be the focus. And after a rigorous selection process where thousands of lending opportunities are reduced to a few, general partners negotiate the structure of the loan directly with the private equity sponsor or the borrowing company themselves before funding.

The loans typically include covenants with senior debt providing greater creditor protection, and in turn, lower risk than subordinated debt, distressed credit and some specialty products that are all included in the asset class. Where the majority of our pool will be deployed, loans are expected to be held to maturity with an expected 5-to-7-year term. And while these loans are often prepaid, it’s very important to note that they are illiquid, there is no readily available secondary market and in addition to being a relatively inaccessible market, the liquidity premium that you get is a contributing factor for why the returns are materially higher than what you would expect to get from public bonds or what has been historically realised from public bonds.

Another plus from the asset class perspective is that the loans in private credit are typically floating rate. They usually have LIBOR or EURIBOR as a reference rate and that helps to limit the asset class’ exposure to interest rate risk.

The companies that typically access the market, the private credit market, are defined as middle market companies. And they have on average earnings between US$10 million and US$100 million. And if you took the 180,000 middle market companies from Germany, France, the U.K., and Italy, they would be a top 10 global economy on their own. In the U.S., the middle market consists of 200,000 companies, and employs 48 million people, and is 33% of private sector GDP in the U.S. That’s a powerfully large group of companies making up the middle market in Europe and in the U.S.

Companies that tend to be a little bit more resilient, in that they’ve got a better ability to repay their obligations, they have historically had a lower default rate versus levered loans. Levered loans are broadly syndicated. And partially because of the conservatively structured lending that are typical to the middle market borrowing company, we’re expecting that a recovery rate would be higher, should defaults actually occur.

What is our approach to private credit, the MD Platinum Global Private Credit Pool?

Wesley Blight [14:03] This is all about preservation. So, we know that when we enter into a loan, the upside for that loan is typically known. So, for the asset class, what we’re seeking to deliver is a target return between 6.5% and 8%. And everything that we do after we make the loan and we go through the process of funding the investment is to preserve our ability to realise that target return.

Appreciating that the upside of the asset class is known, we’re seeking wide sources of origination. And what that means is we want to have lots of different opportunities coming in so that we can evaluate the risk characteristics of those loans and have an opportunity to say no to a lot of opportunities and be really selective about the ones that we do actually pick.

Then we want to ensure that we have as much diversity as we can. So, by increasing the diversity, it helps to improve the probability of realising that target objective. And depending on the amount of capital that is raised through the subscription period, we’re seeking to select between three and 10 underlying fund managers, and we seek to have more than 200 loans within the [MD Platinum Global] Private Credit Pool.

The majority of those loans that will be held within the Pool are to be invested in first-lien senior secured loans and as I mentioned earlier, those are the ones that have greater creditor protection embedded in them. And that’s the reason why we’re looking for those as we go out and seek elevated yield while targeting capital preservation.

The target returns, as I mentioned, are 6.5% to 8% and it includes the moderate use of leverage to augment returns. We have gone through an exercise to make sure that the amount of leverage that’s being used as part of the product is limited. We don’t believe that we need to make extreme uses of leverage in order to hit our return target. So we’ve capped that at one time. So what that means is for the cash that is invested in the fund, we’ll have the ability to lend twice as much. We believe that will help us enhance the return and providing a valuable exposure to private credit.

Investing in senior loans is considered more of an all-weather strategy, it’s got less exposure to the business cycle. And in addition to being the highest rank in the capital stack, senior lenders typically negotiate structural protections via covenants that restrict the use of proceeds, it embeds restrictions on the ability to pay dividends, the lender has sometimes the opportunity to take board observation seats and get closer to the borrowing company, to better monitor the loan and the performance of those loans.

We seek to increase diversity, not just from having more than 200 loans, but we’re looking for broad industry diversity as well as diversity on a geographic basis. We’re targeting 60% of the loans to be made to companies in the United States and 40% of the loans to be made to companies in Europe.

Primarily the loans will be direct to private equity sponsor, or to the borrowing company themselves. And what we’re doing there is we’re seeking to maximize the control that we will have over the deal. What that means is, we want to have greater influence over the structuring of the loan, we want to have greater influence over the management of the loan. And should we encounter defaults, we want to be able to maximize the recovery and minimize losses. And one of the ways that you can do that is by making sure that you’re in [a] control position as you work through those challenges.

With the types of businesses that will be seeking, similar to what I was talking about for private equity and private real estate, we’re seeking to avoid cyclical businesses, so we have a limited exposure to companies involved in the energy industry. We will seek to have less than 30% exposure to a single sector. And we’re really looking for resilient companies with understandable business models, sustainable and stable free cash flow, we want strong management teams, we’re looking for recurring revenue, defensible market niches and diverse customer as well as supplier bases. So those are some of the characteristics of the companies that we’re seeking to lend to, that they will have.

The MD Platinum Global Private Credit Pool is a powerful portfolio building tool. How do you see the Pool fitting into client portfolios?

Greg Scott [18:49] That’s a really important question, Alex. Our starting point in any investment recommendation is to fully understand the purpose of the investment and what personal goals that it’s intended to fund. This allows us to determine the objectives as well as the constraints that include such things as how long to invest, liquidity needs over time, and how much risk our clients can take and be willing to take to meet their objectives. Ultimately, this determines the desired asset allocation and what required return we need to obtain those objectives.

Alternative investments, including private credit, will become a part of that well-diversified portfolio. Due to the previously stated lock-in provisions, we’ll ensure that there’s adequate liquidity within the rest of the portfolio to provide more immediate cash flow needs and then add the MD Platinum Global Private Credit Pool as a reasonable percentage in their portfolio.

There’s not a fixed percentage that we would recommend for all clients, but it should be a meaningful enough amount to make a difference to their overall portfolio returns. Generally, this could be from 5% to as much as 20% of the portfolio, but liquidity constraints and client preferences will ultimately drive that final allocation.

In some cases, clients may be using this as an opportunity to lower risk without reducing returns by taking a portion across their overall portfolio. For other clients who prioritize higher returns versus specifically reducing risk, they may target their fixed income component directly and move a portion of that to the MD [Platinum Global] Private Credit Pool.

Our MD Private Investment Counsel Portfolio Managers will work with our clients to understand those needs and preferences and provide advice on how to incorporate the MD Platinum Global Private Credit Pool into a well-constructed investment portfolio.

If you have any questions about these topics, questions about your portfolio, please don’t be shy. Reach out to an MD advisor. Whether you’re a client or not, we are here to help.

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The information contained herein provides key information about the respective MD Platinum™ funds and is not intended to be taken by and should not be taken by any individual recipient as investment advice, a recommendation to buy, hold or sell any security, or an offer to sell or a solicitation of offers to purchase any security. The Platinum funds described in this document are subject to additional terms and conditions set out in the Platinum funds’ operative agreements and regulatory suitability requirements as considered by the MD Private Investment Counsel Portfolio Manager. The Platinum funds’ operative agreements will also set out additional information about the investment objective, terms and conditions of such fund, tax information and risk disclosure that are a material terms regarding a fund. Any investment in a fund would be speculative and would involve significant risks. The information and strategies presented here are not suitable for U.S. persons (citizens, residents or green card holders) or non-residents of Canada, or for situations involving such individuals. Employees of the MD Group of Companies are not authorized to make any determination of a client’s U.S. status or tax filing obligations, whether foreign or domestic. The fund is intended for individuals that are discretionary managed account clients of MD Private Investment Counsel, an operating division of MD Financial Management Inc., which provides investment counselling services.

Management fees and expenses associated with investing in MD Platinum™ private funds may be higher than fees and expenses in public security funds. No guarantee or representation is made that any MD Platinum™ private investment fund offered will achieve its investment objective.

There are additional risks associated with investing in private investments that are not applicable to typical investments in the public securities markets. These risks include, but are not limited to, the following: private investment funds are speculative and involve a high degree of risk; an investor could lose all or a substantial amount of his or her investment; interests in private credit investments are illiquid and there is no secondary market, nor is one expected to develop, for interests in such investments; there are significant restrictions on transferring private credit investments; private credit investments experience volatile performance; private credit funds are often concentrated and lack diversification and regulatory oversight. Leverage may be employed, which can make investment performance volatile. Private credit investments are sensitive to factors such as changes in equity values of borrowing companies, interest rates, cash flow of underlying borrowing companies, loan documentation and structuring, and a manager’s skill as well as credit risks and tax and regulatory requirements.

MD Platinum™ is a trademark of The Bank of Nova Scotia, used under licence. MD Financial Management provides financial products and services, the MD Family of Funds and investment counselling services through the MD Group of Companies. For a detailed list of these companies, visit md.ca.

Certain information contained herein constitutes “forward-looking statements.” Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. As a result, the Recipient should not rely on such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements. The information contained in this document is not intended to offer foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals. Incorporation guidance is limited to asset allocation and integrating corporate entities into financial plans and wealth strategies. Any tax-related information is applicable to Canadian residents only and is in accordance with current Canadian tax law including judicial and administrative interpretation.

For further information on the structure, features and risks of the MD Platinum™ Global Private Credit Pool Limited Partnership, please consult the MD Platinum™ Global Private Credit Pool Limited Partnership Term Sheet and your MD Private Investment Counsel Portfolio Manager.