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Private credit may offer opportunity for ultra-high-net-worth investors

Risk tolerance and liquidity needs are two key factors in determining which fixed-income-type instruments are right for a portfolio

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With interest rates at near-record lows, ultra-high-net-worth (UHNW) investors with a focus on wealth preservation face special challenges. But they also have certain advantages – including a longer time horizon with which to make their money work for them.

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That opens up potential new fields of investment that might be too risky for investors with average sized portfolios, notably private credit funds, which are less liquid and transparent than publicly traded funds, but which might also provide a much higher reward.

“If you’re high-net-worth, and you don’t need the money tomorrow, it’s a reasonable place to build a portfolio and I think it provides a better risk-return profile than the publicly traded high yield market,” says Greg Thompson, executive chairman of Focus Asset Management, a privately owned high-net-worth wealth management firm in Toronto.

“We think there is opportunity in private credit. Over half the economy is private,” adds Thompson, who explains that banks have had to become much more conservative in their lending practices as a result of the 2008 financial crisis, thus opening up new opportunities in private credit.

Private credit is a legitimate class, but should not be overweighted. “We would not be comfortable having much more than 40 per cent in private investments across the board,” Thompson says.

“Most people would think that’s a large number. But with UHNW investors we’re dealing with people who, for the most part, do not need the money. Most of the money is earmarked for things like estate planning and charitable giving upon death. It’s more about the longevity of their capital preservation of what they’ve built up,” he elaborates.

If you’re high-net-worth, and you don’t need the money tomorrow, it’s a reasonable place to build a portfolio.

Greg Thompson, Focus Asset Management

Mike Stritch, chief investment officer with the BMO Family Office in Chicago, says that many UHNW clients in particular are gravitating toward the illiquid end of the investment spectrum.

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“There are all kinds of different solutions in that space. You can be a lot more targeted, too, when it comes to private investments – anything from real estate, to oil and gas royalties, infrastructure, and private credit offerings that are maybe a little bit more leveraged,” says Stritch.

These investments can potentially generate annual returns in the high single digits, or maybe even lower double digits, depending on the strategy, he adds.

Private infrastructure, such as a windfarm or water purification plant, is an asset class that UHNW individuals should consider investing in, says Thompson.

These projects typically return in the range of 7 to 10 per cent annually. There is very low volatility in that asset class. It is equity, but behaves more like fixed income, providing a higher yield. Project earnings, paid on a regular basis, such as quarterly or semi-annually, provide very stable cash flow streams, he explains.

“Private credit is a very broad kind of category,” says David Wong, managing director and head of portfolio solutions at CIBC Asset Management in Toronto.

“Private infrastructure would tend to be a bit on the safer side of that spectrum. If that underlying asset is an essential part of an economy, then those are pretty good assets to lend against,” adds Wong, who also manages CIBC Asset Management’s research and investment oversight functions.

From a pure economic-financial standpoint, higher-net-worth individuals have the means to put more money in illiquid investments because they do not, for example, need to generate cash flows for immediate living expenses over the next several months, Stritch says.

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“That money potentially has a much longer horizon and can withstand market downturns without having to dig into that principal,” he elaborates.

Moreover, UHNW investors are often entrepreneurial individuals who understand that a lot of wealth might be tied up inside of businesses, because that is how they run their own enterprises. So they are generally comfortable with the idea that they do not have access to their money right away, adds Wong.

But that is not always the case. Some people are unwilling to accept less liquidity, even if they are in a strong financial position to do so. “There’s an emotional component that is independent of net worth,” explains Stritch. The thought “‘Do I want to have the ability to access my money immediately or not?’ is something that should be considered across the board regardless of wealth level.”

Risk tolerance and liquidity needs are the two key factors in determining which instruments are right for any investment portfolio, Stritch notes.

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