Negative Interest Rates Increase the Attractiveness of Private Debt

Private Debt Boutique

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Katch Investment Group is an asset management company dedicated to liquid, senior-secured private debt, focusing on investment strategies where capital is scarce with relatively high and stable returns.

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Years ago, it would have been unthinkable to contemplate that Interest rates, which are the cost of money, could ever be negative. What this means is that the lender, or investor, will have to pay in order to lend his money, in short, he is assured of a loss, which doesn’t make any sense at all; yet the problem is that this is now a fact in developed economies.

Almost 1/3 of the global bond market (US $16 trillion) offers returns below 0%. Both short- and long-term bonds issued by the governments of Germany, Denmark, Finland, and Switzerland offer negative rates. These governments are rewarded for issuing debt, as they will have to return to bond buyers less money than they collected. Even more surprising, the third-largest bank in Denmark called Jyske Bank has begun to grant 10-year mortgage loans with annual rates of -0.5%, the bank must now pay consumers, and to put the cherry on the cake, approximately 3 % of global bonds offer interest rates greater than 5%, something never seen before.

How did we reach this point? It all started when, in 2012, Denmark’s central bank reduced its reference interest rate to 0.20%. Later, the European Central Bank and the Central Bank of Japan reduced its rate to –0.10% in 2014 and 2016, respectively. Today, “the negative interest rate policy” (NIRP) is another tool in the arsenal of unconventional monetary policies of central banks to face deflationary pressures, unwanted appreciation of currencies, and disappointing rates of economic growth. It’s no coincidence that central banks covering about ¼ of the world’s GDP have negative benchmark rates.

The only one not currently treading this unchartered territory is the United States. However, interest rates in the world’s largest economy have fallen dramatically and are not indifferent to the global environment. The 10-year Treasury note currently offers a yield of 1.7%, accumulating falls of about 100 basis points during the year, in August alone the fall amounted to 40 basis points.

At the moment, the inflection point is still out of sight, the fixed income market is becoming increasingly riskier and less attractive, and if you want to obtain good returns on traditional investments you must be prepared to assume a fair amount of risk. So where can investors find attractive returns? Private debt is an interesting option.

This asset class shines in an economic environment of high uncertainty, high levels of volatility, and low, and even negative returns, because it provides benefits such as low volatility with deviations below 2%, solid collaterals, excessively low default rates, stable returns, and low correlation with traditional markets.

The Katch Global Lending Opportunities (GLO) fund offers these and other benefits, such as short duration, as the term of the loans is normally between three and nine months, being little sensitive to the movement of interest rates and with a lower credit risk, with more predictable economic environment, financial stability and credit profile of the borrower. On the other hand, all the fund’s loans have solid guarantees and the amount borrowed does not exceed 70% of the value of the asset that backs it.

Diversification is another great feature of the Katch GLO fund, with exposure to different strategies (factoring, bridge loans, commercial financing, amongst others) with no correlation between them and different geographies, such as Brazil, the largest economy in Latin America, which, although it contracted by 6% in 2015, during the strongest recession in at least 50 years, the default rates in factoring remained below 1%.

Loan terms, such as those mentioned above, largely help to explain the low default rates. For example, in the commercial financing strategy, the default rate in the last 15 years, including the Great Financial Crisis of 2008, has been 0.1% vs. 3.5% of that in high yield bonds. Additionally, the recovery rate is high, close to 75%.

Negative Interest Rates Increase the Attractiveness of Private DebtIn conclusion, in an environment of low, and even negative, interest rates, private loan funds such as the Katch GLO fund, are quite attractive, thanks to their characteristics such as a very low correlation with traditional financial markets because they operate in completely different niches, the strong guarantees that substantially reduce credit risk and allow for very high recovery rates in cases of default, as well as to high and very stable returns with very little volatility, are a great option to complement investment portfolios.