Episode 79

FEBRUARY 1, 2023

Laila on operational considerations for investment grade private credit investors

Laila Dunphy, Director of Insurance Client Relationships at SLC Management, discusses what private credit investors should consider when entering the asset class.

Steve Peacher: This is Steve Peacher from SLC Management today I'm with Laila Dunphy, who's on the client relationship-side SLC, focused on insurance companies. Thank you for taking a few moments today.

Laila Dunphy: Thanks so much for having me, Steve. I'm really excited to be here.

Steve Peacher: So, in past podcasts, we’ve spent a lot of time talking about what we call private fixed income, private credit, but on the investment grade front, in particular which has been an important area for insurance companies for a long time, certainly an important area for SLC. And we want to talk about that today not so much the investment merits, but what do you need to consider from an operational perspective if you want to invest in this asset class? And there are different ways to invest in it. But there are different things you have to consider. That's what we're talking about today, maybe we can start by just at the high level - how do investors access private credit? What are their options, and maybe to help explain that what are some of the kind of vehicles that we offer at SLC to allow clients to invest in the private credit?

Laila Dunphy: Sure. So, there’s a number of ways that that investors can access private credit. There is direct investment and fund investment opportunities within the private market. SLC has a number of U.S. and Canadian based fund offerings, and we also offer custom private credit portfolios via a separately managed accounts or SMAs. There's several economic considerations unique to each investor, you know, liquidity, ramp up, customization, etc., to assess the most suitable vehicle. But there's other hassle factors as we like to refer to them, namely operational needs that might be under appreciated when venturing into this market.

Steve Peacher: When you think about these operational considerations and you think about the vehicles you might go into, to what extent does the owner does ownership structure have an impact in in terms of the choices that a a potential investor might make or the issues they're gonna have to, you know, think about dealing with?

Laila Dunphy: Ownership structure actually has some pretty heavy implications for operational need in private credit. When you invest in a fund, assets are held by the fund and ownership is held in a share interest. The fund operational needs are handled by the admin or manager, and that's not the case for SMAs. When you're investing directly in these assets really, all the operational need is on the client or their manager. It's something that’s much more onerous than they may be used to in their private mandate or in their public mandates. And there's additional steps that automation that may not be captured in this asset class that are that can be implemented elsewhere.

Steve Peacher: So, that kind of gets into operational consideration. So, get you maybe delve in that a little bit. If someone decides to invest directly in these underlying loans and through it separately managed account an SMA as opposed to through a fund, they're gonna do it directly. What are some of those operational issues that they need to consider when they when they implement the strategy and when they execute on it?

Laila Dunphy: That's a great question, Steve. Given the bespoke and physical nature of private credit, many typically automated operational functions require manual intervention. It doesn't allow for electronic trading, assets aren't or stored in a in a vault, delivery has to be tracked and accepted for safe keeping. All post spending changes have to be manually communicated. So, anything that you might be able to electronically communicate on your core fixed mandate. You're gonna need to reach out to somebody and say, hey, I’m changing my custodian I need you to notify each issuer or paying agent with updated payment instructions or updated reference information. It's not something that you can just do with the click of a button. There's a lot more communication that needs to be manually handled. Additionally, you'll need a flexible cash management program to accommodate for changing funding dates with the confidentiality in lack of publicly available data you can't just pull data from Bloomberg. You can't just look up an issue and run analytics like you would on public debt. Coordinating with third party servicers is very important. Your manager, your custodian, your accounting provider, should all be in alignment and timing variances are very common in this asset class because of the manual nature of assets. So, we do need to be really diligent about our reconciliations and making sure that everybody is aligned. You can't have any breaks coming over a reporting period. There's just so much greater opportunity for human error. That’s one of the it's one of the many reasons it's so important to have a trusted partner in this space and when implementing a private strategy, and that's really how we view ourselves when and our clients at SLC Management. We're an extension of their team, and we're partners.

Steve Peacher: One of the challenges that you reference, this is simply that you know what with a lot of these deals you can be drawn down at different times. You can commit to a certain amount, and then the user of the funds will call you at different points of time, and say, those who signed up for this deal have to now forward, cash. It's not all done at once, so that's just one of the many considerations. You know what we're not talking about today, but those who listen to past podcasts you might say, why would I do that? That's a lot of operational hassle. The reason is that from an investment standpoint the private credit markets have proven to provide really nice premiums over public markets for similar ratings, and even at similar ratings you end up in in some respects having lower risk if you know the market well, because you have so many more protections built into deals so that if something goes wrong you're in a much better position to have better recovery. So, there are a lot of good economic reasons to go in to this asset class, but you gotta go in the eyes wide open. It's not as easy as just buying public bonds on an electronic trading system. When you buy it, and then, as you own it, especially if you're gonna do it through an SMA. I think that's a lesson from your comments. Let me let me switch, I like to ask a personal question. We were talking before about how for a long time you've been lover of animals and have channeled that by getting into animal rescue and volunteerism and things. But then you're also relating a story about basically how the personality of one of those animals has gotten in the way in a in a way. So, tell me about that.

Laila Dunphy: So, what I’m an avid animal lover. I fostered animals. We used to foster dogs, used to being the operative word there. We fostered kittens now, but we stopped fostering dogs because our resident dog, every time we brought in a new, a new puppy, faked an injury. The last time he faked a broken tail that cost thousands of dollars to diagnose and treat, only to find out that he was faking the whole thing.

Steve Peacher: Well, it sounds like you have a dog that should be in the circus who can actually fake injuries. I don't know how you think a broken tail that's pretty sophisticated stuff. So,  you gotta take this show on the road because…

Laila Dunphy: That's not a trick that we taught him.

Steve Peacher: Yeah, to be a reality TV show, I think. Well, listen. Thank you very much, you know, for diving into some esoteric but really important issues for those who are considering the asset class, and thanks everybody for listening to this episode of “Three in Five.”

Laila Dunphy: Thanks so much, Steve.


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