By Hamlin Lovell, NordicInvestor
Mandatum Life is a fully owned subsidiary of Finland’s publicly listed Sampo. Its other fully-owned subsidiary is IF, the largest P&C Insurance company in the Nordic Countries. In total the Group has assets under management of EUR 22 billion. Mandatum has been allocating client capital and proprietary capital to private debt strategies since 2008, and currently has approximately EUR 1.5 billion invested in the space. NordicInvestor asked Mandatum’s Head of Alternatives, Jussi Tanninen (pictured above), and its portfolio manager for private debt, Matias Hauru, what they seek from external managers.
Mandatum researches at least 100 private debt managers each year and allocates to between 6 and 8, with a wide range of return targets. “The private debt market is broad and targeted returns vary a lot between sub-segments. Return targets could range from 6% for a more conservative strategy to 10% or even 15% for a more complex strategy or one focused on smaller companies. This means that some private debt strategies can offer returns comparable to private equity”, says Tanninen.
Mandatum allocates to managers in the US and Europe. Until recently, the high cost of hedging from USD back to EUR meant that the US allocation had to focus on more complex strategies offering higher yields, such as distressed debt or special situations. Now, the drop in US interest rates means that the US and European strategies can be more evenly balanced in terms of risk profiles.
The geographic split is only one aspect of diversification. “We want to be diversified over multiple segments and funds. We diversify by lender, timing of vintages, and strategy. We build a portfolio of private debt funds with different sources of risk and return. We are taking a longer-term view”, says Hauru. Mandatum mainly invest in the longer duration space, in closed end funds with maturities of between three and ten years.
Covenants and collateral
Mandatum has allocated to funds lending against cashflows or assets (though their real estate debt comes under the umbrella of their real estate portfolios).
Stronger covenant protection is a key attraction of direct lending relative to public credit markets. “In the bond and loan markets, we have not had proper maintenance covenants for a while now, but still have them in the direct lending market. Terms in direct lending had been deteriorating a bit, but early indications show that this has stopped or reversed since Covid 19”, says Hauru.
Collateralisation can also be much better in private markets: “even before Covid, we were very cautious on private equity related buyout debt due to the multiples. Leverage multiples in public credit markets had been escalating to all-time highs in 2019, even before the earnings add backs, which were in some cases completely ridiculous for syndicated loans”, says Tanninen.
Matias Hauru, Portfolio Manager Private Debt, Mandatum Life
Investing through the cycle
Mandatum has been active in adding to distressed debt in 2020, but in general is not really making calls on timing the cycle. “We have a long-term strategic allocation to private debt and allocate through the cycle to smooth out timing risk. We allocate to 5-8 funds per year and may invest in consecutive vintages. We have often invested with managers for many years, investing in four or five vintages”, says Hauru. Mandatum’s multi-manager private debt strategy also has a series of its own vintages, with the latest one having had its first closing in April.
Covid 19 and defaults
Covid 19 has not changed the longer term attractions of the strategy. “We do not have full visibility yet, but the early indications are that Covid-19 has increased yield pickup by 1-2%. We do not have a crystal ball for predicting defaults and recovery rates, but new deals seem very compelling on a risk adjusted basis. We have not seen the number of defaults increase yet”, says Tanninen.
When and if defaults do occur, they can be easier to manage in private than public debt: “workouts and restructurings can be much simpler when there is only one lender to negotiate with, compared with public markets where there may be multiple classes of lenders, bondholders and others”, says Hauru.
A diverse range of managers and borrowers
Mandatum has invested in more niche funds as small as EUR 200 million, run by managers with assets as low as EUR 2 billion. “These tend to be regional specialists in the less competitive lower mid-market space, which might for instance be focused on Spain or German-speaking Europe”, says Hauru. “The companies they lend to could have an enterprise value as low as 20-30 million, and EBITDA of 3-5 million. Smaller deals can offer lower leverage, and better collateralization or asset backing, but the risk of default can be higher as well. We also have portfolios of SME loans where a more statistical approach is taken. We generally expect higher returns from smaller managers”, he adds. Mandatum also invests with some of the largest managers running tens of billions, who will often be involved with larger transaction.
“Our median ticket size of over EUR 50 million is big enough to negotiate fee discounts”, says Tanninen. Headline management fees typically range between 0.5% and 1.5%, with hurdle and performance fees also varying a lot. Mandatum may then seek discounts and has seen innovative structures entirely based on performance fees, with no management fee. Some managers have also offered discounts in order to raise funds quickly. Mandatum will sometimes look at co-investments, subject to diversification constraints.
“ESG is a major element where we are constantly trying to improve, though it is less straightforward for private debt than in private equity or real estate. We set high ESG standards as much as we can and our side letters, demanding transparency, have influenced the rules of funds. We carry out an annual review to monitor measures such as whether bonuses are linked to ESG. Overall, ESG is a key part of due diligence and we may reject some funds that do not meet our ESG criteria”, says Tanninen.
ESG does not at this stage extend to impact investing however. Since Mandatum is investing indirectly, via managers, there is no direct contact with the underlying companies, and Mandatum would therefore find it difficult to pursue impact investing via its external private debt managers.