Read this article to understand:
- How the current macroeconomic environment is reflected in illiquidity premia across private market debt asset classes
- Drivers of debt activity and demand over the past 12 months
- Opportunities available across private debt asset classes
At the start of 2024, our portfolio managers and Private Markets Research team flagged some of the investment opportunities that had emerged in the private debt universe following a period of high inflation, high borrowing costs and slower economic growth (see Rents, rates and the refinancing gap.)1
Since then, there has been a general uptick in deal activity as central banks started cutting interest rates and amid optimism that a recession will be avoided. However, the year ahead is likely to be marked by significant policy uncertainty, leading to a wide range of possible outcomes for the global economy. In this article we consider what this means for private debt illiquidity premia, and where we see opportunities.
Using illiquidity premia to assess relative value
Illiquidity premia (‘ILP’) are a key factor to consider when comparing different types of private sector debt to each other and to public debt. These premia represent the reward on offer to investors willing to provide long-term patient capital. They also allow investors with a ‘multi-sector’ or opportunistic approach to take advantage of relative-value opportunities between private debt sectors and pricing dislocations versus public markets.
Our dataset and approach to measuring illiquidity premia
Our dataset encompasses over 2,000 private debt transactions over a 27-year period. It covers sterling and euro investment-grade (IG) deals only. We mainly cover internal transactions but also consider external transactions where we can obtain pricing data.
The illiquidity premia output captures the spread premium over the most relevant reference public debt index (ICE BofAML index data) at the point of transaction, represented as dots in Figure 1. The illiquidity premium represents an additional spread (which is not always positive) over public debt markets to compensate for increased illiquidity and/or complexity risk. Figure 1 also includes the discrete calendar-year average illiquidity premium, which equally weights the underlying transaction data.
It should be noted that the illiquidity premia shown are indicative only as they are rating-band (not rating-notch) matched and are also not duration/maturity matched to the relevant reference public debt index.
Figure 1 below shows that since 2022 average illiquidity premia have improved across all private debt sectors. The key driver of this has been a backdrop of tightening public debt spreads (around 110 basis points since the middle of 2022) while private debt spreads have held relatively firmer.2 Tightening public credit spreads reflect market optimism that with central banks such as the Bank of England, European Central Bank and US Federal Reserve all reducing interest rates, a global recession can be avoided.
Whereas private debt illiquidity premia at the start of last year were high, they have trended back towards long-term averages. A key factor has been increased bank lending which has resulted in greater competition for debt.
Figure 1: Illiquidity premia in private debt to Q4 2024 (basis points)
Past performance is not a reliable indicator of future returns.
For illustrative purposes only. The value of an investment can go down as well as up and there is no guarantee that the forecasted return will be achieved.
Note: The illiquidity premia are calculated based on Aviva Investors’ proprietary deal information. There are various methodologies that can be employed to calculate the illiquidity premium. Please note that the illiquidity premia shown are measured against broad relevant public debt reference data, are rating band (not notch) matched and are not duration/maturity matched.
Source: Aviva Investors and ICE BofA Sterling and Euro Investment Grade Corporate indices. Data as of December 31, 2024.
A key takeaway we draw from this data is that illiquidity premia are not static and vary through the market cycle. Secondly, illiquidity premia across the various private debt sectors do not move in tandem, reflecting different dynamics through market cycles.
Private debt spread dynamics
An important driver of pricing dynamics is the ‘stickiness’ of private debt sector spreads versus public debt.
- Real estate debt spreads tend to be the most ‘sticky’ resulting in illiquidity premia that have historically been correlated to the real estate cycle. Real estate debt illiquidity premia tend to drop when real estate capital values decline, and then typically recover as real estate valuations rise.
- Infrastructure debt spreads tend to be moderately sticky, with spreads re-pricing more gradually relative to public debt markets.
- Private corporate debt spreads tend to be the least sticky and hence re-price fastest relative to public debt markets. Given this dynamic, illiquidity premia tend to remain in a narrower range over the long term. Some of the highest illiquidity premia have occurred during periods of higher market volatility, especially when there is less capital available from more traditional lending sources.
Figure 2 sets out these spread dynamics in more detail. The implication is that when investing in private debt, a multi-asset approach can be beneficial as it allows investors to take advantage of pricing opportunities between private debt sectors given they move at different speeds through market cycles.
Figure 2: Pricing dynamics across private debt sectors
Past performance is not a reliable indicator of future returns
Note: ILP = Illiquidity Premia.
Source: Aviva Investors, 2024.
Across private debt sectors, we are typically seeing more attractive illiquidity premia in private debt denominated in euros, although with UK government bond yields higher than those in the euro zone, sterling debt offers higher all-in yields. Within real estate debt, we believe illiquidity premia in residential and industrial sectors should hold firm in 2025 given broader macroeconomic trends. By contrast, we are cautious on the prospects for non-prime assets, particularly in the office sector.
In our latest House View: 2025 Outlook we expect 2025 to be marked by significant policy uncertainty, particularly when it comes to international trade, with a wide range of possible outcomes for the global economy.3 A trade war has the potential to trigger a sharp slowdown in economic growth and a spike in inflation. That could trigger a sell-off in bond prices, although private debt spreads typically lag those in public markets.
Infrastructure debt
European infrastructure debt volumes at a decade high in 2024
In the fourth quarter of 2024, £46 billion of European infrastructure debt was issued. That not only made it the busiest quarter of the year for new deals but meant 2024 was the busiest year for new deals in the past ten years.4
In the UK, nearly £13 billion of debt came to market with the stand-out deals of the year two carbon-capture projects which were completed in December. The Net Zero Teesside and the Northern Endurance Partnership projects raised combined debt financing of around £8 billion. The largest deal in continental European was for a French data centre, which raised €3.3 billion of debt. Data centres form an increasingly big part of the overall infrastructure debt market.
Real-estate debt
Activity levels and sentiment improve; margins tighten
The fourth quarter saw robust activity across a wide range of real-estate sectors with no shortage of debt and equity capital on offer.
Loan margins have shrunk and debt has become more available
While overall borrowing costs remain elevated due to relatively high interest rates, loan margins have shrunk and debt has become more available.
Both domestic clearing banks and international banks are keen to lend as are a variety of other types of lender, leading to an improvement in funding terms.
Private corporate debt
Downward pressure on corporate spreads
Within the private corporate debt market, issuers have been wary of locking in higher yields, and have instead been opting for bank-style short-dated floating rate financing structures. That has driven spreads down.
Issuers have been opting for bank-style short-dated floating rate financing structures
Where there have been new issues, this has often involved existing borrowers refinancing debt. Sub-investment grade debt spreads have stayed high, amid ongoing caution among investors about the risk of default.
As long-term rates start to stabilise, we expect debt issuance to pick up as companies look to fund capital expenditure. However, it is unclear that will result in spreads widening given increased demand from insurers for long-dated bonds.
Structured finance
Opportunities in emerging markets and fund financing
Emerging-market borrowers, particularly in Africa, are coming under budgetary pressures due to higher borrowing costs. As a result, we are seeing more debt being issued with guarantees from Export Credit Agencies and Multilateral institutions.
Emerging-market borrowers are coming under budgetary pressures due to higher borrowing costs
Some borrowers are starting to issue debt that meets matching-adjustment rules to attract capital from insurers and diversify their funding sources.
The credit spreads available in the securitised market, particularly on highly-rated tranches of Collateralised Loan Obligations, are at record lows. That means we see better relative value in mezzanine tranches where spreads have not fallen as much.
