On the other hand, requirements for capital – and pools of available capital – mean that market participants are trying to figure out how to set up deals and earn yield – a vital consideration in today’s low-yield world. One such organization operating in a niche area of fixed income markets is BroadRiver Asset Management, a firm headquartered in New York City’s iconic Empire State Building. This publication recently spoke to Andrew Plevin, co-chief executive and founding principal, about the firm.

What was the main reason for setting it up?

As natural skeptics, we saw an untapped opportunity in the market towards the tail-end of the 1990s, as the dot-com bubble was rapidly growing, to invest in assets that were more secure. We had an aversion to assets that involved predicting the future of financial markets and an orientation towards institutional clients.  We did not want to be part of an investment business that was fraught with risk. 

Through research, we uncovered an opportunity in the life insurance industry. With life settlements, we identified an emerging asset class that did not display erratic behavior, while at the same time offered compelling levels of return.

All along, we saw an investment that had very stable characteristics and felt really good about the concept and its potential. As a first step, we hired an actuary to determine how many life insurance policies we would need in order to minimize volatility in the portfolio. Fortunately for us, we found that the optimal number fell within the range that we could assemble, given the supply in the market and our investment criteria. Thus, our business was born.

Given our natural inclination not to participate in markets that are primarily based on guesses about the future, we preferred analytical asset classes where external information about what the future would hold was prevalent. We had found our niche and we ran with it. Life settlements was a counter-cultural choice, in that the investment was uncorrelated to the financial markets, yet turned on a risk that had a long history of study by both the private and the public sectors – i.e. longevity risk.  Longevity/mortality can be a very sensitive subject for people, but it is primarily a scientific question – not a financial one – which is an important distinction.

Building upon our initial focus, the firm has been expanding into other areas of private credit that are similarly uncorrelated to the markets, senior in credit position, and provide reliable sources of cash flow.  We’ve seen that with municipal tax receivables and short-term corporate receivables. We think that by investing in combinations of various private credit structures, sophisticated investors can build a fixed income portfolio – one might say a synthetic fixed income portfolio - delivering better returns at acceptable risks and comparing favorably to conventional fixed income alternatives.  

What does it do? What are its unique propositions?

We are alternative fixed income managers who offer investments that behave like bonds, but that do not sacrifice credit quality. 

Our Private Insurance Funds feature attractive yield, little correlation to the markets, and minimal volatility.

Life settlements provide an economic benefit to policy-holders by:

-- Exchanging their unwanted life insurance policies for proceeds much greater than that offered by the insurance companies’ cash surrender values.
-- Providing an aging population with liquidity for a widely-held asset that previously was difficult to monetize.
-- Our strategy is less exposed to external events as life cycles are predictable and largely unaffected by market movements. Our Private Insurance Funds feature attractive yield, predictable cash flow, little correlation to the markets, and minimal volatility.
-- Our strategy is less exposed to external events as life cycles are predictable and largely unaffected by market movements. 

Our Tax Receivable Funds have a shorter duration, while also having cash flows largely uncorrelated to the markets and having a senior credit position. Municipal tax receivables provide needed liquidity to municipalities that need to fund their operations and assist them in collecting revenue that otherwise would be hard to achieve.

Experience has shown that payment of tax receivables has low correlation to the economic cycle. For our investors, tax receivables provide a highly attractive yield, especially in comparison to today’s markets, and a senior credit position that provides strong protection of principal. Our Corporate Receivables Funds have the shortest duration, generally less than six months, and provide a compelling place to park idle cash while still earning a return above that typically found in money market funds and certificates of deposit. 

You talk about the private debt market and the fact that such markets are under-appreciated and have characteristics that will suit family offices, and similar entities. Can you go into a bit more detail about this?

The private debt/credit assets we participate in have the potential to produce predictable, low-volatility, low-risk cash flows for a portfolio of assets that are carefully modeled and underwritten. Constructing stable portfolios usually involves large numbers of self-amortizing assets, which are largely impervious to exogenous events. 

Investors with longer investment horizons – like family offices – do well to acquire non-correlated, low-risk, low-volatility cash flows and above-market yields in exchange for assets that don’t offer daily marketability.

What are the qualities of the private debt markets? Please set out a few concrete examples. How do they work? What is the key difference with conventional bond markets ?

Private debt markets encompass a range of investments and strategies.  Key segments include mezzanine debt, bank loans, distressed debt and a new area, gaining a lot of attention, known as peer-to-peer lending.

These assets often do not have deep, liquid secondary markets, so typically strategies that focus on buy and hold have advantages over those that focus on trading.  In general, private debt is not available in publicly-traded markets or through exchanges.  For family offices, it usually is accessed via asset managers who specialize in one or more niches.  Accordingly, manager selection is a critical component to the investment decision.

You mentioned that with commercial paper having contracted post-2008, there is a funding gap in the market. What is the situation here now? Can the field you operate in make a difference here?

That’s a fair question.  We see a real need and desire by large corporations to diversify their working-lines of capital, drawing on lessons learned from the 2008 financial crisis. We also see that savers and investors are crying out for some level of positive return on their cash and near-term investments.  With the shrinkage of the commercial paper market post the financial crash, there are nascent and promising alternatives being developed.  Time of course will tell, but we see these forces resulting in an important new market and channel for matching the needs of savers with those of corporations, while disintermediating conventional bank lines and money markets.  Our focus on short-term corporate receivables is an example.

For illustrative purposes, what sort of returns/spread over LIBOR can the kind of investments you make produce?

In our Private Insurance Funds, the return is independent of LIBOR and ranges from the low to the high teens over the life of the fund.  Municipal tax receivables are also uncorrelated to LIBOR and return in the mid-to-high single digits, depending on whether leverage is employed.

For corporate receivables, the yield naturally varies based on the corporation, the obligor of the receivables, and the general terms of payment such as whether payment is due in 30, 60, 90  days, and out to 120 days.

Within these boundaries, we’re seeing spreads of LIBOR plus 30 - 150 bps.  It’s worth noting that we aren’t speaking about purchase of receivables from small and medium-sized business: this type of credit generally goes to the factoring market and trades at high teens or even well above that.  Indeed, this is often what peer-to-peer lending is focused on, but then you are taking unsecured credit risk with little opportunity for diligence or monitoring.  In the corporate receivables market, the receivables are secured and warranted against claims about whether good product has been delivered to the seller and, barring the risk that the obligor goes bankrupt before the receivable is due failure to pay.  Thus, the main judgment is about the timing of repayment.

There are risk of course with all investments - the day of the "risk-free" rate may be dead for a while. What are the risks/challenges with private debt? There are no free lunches in economics. Does it take a lot of resources to work in this space? Who can do this sort of investment and who shouldn't?

Harry Markovitz, the Nobel Prize winner in Economics, pointed out that there is one free lunch in investing and it’s the value of diversification.  Investing in private credit does take work, in origination, in pricing and analytics, and in ongoing performance evaluation and servicing.  Accordingly, it’s not practical for most individuals or family offices to undertake this effort directly, so it’s best to access this via specialized managers with dedicated expertise, analytics, IT infrastructure and asset management capabilities in the relevant area.

What sort of demand/inquiry are you getting from wealth managers and family offices in particular? Can you give me some examples of the kind of things they say they want? What sort of frustrations do they express about the broader market?

Everyone is looking for returns and protection of principal, meaning high-credit quality and clear exit.  Non-correlation is a frequent theme.  Many also want predictable cash flow.   Many want low volatility as well.

Some have moved down the credit curve or added leverage to boost returns.  These strategies usually reduce the risk-adjusted return, although there is a lot of cheerleading in the investment world for taking on risk that family offices found unacceptable in higher interest rate environments.

Going forward, do you have any specific predictions to make about the family offices to take on risks they wouldn’t find acceptable in a higher interest rate environment/debt market? Do you see regulation/other risks to its growth, or are you relaxed about that?

Early adopters of these strategies have sustained these markets at fairly robust levels. Our market intelligence says that there are few deals left in conventional private debt that provides an adequate return for the risk.  Thus, one finds increasing pressure to invest in “emerging markets”, where political risk and information risk is added to credit risk.  We don’t see the appeal of this approach.

What sort of parallels/differences are there with the evolution of the private equity markets in recent years?

Like private equity, returns can only be achieved by holding assets until their maturity. So, if you can afford some degree of illiquidity, you should allocate accordingly in order to capture higher returns and reduce volatility.

Are there other points you want to make?

We think the time is right for private credit to blossom as an asset class.  As with private equity, access to high-quality assets and high-quality deals is critical. We think private credit is right for sophisticated family offices and institutional investors. Considering that private credit is not a liquid market with well-developed benchmarks and indexes, choosing the right manager is vital.