BCI's Daniel Garant on Private Debt and More
British Columbia Investment Management Corporation (BCI), the C$295 billion ($214 billion) asset manager for public sector bodies in Canada’s western most province, oversees a C$20 billion ($14.5 billion) allocation to private debt in a strategy that is defined by a few key characteristics: a large and growing allocation to co-investments, an avoidance of mega deals and an expansion into Europe and APAC.
Around 65 per cent of the private debt allocation is direct or in co-investments via partnerships with external firms, which although not unique, sets BCI apart from many other investors and reaps benefits like diversification, deeper relationships, deal selectivity and lower fees.
“Not everyone can do direct or co-investments but having an overall portfolio of 65 per cent in direct and co-investments is a high number, and we are looking to do more,” says Daniel Garant, executive vice president and global head of public markets, in conversation with Top1000funds.com.
BCI has been doing direct lending in the US ever since the portfolio was launched in 2018. But moribund M&A activity continues to push private credit firms to jump on every opportunity. It’s drawn huge investor flows into US private debt and tightened credit spreads. The fiercely competitive market for lenders has propelled BCI into new geographies – first Europe and more recently, Asia Pacific.
“For the last three years, we have increased our allocation to Europe for the simple reason that credit spreads and returns are currently attractive. Having a portion in Europe, and a growing portion in Asia Pacific, is helping us as these markets will develop over the years. They won’t get to the same size as the US, but private debt in Europe and Asia will get a growing share of this portfolio,” he predicts.
Another important seam to strategy involves avoiding mega deals where “everyone” is bidding. It’s not that these deals aren’t interesting, says Garant, it’s just that they are competitive and tightly priced. Instead, he is focused on transactions that are less crowded to get a better spread, calling on BCI’s strong partners to bring deal flow in the upper middle market and middle market.
Another reason to avoid mega deals in private debt includes competition in the space from broadly syndicated loans (BSLs), which corporate borrowers can tap into as an alternative to private debt. BSLs are usually cheaper, and lenders don’t ask for as much spread as private credit investors. In return, they don’t have the same flexibility.
“A private debt loan is more flexible, but it is more expensive,” he says.
Adjacent opportunities
Another successful seam to strategy includes adjacent opportunities. In one example, the team has broadened its remit and ventured into more asset-backed lending. Garant says it’s less competitive and offers a better risk return, and although deals are more complex, BCI can draw on its deep internal expertise and talent pool for support – around 85 per cent of BCI’s total assets are managed internally.
Traditionally, asset-backed lending where loans are secured against property or equipment, consumer loans or credit card balances, used to be the domain of banks. Unlike direct lending which involves analysis of the corporation, financial projections and strategy, investors in the asset-backed space must also ensure they have the capacity and infrastructure to successfully select the assets that sit behind each deal.
“This is where the secret lies,” he says, adding that managers (and their selection) play a key role in sourcing the assets that back the loans. “Asset-backed lending is usually part of a broad diversified portfolio and that requires technology, including AI tools, to better enable us to see the portfolio behind it because this is where the risk sits.”
Adjacent opportunities also include looking for openings in investment-grade (private) debt where investment-grade corporates go to the private market in search of a more flexible portion of funding.
It’s a strategy that also plays into another inherent strength of the portfolio.
The public markets team oversees both the allocation to private debt and absolute return strategies, alongside more obvious public allocations to passive and active public equities, government and corporate bonds, derivatives, trading and FX and managing portfolio leverage. Garant believes the hybrid portfolio works particularly well given today’s demands on investors to remain flexible, and the fact that the lines that used to define markets are increasingly blurred.
“Investment grade private debt is a hybrid between corporate bonds which are investment grade, and private debt per se, so having the view of both markets is essential in my view to do a good job in terms of capital allocation and risk return.”
Absolute return and synthetic index replication
The C$12 billion ($8.7 billion) absolute return portfolio, the other slight anomaly in BCI’s public markets allocation, seeks opportunities that are uncorrelated to equity – namely unique, idiosyncratic investments that are expected to perform well in all market environments.
The strategy provides a welcome corner of active risk in an equity allocation that has steadily moved into passive.
At 23.6 per cent, BCI’s current allocation to public equities is a smaller proportion of assets under management than it used to be and subjects the portfolio to less volatility than in the past. Of that, the majority is passive in index strategies for rebalancing.
Absolute return investment opportunities have a specific risk-return profile that typically comprises low downside risk and a capped upside, but which is above the market beta return. Absolute return implementation comes via an overlay above public, indexed equities whereby BCI’s clients receive the beta of equities, and a value add over the benchmark from uncorrelated strategies.
“Of course, the quid pro quo is if the downside is capped and limited, the upside is also going to be capped. The key success factor is the right partnership and sourcing, as well as the skill of the team and being agile and nimble to look at opportunities that are a bit different,” he says.
The largest exposure is to a long-short market-neutral credit manager. Other uncorrelated instruments providing strong returns in the overlay strategy include transactions in litigation finance and structured debt instruments with penny warrants. Here, the downside credit protection caps potential losses and the upside comes via the interest rate paid on the debt instrument and potential equity returns from the penny warrants.
In keeping with BCI’s overarching approach, the structure of the overlay is managed internally with capital allocated to partners where BCI will co-invest if the team decide they want more exposure to particular opportunities. “The positions are not short-term, we target transaction maturities to be within five years – we don’t aim for short-term tactical positions that are, say, three months.”
It’s a topical point. As more investors explore tactical asset allocation in the current climate, Garant remains lukewarm.
“I’m not a strong believer in tactical asset allocation. Our strategy is not based off short-term market moves.”
“Tactical asset allocation requires coping with significant mark-to-market volatility with features such as stop losses, and although some firms are good at it, many aren’t because it’s extremely difficult to time market movements. If you want to perform, you need to change positions quickly, and positions need to be large to have a meaningful impact on your return. For example, relative value trades between equity and bonds consume a lot of active risk.”
BCI has no edge investing tactically, he continues. It’s much better to invest the way they are, whereby partners bring opportunities, the internal team hunts for specific returns and risk profiles, and where transactions are less crowded.
A second active equity strategy in addition to absolute return comes via synthetic indexation, where the team move investment between physical and synthetic index replication according to market opportunities.
The physical allocation involves trading a basket of stocks alongside a synthetic index replication exposure via swaps, he explains. Every year, the team has added value by doing synthetic index replication and he concludes that the strategy is important because active equities are difficult in the current market.
“In public equity markets, we have never seen this type of market concentration before. In Canada, we are used to having a few stocks dominating the benchmark, but in the US, this is a new feature in the modern era. It adds complexity for long-only public equity active investors.”
Excellent interview with Daniel Garant, EVP and Global Head of Public Markets at BCI where he goes over their approach to private debt, absolute returns and other strategies.
He also explains why he's not a big believer in tactical asset allocation and how synthetic indexing adds value to the fund.
How did BCI grow its private debt portfolio to an C$20 billion ($14.5 billion) allocation in seven years?
They seeded the right funds like Hayfin Capital in Europe which they sold back in February, got an equity stake, negotiated lower fees and co-investment rights and they're continuing on this track.
BCI recently announced that BCI-backed Brinley Partners secured an additional US$4 billion commitment from a leading US insurance company.
BCI also recently announced the signing of a strategic minority investment agreement to support Three Hills, a private markets investment firm specialised in providing bespoke capital solutions to entrepreneurs and management teams in Europe and North America to help long-term corporate development and growth objectives
The structure of these deals gives BCI important leverage to negotiate lower fees and co-investment opportunities.
What else did BCI do to grow its private debt portfolio? Early on, it invested in CPP Investments' Antares Capital, a leader in US middle market lending.
But the key point in all of this is they structure their deals intelligently to negotiate better terms (lower fees, more co-investments) and they also get huge upside from their equity stakes in these firms.
Daniel Garant states this:
“Not everyone can do direct or co-investments but having an overall portfolio of 65 per cent in direct and co-investments is a high number, and we are looking to do more”
That's a huge percentage in direct and co-investment and to do more, they need to structure the right deals with strategic partners.
What else? Similar to what IMCO's Jennifer Hartviksen told ION Analytics (see my recent post here), their credit team is flexible across the capital structure and even does hybrids between corporate bonds and private debt.
The ability to do more directs and co-investments and be flexible across different credit products requires a strong credit team that can gauge opportunities as they arise and solid technical knowledge to provide bespoke investment solutions to capitalize on hybrid opportunities.
Interestingly, a month ago, BCI posted this on LinkedIn on how they invested in a portfolio of student loans, exemplifying their strategic shift toward diversified credit exposure:
You can read more about this student loan portfolio in BCI's annual report here.
Lastly, the time frame for co-investments is three to five years because it increases the probability that they will not get caught in a short-term storm, it's just a smarter risk-adjusted framework than short term tactical asset allocation which is fraught with risks.
Equally important, they avoid mega deals where spreads are tight and look to capitalize in less crowded strategies where spreads are wider (that carries more risk but better returns and if the team knows how to analyze these deals properly, it's a smarter strategy than chasing mega deals where returns are lacklustre).
Alright, let me wrap it up there.
Below, a panel discussion form last year's Milken Institute Global Conference featuring Daniel Garant, EVP and Global Head of Public Markets at BCI. The panel discusses trends in private markets including private debt and you can fast forward to around minute 9 to hear Daniel's insights (there's more, entire panel is worth watching).
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