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Capital Solutions: A Growing Opportunity
By: Barings' Capital Solutions Team
The massive growth in private credit markets, combined with structural changes in public markets, have created opportunities to use creative financing structures and strategies. “Capital solutions” has become an increasingly popular term to describe some of these flexible new strategies, which are more credit-focused and provide the potential for both compelling and uncorrelated returns. In this Q&A, the Barings' Capital Solutions team sheds light on the growing opportunity in this space.
This is an excerpt from NCPERS Spring 2024 issue of PERSist, originally published April 25, 2024.The massive growth in private credit markets, combined with structural changes in public markets, have created opportunities to use creative financing structures and strategies. “Capital solutions” has become an increasingly popular term to describe some of these flexible new strategies, which are more credit-focused and provide the potential for both compelling and uncorrelated returns. In this Q&A, the Barings' Capital Solutions team sheds light on the growing opportunity in this space.
The massive growth in private credit markets, combined with structural changes in public markets, have created opportunities to use creative financing structures and strategies. “Capital solutions” has become an increasingly popular term to describe some of these flexible new strategies, which are more credit- focused and provide the potential for both compelling and uncorrelated returns. In this Q&A, we shed light on the growing opportunity in this space.
How do you define “capital solutions” strategies?
At Barings, we view capital solutions as an opportunistic, “all-weather” credit strategy that seeks to deliver attractive risk-adjusted returns across all market environments. The volatile economic environment over the last few years has seen banks and other traditional lenders retreat from the market, and there are many situations where traditional capital is simply not available—but businesses still need financing. This presents an opportunity to provide these companies capital through a customized financing solution.
How does this differ from more traditional special situations or distressed strategies?
We think of capital solutions as an evolution of special situations investing. While the situations that we invest in are often similar—fundamentally good companies facing challenges or going through some kind of transition—the solutions toolkit has become much more developed. Whereas traditional special situations investing would target buying into an existing structure at a discount, the capital solutions model involves engaging with a business to understand its financing needs, and then structuring a transaction which solves for this and optimizes the position of our capital at the point when we invest. A capital solutions lens, therefore, sees possibilities in any market environment, making it less episodic and cycle-dependent than the traditional special situations approach.
What is the ‘solutions' premium?
The investment appeal of capital solutions lies largely in the potential for attractive risk-adjusted returns with low correlation to traditional debt and equity markets. This stems from sourcing and structuring bespoke solutions to meet what are often idiosyncratic needs of companies. Through capital solutions investment strategies, managers— and by extension, investors—are positioned to capture the ‘solutions' premium that comes with providing bespoke financings into situations where the supply and demand of capital is favorable (Figure 1).
Looking across the market today, where are you seeing opportunities?
In implementing capital solutions strategies, managers can choose from a wide variety of investment scenarios and structures. At Barings, we view opportunistic lending as the core of our capital solutions portfolio, which reflects our credit heritage and the experience of the team. We also seek opportunities across markets where we see strong relative value — including structured asset finance, such as healthcare royalties, or accessing the secondary market during periods of dislocation.
For example, in the U.S., we recently worked with an auto insurance brokerage who approached us seeking capital to satisfy some contingent liabilities which had become payable. While the business demonstrated a strong track record of generating operating cash flow, we were reluctant to invest in a junior debt position behind the banks. Instead, we proposed a full uni- tranche refinancing at an attractive margin, which put us in a senior position in the structure, and took an equity warrant alongside the shareholders. A year on, with management freed to focus on the business, the company's performance is strong, leverage has declined, and our warrant will enable us to share in the upside that the financing has helped to create.
What should investors keep top of mind when considering capital solutions?
Given the growing number of managers offering their own version of capital solutions strategies, there are some important questions for investors to be aware of when considering this space:
- How is the manager seeking to achieve targeted returns? At Barings, the protection of capital and careful attention to identifying and managing risk are important components to how we invest.
- How does a manager source deals? Having access to multiple sourcing channels in order to build a wide funnel of opportunities is a prerequisite when selecting and designing bespoke investments capable of delivering the attractive returns investors seek.
- What is the manager's structuring experience? Managers should have broad and deep experience crafting transactions over an entire market cycle and across a wide range of industries. At Barings, our capital solutions team have been negotiating and structuring transactions for over 15 years, enabling us to dig deep into situations and analyze risk, before structuring and pricing it appropriately.
About the Author
The Barings Capital Solutions team is focused on providing investors attractive, through-the-cycle risk- adjusted returns that are less correlated with traditional debt and equity markets. We pursue public and private market opportunities across the capital structure, seeking to exploit market inefficiencies.
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