We begin today\u2019s Irregular Roundup with private debt.<\/p>\n
Private Debt<\/span><\/h6>\n![\"Joachim](\"https:\/\/the7circles.uk\/wp-content\/uploads\/2019\/11\/Joachim-Klement-300x270.jpg\")
<\/a><\/p>\nJoachim Klement looked at the true return on private debt<\/a>.<\/p>\n\nPrivate credit has become the hottest asset<\/a> class in 2024. This boom is fuelled by pension funds, family offices, and other institutional investors chasing uncorrelated and stable returns with low to medium risk.\u00a0<\/span><\/p>\n<\/blockquote>\nI think we\u2019d all like some of that.<\/p>\n
\n- Unfortunately, the asset<\/a> class can\u2019t deliver that.<\/li>\n<\/ul>\n
![\"Private](\"https:\/\/the7circles.uk\/wp-content\/uploads\/2024\/06\/Private-Credit-alpha-7-Circles-300x204.png\")
<\/a><\/p>\nA recent study found that the average cumulative return (above the risk-free rate) of a private credit fund was 34%.<\/p>\n
\n- With an average life of 5.5% years, that\u2019s a very handy 8.6% pa, but:<\/li>\n<\/ul>\n
\nComparing returns to the risk-free asset<\/a> is not fair because private credit is essentially high yield debt structured by banks and specialist asset<\/a> managers. One needs to adjust the outperformance by the risk factors inherent in bond<\/a> investments. If one does that, the lifetime cumulative alpha is still 10.5%.<\/span><\/p>\n<\/blockquote>\nThat\u2019s a lot less when spread over 5.5 years. But Joachim is not done:<\/p>\n
\nPrivate credit are high yield loans, so they are riskier than normal bonds and effectively lie somewhere between stocks and bonds. One can adjust the alpha by the risk factors in stocks or, even better, the combined risk factors of stocks and bonds. The resulting alpha over the lifetime of a fund is\u2026 drum roll\u2026 -0.1%.<\/span><\/p>\n<\/blockquote>\nSo private credit doesn\u2019t really offer much to a portfolio that is already diversified between stocks and bonds.<\/p>\n
\n- And the current popularity of private credit (more money chasing limited opportunities) means that future returns will probably be worse.<\/li>\n<\/ul>\n
Private equity returns<\/span><\/h6>\nJoachim is in good form at the moment, and a second article looked at private equity returns<\/a>.<\/p>\n\n- He was interested in the way the fee structure changes.<\/li>\n<\/ul>\n
After five years of grace to invest the funds (during which time managers charge a fee on uninvested assets), fees are only charged on assets that have been invested.<\/p>\n
\nWhat is a fund manager to do when after three years or so, a large part of the committed capital is not invested yet? The incentive then changes to invest as much money into any project, whether it is viable or not. One would expect that investments made in years four or five of the life of a fund are worse than investments made earlier.<\/span><\/p>\n<\/blockquote>\n![\"Growth](\"https:\/\/the7circles.uk\/wp-content\/uploads\/2024\/06\/Growth-by-investment-year-7-Circles-300x194.png\")
<\/a><\/p>\nCertainly, the returns are worse.<\/p>\n
\nThe chart uses EBITDA margin growth as a measure that is difficult to manipulate. Investments made at a later stage in the fund\u2019s life have a higher likelihood of being unprofitable and create a drag on fund IRR and money multiples.<\/span><\/p>\n<\/blockquote>\nThe effect is stronger for more experienced general partners of firms.<\/p>\n
\nIt\u2019s almost as if experienced private equity managers have learned that fee income is more valuable than performance.<\/span><\/p>\n<\/blockquote>\nThere\u2019s also a larger effect for firms with a lot of pension fund money, indicating that these investors don\u2019t look too closely at what\u2019s happening.<\/p>\n
What should investors do?<\/p>\n
\nIf a fund hasn\u2019t made a lot of investments in the first two to three years of its life, investors should increase oversight and (if possible) reduce capital commitments.\u00a0<\/span><\/p>\n<\/blockquote>\nMaybe they should also steer clear of funds run by experienced GPs and with a lot of pension fund money inside them.<\/p>\n
Labour Watch<\/span><\/h6>\nI must apologise in advance for a large amount of politics in this week\u2019s roundup, but it\u2019s mostly about taxes.<\/p>\n
\n- At the time of writing, we\u2019re at that awkward stage of the general election campaign where a new policy leaks or is announced every day, but the manifestos are still unpublished, so we can\u2019t assess a party\u2019s policies in the round (assuming that you believe the manifesto\u2019s that is).<\/li>\n<\/ul>\n
![\"John](\"https:\/\/the7circles.uk\/wp-content\/uploads\/2015\/04\/John_Stepek-300x300.jpg\")
<\/a><\/p>\nIn his Bloomberg column, John Stepek looked at what might actually happen if Labour win.<\/p>\n
First up is the LTA (more on that later), but restoring it won\u2019t be easy:<\/p>\n
\n Nothing in pensions is easy. For a start, Hunt got rid of it partly because of its role in putting off senior doctors from continuing to work beyond retirement age. For another thing, getting rid of it has proved
complicated.<\/span><\/p>\n<\/blockquote>\nA carve-out for doctors would be tricky to operate, and even bringing back a \u00a31M limit would mean new protections for those who have taken advantage of the two-year gap in penalties.<\/p>\n
\n- Steve Webb thinks the simplest thing would be to bring it back at \u00a31.5M (still much lower than the index-linked value of the peak LTA, which is now around \u00a32.7M) \u2013 but that wouldn\u2019t raise as much tax.<\/li>\n<\/ul>\n
Next up is 40% income tax<\/a> relief on pension contributions.<\/p>\n\n- Just before Brexit, George Osborne was toying with leveling the relief at 30% for everyone.<\/li>\n<\/ul>\n
But it never happens, because of the public sector.<\/p>\n
\n Higher earners in DB<\/a> schemes would either find themselves paying a lot more tax or having benefits reduced significantly every year in order for the scheme to pay the tax.\u201d (There are similar issues with reducing the tax-free lump sum).<\/span><\/p>\n<\/blockquote>\nThe tax-free lump sum has now been frozen at \u00a3268K, so that\u2019s another stealth tax (and another reason for people not to save for their retirement).<\/p>\n
\n- Another feature of fiscal drag is that there are a lot more higher rate taxpayers than there used to be, so these moves will be less popular than ten years ago.<\/li>\n<\/ul>\n
Idea number three is another LTA on ISAs.<\/p>\n
\n- The Resolution Foundation (whose former head is now standing as a candidate for Labour) wants to cap ISAs at a laughable \u00a3100K per person.<\/li>\n<\/ul>\n
Since ISAs are much more popular these days than pensions, a lot of people might be against it.<\/p>\n
\n- And as we know from the pensions LTA, admin is a nightmare.<\/li>\n<\/ul>\n
I just don\u2019t understand why people think that tax shelters need a lifetime cap when they already have an annual contribution limit.<\/p>\n
John also makes a more fundamental point about the politics of taxation:<\/p>\n
\n No politician wants to admit to taxing anyone except \u201cthe rich\u201d. But not only do we need \u201cthe
rich\u201d, but the trouble is, \u201cthe rich\u201d (however you define them) don\u2019t have enough money.<\/span><\/p>\n<\/blockquote>\nRaising real money from taxes means hurting a lot of people.<\/p>\n
\n- Which means stealth taxes, carve-outs, and unnecessary complexity.<\/li>\n<\/ul>\n
All because nobody dares to say that maybe we each know how best to spend our money \u2013 certainly better than the government does.<\/p>\n
\n- Which means lower taxes, and hence lower public spending.<\/li>\n<\/ul>\n
One day, someone should try getting elected on such a platform<\/a>.<\/p>\nLTA Watch<\/span><\/h6>\nThe Institute for Fiscal Studies put out a paper this week calling for the swift return of the LTA:<\/p>\n
\n The pensions tax regime is still overly generous to those who already have big pensions,
those with high retirement incomes and those getting big employer pension
contributions.<\/span><\/p>\n<\/blockquote>\nThe good news is that they agree that a higher limit would simplify reintroduction:<\/p>\n
\n The last Labour government set the lifetime allowance at \u00a31.8mn in April 2010; it could, for example, reintroduce it at that level \u2014 or the equivalent adjusted for inflation, which would be around \u00a32.7mn today.<\/span><\/p>\n<\/blockquote>\nI don\u2019t know how many people would be affected by a \u00a32.7M LTA (especially if it were indexed), but it can\u2019t be too many.<\/p>\n
\n- It\u2019s also hard even for me that \u00a35.4M between a couple isn\u2019t enough pension to get by on.<\/li>\n<\/ul>\n
I think \u00a31.5M is a lot more likely, however.<\/p>\n
To counteract this generosity, the IFS wants to see the tax-free cash lump sum cut back, and the amount of pension that can be bequeathed tax-free reduced \u2013 ideally to zero.<\/p>\n
\n- The bequest limit seems fine, but I think it\u2019s already unfair that the tax-free lum has been frozen \u2013 many people are part way through their pension journey and invested on the basis that 25% would be tax-free.<\/li>\n<\/ul>\n
Punishing people for decisions they made according to tax law in past years can never be right.<\/p>\n
Tory Watch<\/span><\/h6>\nAll I could find from the Tories was a pledge to freeze stamp duty (on houses) and then a later announcement that it would be cut for first-time buyers.<\/p>\n
\n- Transaction taxes (including stamp duty on shares) are a bad idea in general, and the high SD rates on expensive homes (and in particular on expensive second homes) just block the top end of the market.<\/li>\n<\/ul>\n
An illiquid market is a market in which resources are not optimally allocated, which is something that all parties claim to be against (though they might use more direct language).<\/p>\n
![\"Joachim](\"https:\/\/the7circles.uk\/wp-content\/uploads\/2019\/11\/Joachim-Klement.jpg\")
<\/a><\/p>\nJoachim Klement looked at the true return on private debt<\/a>.<\/p>\n Private credit has become the hottest asset<\/a> class in 2024. This boom is fuelled by pension funds, family offices, and other institutional investors chasing uncorrelated and stable returns with low to medium risk.\u00a0<\/span><\/p>\n<\/blockquote>\n I think we\u2019d all like some of that.<\/p>\n A recent study found that the average cumulative return (above the risk-free rate) of a private credit fund was 34%.<\/p>\n Comparing returns to the risk-free asset<\/a> is not fair because private credit is essentially high yield debt structured by banks and specialist asset<\/a> managers. One needs to adjust the outperformance by the risk factors inherent in bond<\/a> investments. If one does that, the lifetime cumulative alpha is still 10.5%.<\/span><\/p>\n<\/blockquote>\n That\u2019s a lot less when spread over 5.5 years. But Joachim is not done:<\/p>\n Private credit are high yield loans, so they are riskier than normal bonds and effectively lie somewhere between stocks and bonds. One can adjust the alpha by the risk factors in stocks or, even better, the combined risk factors of stocks and bonds. The resulting alpha over the lifetime of a fund is\u2026 drum roll\u2026 -0.1%.<\/span><\/p>\n<\/blockquote>\n So private credit doesn\u2019t really offer much to a portfolio that is already diversified between stocks and bonds.<\/p>\n Joachim is in good form at the moment, and a second article looked at private equity returns<\/a>.<\/p>\n After five years of grace to invest the funds (during which time managers charge a fee on uninvested assets), fees are only charged on assets that have been invested.<\/p>\n What is a fund manager to do when after three years or so, a large part of the committed capital is not invested yet? The incentive then changes to invest as much money into any project, whether it is viable or not. One would expect that investments made in years four or five of the life of a fund are worse than investments made earlier.<\/span><\/p>\n<\/blockquote>\n Certainly, the returns are worse.<\/p>\n The chart uses EBITDA margin growth as a measure that is difficult to manipulate. Investments made at a later stage in the fund\u2019s life have a higher likelihood of being unprofitable and create a drag on fund IRR and money multiples.<\/span><\/p>\n<\/blockquote>\n The effect is stronger for more experienced general partners of firms.<\/p>\n It\u2019s almost as if experienced private equity managers have learned that fee income is more valuable than performance.<\/span><\/p>\n<\/blockquote>\n There\u2019s also a larger effect for firms with a lot of pension fund money, indicating that these investors don\u2019t look too closely at what\u2019s happening.<\/p>\n What should investors do?<\/p>\n If a fund hasn\u2019t made a lot of investments in the first two to three years of its life, investors should increase oversight and (if possible) reduce capital commitments.\u00a0<\/span><\/p>\n<\/blockquote>\n Maybe they should also steer clear of funds run by experienced GPs and with a lot of pension fund money inside them.<\/p>\n I must apologise in advance for a large amount of politics in this week\u2019s roundup, but it\u2019s mostly about taxes.<\/p>\n In his Bloomberg column, John Stepek looked at what might actually happen if Labour win.<\/p>\n First up is the LTA (more on that later), but restoring it won\u2019t be easy:<\/p>\n Nothing in pensions is easy. For a start, Hunt got rid of it partly because of its role in putting off senior doctors from continuing to work beyond retirement age. For another thing, getting rid of it has proved A carve-out for doctors would be tricky to operate, and even bringing back a \u00a31M limit would mean new protections for those who have taken advantage of the two-year gap in penalties.<\/p>\n Next up is 40% income tax<\/a> relief on pension contributions.<\/p>\n But it never happens, because of the public sector.<\/p>\n Higher earners in DB<\/a> schemes would either find themselves paying a lot more tax or having benefits reduced significantly every year in order for the scheme to pay the tax.\u201d (There are similar issues with reducing the tax-free lump sum).<\/span><\/p>\n<\/blockquote>\n The tax-free lump sum has now been frozen at \u00a3268K, so that\u2019s another stealth tax (and another reason for people not to save for their retirement).<\/p>\n Idea number three is another LTA on ISAs.<\/p>\n Since ISAs are much more popular these days than pensions, a lot of people might be against it.<\/p>\n I just don\u2019t understand why people think that tax shelters need a lifetime cap when they already have an annual contribution limit.<\/p>\n John also makes a more fundamental point about the politics of taxation:<\/p>\n No politician wants to admit to taxing anyone except \u201cthe rich\u201d. But not only do we need \u201cthe Raising real money from taxes means hurting a lot of people.<\/p>\n All because nobody dares to say that maybe we each know how best to spend our money \u2013 certainly better than the government does.<\/p>\n One day, someone should try getting elected on such a platform<\/a>.<\/p>\n The Institute for Fiscal Studies put out a paper this week calling for the swift return of the LTA:<\/p>\n The pensions tax regime is still overly generous to those who already have big pensions, The good news is that they agree that a higher limit would simplify reintroduction:<\/p>\n The last Labour government set the lifetime allowance at \u00a31.8mn in April 2010; it could, for example, reintroduce it at that level \u2014 or the equivalent adjusted for inflation, which would be around \u00a32.7mn today.<\/span><\/p>\n<\/blockquote>\n I don\u2019t know how many people would be affected by a \u00a32.7M LTA (especially if it were indexed), but it can\u2019t be too many.<\/p>\n I think \u00a31.5M is a lot more likely, however.<\/p>\n To counteract this generosity, the IFS wants to see the tax-free cash lump sum cut back, and the amount of pension that can be bequeathed tax-free reduced \u2013 ideally to zero.<\/p>\n Punishing people for decisions they made according to tax law in past years can never be right.<\/p>\n All I could find from the Tories was a pledge to freeze stamp duty (on houses) and then a later announcement that it would be cut for first-time buyers.<\/p>\n An illiquid market is a market in which resources are not optimally allocated, which is something that all parties claim to be against (though they might use more direct language).<\/p>\n\n
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Private equity returns<\/span><\/h6>\n
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Labour Watch<\/span><\/h6>\n
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complicated.<\/span><\/p>\n<\/blockquote>\n\n
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rich\u201d, but the trouble is, \u201cthe rich\u201d (however you define them) don\u2019t have enough money.<\/span><\/p>\n<\/blockquote>\n\n
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LTA Watch<\/span><\/h6>\n
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those with high retirement incomes and those getting big employer pension
contributions.<\/span><\/p>\n<\/blockquote>\n\n
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Tory Watch<\/span><\/h6>\n
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