Insights

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A Rose By Any Other Name

June 15th, 2023

Market Views

The private debt asset class includes a multitude of strategies that can be grouped into a few general categories. We like Mercer’s framework, which groups strategies into direct lending, structured credit, credit opportunities, asset-based lending, and specialty finance.  HCG sits squarely in specialty finance, a broad category that has one common feature across managers: expertise in a field.

HCG’s expertise is in the democratization of credit through technology.  We identify growth sectors with a loan product, construct portfolios of those loans, and build effective risk management protocols around our portfolios. 

The strategy we invest in has been given many names, including digital private credit, Fintech credit, consumer finance, platform finance, marketplace loans, and so on.  But do any of these names help a private debt allocator understand the assets we buy?  After all, the credit assets in our addressable market span a variety of sectors (e.g., small & micro businesses, skill-based education, consumer and auto), they may or may not be originated through a marketplace, and they generally do not involve a digital asset.

So, that begs the question, what is the typical HCG credit asset in which we invest?

It is an amortizing small-balance loan (~$10,000 at origination), with a loan term less than 5-years, originated by a non-bank lender, and with a robust data set.

An outcome of two of the attributes – “amortizing” and “short term” – is low average life or duration that ranges from 5 to 20 months.  A portfolio of these loans enjoys regular daily cash flow of principal and cash interest, giving a portfolio manager optionality around cash management (e.g., reinvest, distribute, repay financing, sit on cash, etc.).  A large and deep data set enables vigorous risk management and brings about insightful decision-making in near-real time. 

Building a portfolio of small balance loans can lead to a high level of diversification, a powerful risk mitigant in credit.  This becomes more poignant when compared to other private credit asset classes.  Consider an investment manager with $100 million who can choose to build a portfolio of 5 middle market direct loans of $20 million per loan, or a portfolio of 10,000 loans of $10k each, a 2000x diversification multiplier!  Which would you do?

HCG purchases small balance loans from companies that use technology to originate, underwrite, and service those loans.  Referred to as Fintechs, many of these technology companies – several with US banking licenses – range from pure-play marketplace lenders to payment processors.  Based on industry research and HCG estimates, in the US in 2022, these companies originated around $180 billion in small balance loans compared to about $600 billion in middle-market (ex. real estate) private credit issuance.  According to our estimates, HCG’s addressable market could reach about $400 billion in originations by 2027. 

HCG’s mantra is the inevitable digitization of everything. As financial services continue to digitize and move online at breakneck speed, we expect to see continued proliferation of small balance credit assets, and with that, more private capital mobilized to invest in that supply.  Whatever you want to call our asset class, we believe it is an integral component of the future of finance generally and private credit specifically. It smells like a rose to us.

 

DISCLAIMERS AND OTHER IMPORTANT INFORMATION
Confidentiality and Non-solicitation: No information herein constitutes an offer or a solicitation to buy or sell any securities or any interests in any product or investment strategy managed by HCG Fund Management LP (“HCG”).  Any offer or solicitation relating to any such investment will be made only by means of confidential offering documents relating to a particular fund  or investment contract and only in those jurisdictions where permitted by law.
Reliance: This information may not be relied upon for investment decision-making purposes. It does not contain all the information necessary to make an investment decision, including the risks, fees, and investment strategies of investment products advised by HCG. Eligible investors are described in official offering documents, all of which must be read in their entirety and will supersede the information contained herein.  No offer to purchase any securities or interests by a prospective investor will be made prior to receipt of all official documents, and no offer to purchase any securities or interests will be accepted without receipt of all official documentation that has been completed to HCG’s satisfaction.
Opinions — No obligation to update:  The information contained herein represents the views and opinions of HCG.  It is intended solely for informational purposes and is not intended to constitute investment, legal, tax or accounting advice.  The views about digital finance investing and estimated future investment opportunities expressed herein reflect those of HCG management as of the date herein and are a reflection of our best judgment at the time.  They are subject to change based on market and other conditions, and we have no obligation to update.  Actual results, however, may prove to be different from our expectations.  No warranty is given to the completeness or the accuracy of the information contained herein.
Suitability and Risks:  Any investment in products managed by HCG is appropriate only for financially sophisticated investors capable of analyzing and assessing the associated risks fully disclosed in the Private Placement and/or Information Memoranda. Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The Private Placement and/or Information Memoranda contain this and other information about the investment. A prospective investor should have no need for liquidity with respect to its investment and should view it as long-term and not a trading vehicle.  Additional risks are disclosed in the Private Placement and/or Information Memorandum including, including, limited liquidity and restrictions on transfer of the securities, dependence on HCG’s principals, and short operating history of certain productsAs with all private investment funds, investments are deemed speculative and involve risk of loss.
Third Party Data: We do not verify third party data used in certain calculated metrics shown here.