Fixed Income Has Changed: The New Cycle Demands Alternative Strategies
The 2020–2025 cycle has profoundly reshaped capital allocation dynamics in financial markets. A sequence of disruptions—pandemic, unprecedented stimulus, sustained inflation, war in Ukraine, and monetary tightening—has eroded the traditional role of fixed income as a stable anchor for returns and diversification.
In this context, traditional fixed income instruments—particularly investment-grade sovereign and corporate bonds—have lost much of their effectiveness in delivering real returns. Private debt, by contrast, has strengthened its position as a core asset class for constructing diversified credit portfolios, offering a superior risk-return profile and greater customization potential.
In Spain and across Europe, the rise of private debt reflects not only a cyclical shift in capital flows but also a structural transformation in corporate financing models. Post-Basel III and IV, the retreat of bank lending has opened a growing space for specialized funds, particularly in segments such as the mid-market, transitional real estate, and special situations requiring complex solutions.
Private Debt Strategies and Structures: Beyond Direct Lending
For investors with flexible mandates—such as multi-strategy private equity funds—private debt provides multiple levers of engagement:
Senior Direct Lending: Cash Flow Visibility and Control
These are secured, structured loans with seniority over other debt tranches. The most developed segment is Europe’s lower mid-market (deal sizes between €15–100M), where banks have pulled back, and funds can operate with greater agility.
Loans typically have floating rates (EURIBOR + spread), scheduled amortization, and tight covenants (financial covenants, cash sweeps, change of control clauses). In Spain, this type of financing has gained traction in sectors like B2B software, healthcare, specialized industrial services, and energy transition.
Mezzanine and Hybrid Debt: Leverage Without Dilution
Subordinated mezzanine debt—unsecured or second-lien—allows companies to expand their capital base without diluting shareholders. It is particularly useful in recapitalizations, leveraged buyouts (LBOs), or inorganic growth financing.
From an investor perspective, it offers attractive premiums (IRRs of 9–14%) in exchange for increased subordination. Often, it is paired with equity kickers (warrants or preferential rights) to participate in the company’s upside.
In special situations or listed companies with complex capital structures, these instruments can provide synthetic equity exposure without taking a direct shareholder position—valuable for regulatory, tax, or strategic reasons.
Special Situations and Opportunistic Debt: Unlocking Value in Dislocation
The high-rate environment is generating a growing flow of opportunities in special situations. This includes:
• Complex refinancings of companies with pre-2022 leveraged capital structures
• Pre-insolvency processes or out-of-court restructurings
• Hybrid recapitalizations (debt + preferred or convertible instruments)
• Acquisitions of distressed secondary debt at a discount
These strategies offer double-digit returns through tailor-made instruments. They require legal expertise, workout experience, and often active participation in creditor or restructuring committees.
Financial-Sector Private Debt: An Underexplored Frontier
A particularly interesting area is structured financing in the financial sector—such as purchasing non-performing loan (NPL) portfolios, lending to insurers or asset managers with financial collateral, or subordinated loans to regulated fintechs.
These transactions, often overlooked by traditional private debt funds, offer meaningful complexity premiums and lower correlation with the real economy. They also provide indirect exposure to retail and mortgage credit performance without direct equity risk in financial institutions.
Thematic and Sector Opportunities in the European Context
Infrastructure and Energy: Real Assets with Indexed Income
Europe’s regulatory push for the energy and digital transitions has created structural demand for private financing. Renewable energy projects, power grids, data centers, and energy storage all require long-term capital solutions. Structured debt (project finance, green loans) enables investors to access real assets with predictable cash flows, indexed contracts, and high barriers to entry.
Spain stands out for its robust pipeline in solar, wind, and green hydrogen, supported by local developers with strong track records and flexible capital needs. Investors with on-the-ground presence can access primary deals with attractive spreads and robust structures.
Transitional Real Estate: Logistics, Redevelopment, and Tourism
Real estate price corrections have created selective opportunities to finance transitional assets. Key focus areas include:
• Urban logistics and distribution centers
• Office-to-residential conversions
• Subordinated debt in hotels and tourism assets
In these niches, mezzanine or bridge loans allow investors to capture returns without taking direct equity exposure. Additionally, distressed strategies involving repossessed assets or NPL portfolios remain relevant in Spain due to the presence of specialized servicers and a relatively predictable insolvency framework.
Spanish SMEs and the Mid-Market: A Structural Gap
Spain’s SME segment remains underserved by traditional bank credit. Direct lending transactions to unlisted or semi-public companies allow for granular, diversified portfolios with strict covenant packages. Especially in sectors like enterprise tech, professional services, healthcare, or agribusiness, private debt enables growth financing with senior secured structures and returns in the 6–10% range depending on risk.
Here, local access is the key competitive advantage: direct origination and the ability to structure flexible solutions are essential.
Portfolio Construction Principles: Balance, Control, and Diversification
A professionally built private debt portfolio should target diversification across five dimensions:
1. Capital structure and risk level: Combining senior, subordinated, and distressed debt to capture value without compromising overall solvency.
2. Maturity and amortization profile: Balancing bullet loans, amortizing structures, and staggered maturities to mitigate refinancing risks.
3. Economic sector: Blending defensive assets with structural growth themes (energy transition, digitalization).
4. Jurisdiction: Favoring European markets with strong legal protection while avoiding excessive country concentration.
5. Vehicle and manager: Leveraging both closed-end funds with a strong track record and evergreen strategies, co-investments, or direct mandates.
Construction should remain dynamic, with tactical adjustments based on economic cycles, interest rates, and maturity calendars. In practice, institutional investors are combining core portfolios (senior debt, stable coupons) with satellite allocations (mezzanine, distressed, financial sector) to enhance return convexity.
Structural Risks: Addressing Them Through Governance and Diligence
Private debt carries risks that must be managed proactively. Key risks include:
• Structural illiquidity: Requires long-term commitment and disciplined selection. Can be partially mitigated through semi-open or evergreen strategies offering some flexibility.
• Default and credit deterioration: Managed through fundamental analysis, sector segmentation, and active monitoring. Covenant packages and collateral play a critical role.
• Refinancing risk: The 2025–26 maturity wall requires forward-looking assessments of post-refi solvency and avoidance of excessive bullet structures.
• Interest rate sensitivity: In floating-rate portfolios, this risk transfers to borrowers. In fixed-rate portfolios, it can be hedged with derivatives or duration management.
• Regulatory and tax risk: The evolving European framework (ELTIF 2.0, SFDR, taxonomy, Basel) demands internal teams capable of anticipating impacts and adapting structures accordingly.
Tactical Recommendations for Uncertain Environments
In highly volatile settings, it is wise to follow a tactical logic grounded in discipline and flexibility:
1. Increase allocation to high-quality senior debt: Protects capital, offers stable coupons, and maintains relative liquidity.
2. Selective allocation to distressed strategies: The current moment is favorable for capturing value in complex restructurings and refinancings.
3. Maintain exposure to floating-rate instruments with solid collateral: Provides cash flow, rate indexation, and inflation protection.
4. Diversify vehicles and managers: Reduces concentration of operational risk and enables access to various market niches and management styles.
5. Actively manage duration and interest rate sensitivity: Adjust the portfolio’s maturity structure based on interest rate and inflation expectations, using fixed-rate debt or swaps when appropriate.
Private Debt as a Strategic Tool in the Current Cycle
For professional investors with a medium- to long-term outlook, private debt now represents a real opportunity to build robust portfolios that generate risk-adjusted returns aligned with current macroeconomic challenges.
Far from being a static asset class, private debt offers sophisticated tools to finance companies, real assets, and special transactions through customized structures. In an environment where liquid markets offer insufficient premiums and capital must be protected against cyclical shocks, well-executed private debt delivers what professional investors demand: control, predictability, and return.
