On September 20, at the annual Global Investment Forum in Toronto, more than 650 of Canada’s top financial advisors explored the latest thinking on asset allocation. The event featured keynote speakers Michael Lewis, best-selling author of Moneyball and Flash Boys, and Morgan Housel, author of The Psychology of Money.

Arif Bhalwani, CEO of Third Eye Capital, one of Canada’s leading alternative investment firms, participated in a panel on the growing importance of private debt. The panel was moderated by Rita Trichur, senior business writer for the Globe and Mail. The two had an insightful discussion on the factors that distinguish private credit markets in Canada from other countries.

Bhalwani has witnessed the Canadian private credit market’s evolution and expansion, triggered mainly by the Great Financial Crisis and the increasing volatility of the public securities markets. However, Canada is still significantly behind other developed countries in the adoption of private credit by both borrowers and investors.

The CEO illuminated some of the obstacles that his investors, as well as his industry, are facing when pursuing non-traditional asset paths.

“Canada has a robust regulatory environment that is distinct from its counterparts, particularly the United States,” said Bhalwani. “While U.S. regulations like Dodd-Frank have been instrumental in driving businesses towards private credit, the regulatory landscape in Canada is more accommodating, which is part of the reason why banks still dominate business lending in this country. This creates a different competitive dynamic between banks and private credit providers and leads to adverse selection risks for private credit in Canada.”

Bhalwani adds that many of the deals available to firms like his are the ones that have been passed over by the Big Six banks in Canada. This forces his colleagues to navigate a pool of opportunities that, on average, carry higher risk. But, he says, these are precisely the opportunities for which his practice is designed.

“Businesses that are overlooked or that find the terms of traditional bank loans too restrictive can offer fertile ground for firms like us who are willing to customize solutions and bundle value-added services to our capital, such as strategic advice, operational expertise, and business connections.”

According to Bhalwani, the maturity of the private credit markets in the U.S. and Europe create a wider choice of products, as well as a broader acceptance by borrowers that these markets offer a legitimate source of capital. In Canada, he says, retail investors seem to be more willing than institutional investors to adopt private credit as an asset class.

“Outside of the largest public pension plans, institutional investors in Canada are still significantly underweighted in private credit relative to their U.S. peers. Canada’s investment advisors are becoming increasingly more keen to pursue alternative paths like these, but the inertia of traditional institutional investment targets remains strong,” says Bhalwani.

In highlighting some of the major differences of the Canadian private credit market, Bhalwani notes that the market is much smaller than the U.S. in terms of the number of deals and the size of individual transactions. This means less competition in Canada, but also fewer opportunities for large-scale investments.

Bhalwani also points out that the Canadian business culture places significant emphasis on long-term relationships, trust and reputation. “This can influence deal-making in the private credit space, making relational capital an essential asset for a firm like ours,” says Bhalwani. “Over two-thirds of the deals we source, and close to 90% of the deals we complete, come through previous borrower relationships.” 

The panelists all believe there will be significant growth in private credit markets. Bhalwani foresees a likely credit default cycle intensifying as higher borrowing costs and increasingly unsustainable debt burdens cause a broad-scale retreat from risk-taking.

“Elevated interest rates and diminished credit availability are exacerbating the difficulties experienced by companies across sectors,” says Bhalwani. “In past credit cycles, this negative loop could be somewhat offset by more accommodative monetary policy. However, the current cycle deviates from this historical norm, characterized instead by the continued tightening of monetary policy.”

The panel pointed to latest surveys on business lending conditions in the U.S. and Canada, which showed that both price and non-price related terms for bank loans have been tightening in 2023, and a larger proportion of banks now expect businesses to have trouble in accessing credit.

“For firms like ours, it opens up a compelling array of opportunities to step in and fill the credit gap.”