Illiquidity premia in private debt

In private debt markets, illiquidity premia (“ILP”) are a key factor in assessing relative value between private sectors as well as versus public debt. For investors who can provide long-term patient capital, these premia represent the potential to harvest additional returns from investing in private debt, while also enabling investors with a “multi-sector” or opportunistic approach to take advantage of relative-value opportunities between private debt sectors and pricing dislocations versus public markets.

Figure 1 below shows that since 2022 average illiquidity premia have improved across all private debt sectors. The key driver of this has been a backdrop of tightening public debt spreads (around 110 basis points since the middle of 2022) while private debt spreads have held relatively firmer.¹  Tightening public credit spreads to the end of the first quarter of 2025 had reflected market optimism of a “soft landing” outcome, with inflation moving back towards target levels and the Bank of England, European Central Bank and US Federal Reserve all cutting interest rates. Given this, private debt illiquidity premia were back around long-term average levels in the first quarter of 2025, as shown in figure 1. 

A key takeaway we draw from this analysis is that illiquidity premia are not static and vary through the market cycle. Secondly, illiquidity premia across the various private debt sectors do not move in tandem, reflecting different dynamics through market cycles.

Private debt spread dynamics

An important driver of pricing dynamics is the ‘stickiness’ of private debt sector spreads versus public debt.

• Real estate debt spreads tend to be the most “sticky”, resulting in illiquidity premia that have historically been correlated to the real estate cycle. Real estate debt illiquidity premia tend to compress when real estate capital values decline, and then typically recover as real estate valuations rise.
• Private corporate debt spreads tend to be the least sticky and re-price the fastest to public debt markets. Given this dynamic, illiquidity premia tend to remain in a narrower range over the long term. Also, some of the highest illiquidity premia have occurred during periods of higher market volatility, especially when there is less capital available from more traditional lending sources.

• Infrastructure debt spreads tend to be moderately sticky, and reprice more gradually to public debt markets. 

Figure 2 sets out these spread dynamics in more detail. The implication is that when investing in private debt, a multi-asset approach can be beneficial and allow investors to take advantage of relative value pricing opportunities between sectors.

Figure 2: Pricing dynamics across private debt sectors

Past performance is not a reliable indicator of future returns

Note: ILP = Illiquidity Premia.

Source: Aviva Investors, 2025.

Since the end of Q1 2025 the world has moved on. On April 2, 2025, President Trump announced the introduction of significant tariffs aimed at reducing the US’ reliance on foreign goods. This shift has led to increased market uncertainty and volatility (see our House View Q2 2025 for more detail), and investment grade credit spreads are up around 20 basis points since this period.

While it is too early to predict the full impact of tariffs and economic uncertainty on public corporate spreads throughout 2025, we anticipate more short-term opportunities in private corporate debt and structured finance. These private debt sectors typically reprice to public markets the fastest and have the shortest completion times, particularly when there is a distressed seller or an urgent need for capital.

In contrast, real estate debt and infrastructure debt generally reprice more slowly to public markets. Consequently, we might observe some compression in illiquidity premia in the short term. However, this does prohibit there being attractive pricing opportunities that offer good relative value.

In Q1, European debt totalled around £30bn, with the UK contributing nearly £8bn, almost double France's £4bn. Renewable energy was the main sector, accounting for £12bn, including £4.5bn for solar energy. Major transactions included Brookfield's acquisition of Neoen, financing of Inch Cape offshore wind in the UK, and Poland's Baltica 2 offshore wind asset. Inch Cape was the largest UK deal, raising £4bn from a 22-bank group, showing strong liquidity for renewables.

Datacentre market activity continued with five deals in Europe worth around £1.4bn and a growing pipeline of opportunities. Recent market volatility hasn't significantly impacted infrastructure debt activity. However, infrastructure investment is being discussed across Europe as a means to drive economic growth and support decarbonisation and digitalisation. Given high public debt levels across Europe, there's a push for private investment to bridge the infrastructure gap.

Activity levels and sentiment improve; margins tighten

The first quarter of 2025 saw a significant uptick in investor interest, particularly for larger transactions. Notwithstanding some of the macro uncertainty, a wide range of property investors have been active with purchases and refinances and finding considerable available liquidity across different lender types from banks, debt funds and institutional investors. The willingness of lenders to hold larger commitments (over £250m in some cases) is in stark contrast to the approach in Q1 2024. Consequently, we have seen loan margins come under some pressure and advance rates increase. Particularly notable has been the margin pressure on whole loans and other higher yielding debt which has largely been driven by the growth in back leverage.

Corporate spreads across most sectors have rebounded over the past three weeks after hitting all-time lows, presenting attractive entry points. Despite the macroeconomic volatility:

• Investment-grade (IG) borrowers are tapping into the market, even though the rates outlook remains largely unchanged and credit spreads have widened. 
• In the sub-investment-grade (sub-IG) space, the high yield market saw a sharp reduction in liquidity due to tariff-induced volatility. 
• Sub-sovereign spreads in both Europe and the UK have widened again, offering good entry points.

Regarding credit risk, we believe IG markets offer favourable entry points. However, it's crucial to maintain discipline in sub-IG sectors and focus on strong defensive sectors like consumer staples and healthcare.

The collateralised loan obligation (CLO) market quickly reacted to recent tariff induced volatility, with spreads on BB-rated tranches reaching mid-700s compared to low 500s just weeks ago.

Emerging market borrowers, particularly in Africa, are facing budgetary pressures due to the heightened interest rate environment. Consequently, there is increased issuance with export credit agencies (ECA) and multilateral covers. Borrowers are now using matching adjustment eligible structures to attract interest from the insurance sector and diversify funding sources.

Fund financing as an asset class is offering significant illiquidity premiums. With subdued M&A activity, funds are using fund-level leverage to delay asset sales, increasing the importance of fund finance as a liquidity management tool.