Once considered an emerging trend, private debt now has a place firmly at the table of alternative financing. But what does the future hold for this asset class?
In panels that included those involved in direct lending as well as distressed debt and special situations, there were plenty of opinions being bandied about at the Private Debt Summit at SuperReturn International 2019 in Berlin.
Too much dry powder?
One of the biggest concerns in the private markets is the amount of dry powder that funds have yet to allocate.
Ray Costa, Managing Director, Special Situations at Benefit Street Partners, said that around 10% of their capital base would be deployed per quarter, and that deployment could pick up dramatically if the environment changed. The real challenge, he said, was that windows for investment were much narrower.
“Because of the policy response to every opportunity, when a buyer’s market occurs the window in which you can step in to deploy capital is much smaller. We won’t see the massive opportunity we saw in 2008.”
Cécile Mayer-Lévi, Managing Director-Private Debt at Tikehau Investment Management, whose focus is on direct lending, said that pipelines were heavy, and deployment levels would stay high. However, she warned, the market had matured greatly in the last decade, so the industry could no longer expect a clear upward trajectory.
Eric Muller, Portfolio Manager & Partner at Oak Hill Advisors, was confident that the dislocation seen in the fourth quarter of last year would continue, driving more companies into the private debt space.
Shary Moalemzadeh, Managing Director & Co-Head at Carlyle Strategic Partners, added that it remained to be seen how credit funds performed in the downturn, but that investors could protect themselves through manager selection: “Firms that have large, scaleable platforms or an information edge will outperform the market and will distinguish themselves from others,” he stated.
As for there being an abundance of dry powder, he argued that there was too much capital in general, and some perspective was needed. “On the distressed side you need to take a step back and look at the size of high yield; it’s doubled. Our view is that there is always some form of distress, there’s always an over-leveraged company or a management team that makes bad decisions.”
Taking market share from banks
Looking at the total assets of the largest banks in 2007 and comparing them to today showed a great deal of shrinkage. Did this mean that the larger private credit players were turning into banks themselves?
Eric thought so, arguing that, as private lenders had become more sophisticated, they often preferred to be a credit solution than part of a syndicated capital restructure. In addition, the pools available in private credit were much larger today.
Cecile agreed that the “lines are getting fuzzier”, but many still operated on a case-by-case basis. “Our main clients will select the option depending on each transaction. Sometimes they will select unitranche because it’s the right way to find the solution. Sometimes they will be more focused on better conditions and pricing, in which case banks will prevail.”
A critical aspect to the lending process was having access to a workout team, said Michael Ewald, Managing Director at Bain Capital Credit. “When something goes south you need to get control as quickly as you can to avoid any further leak. Many of us are part of larger firms, which means that we have those capabilities in-house.”
What’s next for the private credit market
Picking up an imaginary crystal ball, Eric thought that private credit would perform well in the next cycle. “Private credit lenders in general have better access to information and due diligence and can be more patient when compared to liquid credit strategies,” he said.
Cécile felt that the market was more immune to market trends: “I don’t see a market impact or effect, or a timing of the market like we have for liquid strategies. The most important thing is to stick to what you are doing, be patient and deploy nicely.”
A second panel later in the day also debated the direction that private debt was heading in – starting with investor motivation for entering the market.
For most of the panel, the liquidity premium is a big draw, as is the opportunity to diversify their portfolio. All agreed that it is now a bona fide asset class in itself and no longer a subset of alternatives.
Reji Vettasseri, Executive Director at Morgan Stanley Alternative Investment Partners, said that in the last couple of years, there had been an explosion in interest from his clients. “And the reason is that, with the retreat of banks, a larger number of strategies have become more actionable for private credit. Many of those strategies are in interesting areas where you do get illiquidity premium that wasn’t previously accessible or didn’t really exist before.
“The benefit of a private credit strategy is its much lower duration and reduced J curve relative to the traditional private equity strategies, which is very appealing to many of our clients,” he added.
Asset class dangers
But the panel recognised that there was a real concern about the ability of managers to manage these investments during a crisis. So what kind of managers did they seek?
Ingrid Neitsch, Head of Strategic Credit at Aberdeen Standard said that it had to be someone who had been through a cycle and who understood restructuring, who understood the tremendous opportunities in private credit today and had a strong workout capability.
Sebastian Schroff, Global Head of Private Debt at Allianz Investment Management, argued that the management approach had to be less like that of a private equity one – where the upside and downside were considered – to one analysing what the workout capabilities were.
Another concern was whether, with its growing popularity, the asset class could maintain its opportunity set. But Reji felt that, while this was a valid concern, the opportunities were still there – they were just changing.
“Even in markets that have become well capitalised, new areas are emerging where the transition from the banking system to private debt hasn’t fully developed,” he said.
“But yes,” he conceded, “in terms of certain parts of the core direct lending landscape, there is a huge amount of credit in the market, and there is a lot of pressure to deploy it. We wonder exactly how it will be deployed and lots of managers worry about their ability to deploy the capital that has been raised.”
Ingrid added that there was a natural balance between different approaches to credit markets, each had returns available, but the timing of those returns was different.
Patrick Suchy, Director, Alternative Investments Markets, Germany & Austria at HSBC Deutschland, saw opportunities for niche investments in speciality funds, and that Eastern Europe was becoming an interesting area.
There were certainly opportunities in emerging markets as a whole, said Ingrid, but things were trickier there, such as how to deal with the inherent FX risk.
Ultimately, said Sebastian, the more established it became as an asset class, the more popular it would become. But, as we head into a tougher economic climate, there would continue to be lots of opportunities.