We are in a period of healthy and active market conditions for private credit. While most would regard this as a good thing, it might not be all song and dance for investors, who have to pay close attention to those involved. Vincent Marcoux shares his thoughts with us in an exclusive interview.
How would you characterise today’s private market trends and more specifically for the credit market in terms of pricing and leverage?
The private credit market is quite healthy. We have seen capital inflows double since the 2008 crisis and ample liquidity, with inflows in North America nearly twice those in Europe.
In such an active market, investors might find it difficult now to access the best managers. At the start of the credit crisis, investors easily enjoyed 10% net IRR even with 3rd quartile performers. In recent years, return dispersion has in some cases resulted in bad news for investors. Prudence is highly recommended in future manager selections.
The private credit market is boiling and is clearly in transformation. An interesting phenomenon is the increase in velocity, where the historical four to five-year deal duration is now closer to two years, and we now have distributions in the first fund year compared with the second or third year seen in the past.
Given these market conditions, investors should pay close attention to the increasing pressure on borrowers’ ability to pay, and debt leverage embellished by a never-ending bull market. Recent transactions might be a sign of ominous developments ahead.
How does that differ from the market prior to the 2007-2008 global financial crisis?
The private credit market is much more mature than it was prior to the global financial crisis and much more disciplined. The default rate has fallen quite significantly compared with pre-crisis levels. Before 2008, the rate was about 17 percent; today it is about 10 percent. That is a significant improvement bolstered by the popularity of senior loans. In terms of pricing of the assets underlying the debt, while we have seen a discernable increase, prices appear to have stabilised. They are in fact quite stable compared with several years ago, and compared with the buyouts sector.
What are the main attributes of private credit allocation in a total private market portfolio? How might pricing and leverage impact results?
A private credit portfolio is less volatile than many other asset classes and offers better downside protection. However, investors need to pay close attention to the pricing of the underlying assets as well as the level of debt. When investors focus on reasonable leverage and assets, they should expect added value on their private credit investment. Also, we have seen great disparity in terms of results between industries and also within same industry. For example, in recent years, the Internet and insurance industries have delivered good results with minimum effort, while the energy and automobile segments have struggled with a variety of difficulties.
Where do you see challenges for LPs and how might they be mitigated?
In terms of industries, investors should be cautious of the industrial and energy sectors, where there is greater volatility and downside risk. It is interesting to note that in terms of financing structure – senior debt to EBITDA and junior debt to EBITDA – most industries are at the same level or higher than they were prior to the credit crisis.
In addition, currency risk in private credit has to be taken into consideration. When looking at results in US dollars, one needs to be cautious and keep in mind that over the last four or five years the dollar has appreciated quite a bit compared with other major currencies, such as the euro.
Finally, with the growing disparity in results of private credit funds, investors must become better skilled at selecting the right managers to more effectively achieve their investment goals.
Can you discuss where you see notable opportunities today in private credit? Do you expect any notable changes in 2019?
The US market, which offers very strong downside protection compared with many other regions, and very good performance, continues to provide significant private credit opportunities. As mentioned, investors need to remain cautious given the degree to which the US dollar has strengthened over the last four to five years. In addition, they should be mindful of the level of senior debt, which has reached pre-credit crisis levels. That is not the case with junior debt, which still has some capacity.
The computer technology, financial, infrastructure/social and healthcare sectors have performed quite well in the private credit market and we hope that will continue. Overall, if investors are disciplined and diversified in their approach and focused on reasonable multiple assets, they should expect superior returns in the private credit market.
Under the spotlight:
Vincent is responsible for CEPRES North America client delivery. He has over 20 years of experience in the asset management industry, assisting pension funds, foundations and other institutional investors. He is a CFA charter holder, MBA graduate and retired Fellow of the Canadian Institute of Actuaries.