Concerns over private equity valuations, turmoil in public markets, rising interest rates and a looming global recession have triggered more asset owners to scale up their private credit allocations, although questions remain about whether this is sustainable.
The buzz in the asset class comes as everyone from sovereign wealth funds to VC firms have been gearing up their exposure to private credit, much like was the case with the hype around private equity and hedge funds at the height of the Covid-19 pandemic.
Financial institutions such as DWS Group, Fidelity International, PGIM, SoftBank and T Rowe Price are among the stalwarts that are buying or building out private credit franchises. For instance, PGIM Private Capital – the private capital arm of PGIM – reportedly provided $16.1bn of senior debt and junior capital to 241 middle market companies and projects globally last year. More recently, the firm has bolstered its $237bn global alternatives platform and private credit capabilities through the $5bn acquisition of private credit manager Deerpath Capital.
In another case, Fidelity expanded its lineup of alternative investments with the addition of the Fidelity Private Credit Fund, a new business development company aiming to generate current income and long-term capital appreciation by originating loans to private companies.
“For many SMEs, especially family-owned businesses, selling an equity stake is not an option as they typically want to retain ownership within the family, which leaves borrowing from alternative financing channels as the most viable avenue to pursue their growth plans,”
Sam Clothier, executive director, business development, VI Asset Management
At present the global private credit market has some $1.5trn in assets under management (AUM), up from $440bn a decade ago, recent statistics released by data platform Preqin reveal.
Asia remains the world’s fastest growing credit market with private credit fundraising in the region hitting a record high in 2022 with $11.2bn raised across 27 funds. This is a 42% jump from the levels seen in 2021, according to a report released by the Global Private Capital Association in March.
Sam Clothier, executive director for business development at private credit firm VI Asset Management, believes that the private debt market in Asia will continue growing at the same fast trajectory it has over the last few years, especially at a time when corporate SMEs are finding it harder to access capital for their growth financing plans from traditional banking channels.
“We’ve heard from numerous SMEs that with the retreat of bank financing in the region, they’re reviewing the options available to them to finance their growth ambitions, however, the options are limited typically to selling equity to raise capital or find alternative financing channels to borrow from to fund their growth. For many SMEs, especially family-owned businesses, selling an equity stake is not an option as they typically want to retain ownership within the family, which leaves borrowing from alternative financing channels as the most viable avenue to pursue their growth plans,” he said.
When asked where the opportunities for private credit in Asia lie, Clothier said: “Asia is a very broad, fragmented market which offers plentiful opportunities for experienced alternative lenders but each country has its own characteristics, laws and regulations which need to be carefully navigated making this one of the most difficult aspects of private credit for the region as compared to a single country like the US,” he said.
Agreeing, Vincent Au, managing director and head of investments at independent wealth advisory firm ALPS Advisory, notes that Asia is quite fragmented with different languages and jurisdictions, unlike the US or Europe where the markets are concentrated and operate under a single currency. “An investor will require a high premium to take part in a market like Asia but unfortunately from what I can see, that premium is just not high enough, relatively speaking,” he said.
Is it sustainable?
The growth in AUM in private credit has been triggered by an increase in both demand and supply, Au tells FSA. “The banking sector is no longer lending because of Basel III plus many banks have gone under after the Silicon Valley Bank crash in March, which means that quality has tightened. However, liquidity is still needed for refinancing or to finance projects so there is supply for private credit,” he said.
Meanwhile, a lot of investors consider private credit a favourable investment because of its position in the capital structure. “Companies are bound to struggle in a recession, which means they can’t go on and will not be able to service that debt. However, the benefit of buying private credit is that you are sitting right at the top in terms of the capital structure. So that means if the company defaults on the loan, you have first claim on everything,” Au said.
Even as the private credit market is on the uptrend, some investors caution that this rise may not be sustainable.
For instance, Oaktree Capital Management’s co-founder Howard Marks made headlines recently when he warned in an interview with the Financial Times that the boom in private credit would be tested as higher interest rates and slower economic growth heap pressure on borrowers.
“The banking sector is no longer lending because of Basel III plus many banks have gone under after the Silicon Valley Bank crash in March, which means that quality has tightened.”
Vincent Au, managing director and head of investments, ALPS Advisory
“I think we are seeing bubbles everywhere, not just in the private credit market,” said Au. However, given the ongoing market slowdown he cautioned against investing passively.
Roger Moh, head of capital solutions at VI Asset Management offers a different perspective. “There’s only one or two asset managers who feel like the decline is likely to happen. But I think they’re just taking a very cautious stance, given what has happened to the other asset classes in the past few years, especially when there was a recession that was coming on,” he said. Moh’s stance is that private credit, if structured properly, will offer relatively consistent returns through different interest rate cycles, rather than just benefiting from interest rate hikes.”
Yoon Ng, principal for global asset management advisory at Broadridge, pointed out that private credit is not immune to inflationary pressure, rising rates and the increasing risk of defaults, although some of its characteristics would help during a downturn. “The private or concentrated nature of the private credit business could lend well to re-negotiation of lending terms, which will help corporates better ride through any cash crunch,” she added.
In light of this, Clothier advises investors to navigate private credit carefully by “selecting strong managers who have experience in the region originating, underwriting, managing and getting repaid as this is a different market to the private credit market in Europe or North America.”
This was echoed by Ng. She stresses that size matters when investing in private credit as “larger private credit managers are better capitalised and more well-diversified to mitigate risks of a slowdown or defaults in particular segments of the market”.
Ng adds that it is also critical to ensure that managers have “strong primary due diligence capabilities” as deals structured with favourable covenants will eventually allow for more favourable investment outcomes.
