Private credit has long lived in the shadow of its more famous cousin, private equity. But its growth in the last few years cannot be ignored: assets under management globally have expanded from $500 billion in 2015 to $1.4 trillion today.
Asia is a small part of this, but the regional market had grown by almost 30 times in the last 20 years to top $90 billion by last June. This has likely accelerated since then: a BlackRock survey released in April found that 68% of institutions in Asia Pacific plan to increase allocations to private credit. Even The Economist acknowledges it is “stealing the limelight” from private equity.
So these are exciting times for private credit, which has a particularly bright future in emerging Asia because of its ability to provide capital to underbanked companies. Asset managers and owners active in this asset class can lend to large companies in leveraged finance transactions arranged by banks, or source their own loans to smaller companies. Others buy up more distressed loans in what are known as special situations.
Yet even as private credit managers capitalise on unprecedented interest from institutional investors, they should start preparing their reputations to withstand a reversal in sentiment. We share a few ideas here about why – and how.
For everything there is a season
This may sound pessimistic, but experienced market observers know that appetite for every asset class is cyclical. The narrative arc typically involves growing excitement, peak interest, some kind of (possibly serious) problem, a fading from prominence and then return and rediscovery. This pattern is familiar to anyone who has followed high-yield bonds, tech stocks or Collateralised Loan Obligations.
That doesn’t mean there is anything wrong with any of these asset classes. The way they orbit in and out of favour merely reflects the cyclical interplay of valuation, demand and macroeconomic factors, all of which are magnified by attention from analysts, media and other sources of influence.
Right now, private credit is basking in the earlier stages of the cycle. But as demand heats up, perhaps outstripping some managers’ ability to originate new loans, the price of these assets should rise and returns should fall.
Rising interest rates have so far added to the attraction of private credit, which offers investors exposure to floating-rate interest payments. In theory, though, there will come a point at which higher interest rates start causing borrowers to default because of higher debt servicing costs – especially if an economic downturn impacts their businesses. Concerns about this are starting to surface amid continuing fears of a US recession. This was shaping the discussion about private credit at last week’s Milken Institute Global Conference in Beverly Hills.
Asia can’t escape
Even if US private credit gets into difficulty, for example, the situation may be quite different in Asia. Companies that have turned to non-bank institutions for funds because they are unable to access bank lending may not be so leveraged, or they may have better underlying business growth. But even if the asset class were to outperform in Asia, relatively speaking, regional managers wouldn’t be able to escape the fallout from a global downturn.
Private credit’s popularity today is a key advantage for managers seeking to build resilience against a future turnaround in sentiment and market conditions. Because people are listening right now, managers have the opportunity to explain their investment approach, how they source quality assets and how they ensure there is sufficient liquidity in their funds. Managers that invest in performing loans may want to differentiate themselves from special situations funds, which would likely see a higher rate of corporate defaults as an opportunity to buy attractively-priced assets.
Be the bearer of bad news
Those who have strong relationships with reporters are also in a position to (discreetly) start previewing some of the challenges the asset class may face in the coming months and explaining how their fund is prepared to address them.
It may seem counter-intuitive to start talking about what could go wrong before it happens, but doing this on background now can strengthen credibility and trust for when things do get more difficult. Those who do this well should benefit from coverage that is better informed about their investment process and more influenced by their risk awareness.
Ensuring in advance that media understand the way private market funds operate can make a difference. Blackstone moved to limit withdrawals from its BREIT real estate investment trust last year, leading many media to describe BREIT as having been “gated.” But as it stopped withdrawals from the $70 billion fund again in April, Blackstone said: “BREIT is not a mutual fund and has never gated. It is a semi-liquid product and is working exactly as planned.”
The long game
Ultimately, building a leading reputation for investing in any asset class is a long game and inseparable from investment itself. When the asset class is in favour, you want to generate better returns, attract greater inflows and be more highly regarded than your competitors. When it is eclipsed for a time, you want to ensure that you survive, continue to outperform on a relative basis and remain the most respected name in your peer group so that you will be the first to benefit when the cycle turns again.
The Economist applauds the rise of private credit – and its ownership of loans that could otherwise cause problems in the banking system: “A shift towards private credit, where sophisticated investors bear the risks instead, is preferable.”
We agree – and believe that the asset class has great potential in financing underbanked mid-market firms in Asia in particular. But it will face inevitable storms in the future, so the time to start defending its reputation is now.