2023 Mid-year Alternative Investment Outlook

Private credit in a new regime 

Emeka Onukwugha, CFA, Head of Private Placements
Elisabeth Perenick, FSA, CFA, Head of Portfolio Management, Private Placements
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Mid Year Outlook Designs

The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

This is an excerpt from our 2023 Mid-year Investment Outlook, in which specialists from across our investment platform share insights on the economic and market forces that we expect to influence portfolios in the second half of the year. This is a chapter in the Mid-year Alternative Investment Outlook section.

The first half of 2023 was filled with headlines impacting the outlook for private credit markets. Looking ahead to the back half of this year, we see enduring opportunities fueled by the changing macroeconomic regime, the ongoing banking crisis, and an evolving competitive landscape. 

In this mid-year outlook, we dive into each of these three key themes.

Shifting macroeconomic backdrop

The global economy is experiencing the dawn of a new macro regime, one that is likely to see stickier inflation, higher interest rates, and more extreme cycles. The low-rate environment that we experienced over the last decade was a key factor in the growth of the private credit asset class, as investors sought higher yields to meet their investment objectives. While we think private credit should continue to provide a reliable income stream that appeals to investors, the asset class’s diversification and downside mitigation potential have come into even greater focus given the shifting investment landscape.

Private credit assets continue to exhibit a low correlation to traditional assets. Moreover, the bespoke and privately negotiated covenants often included in private deals can provide investors additional downside mitigation potential. Critically, private asset prices are largely driven by underlying fundamentals and not impacted by mark-to-market volatility. Diversification, exposure to high-quality businesses, and strong credit covenants all become increasingly important during a time of heightened macroeconomic challenges. 

In addition, the ability to take advantage of floating rate exposure may make the asset class even more attractive in a rising rate environment. 

Opportunities for private credit in a banking crisis

As we have seen in previous crises, financial institutions are now tightening lending standards, creating significant opportunities for nonbank lenders. In our view, today’s banking sector issues once again offer the potential for private credit to step in and provide much needed capital to high-quality businesses. For example, year-to-date issuance in the private placement market continues to be strong as investors leverage the “always open” nature of the private market to reduce execution risk and meet their funding needs.

Additionally, the failure of Silicon Valley Bank (SVB) — which accounted for a significant share of venture debt deal volume — may be creating a once-in-a-generation opportunity for nonbank lenders to provide debt capital to innovative companies looking for less dilutive funding sources. Echoing the remarkable growth story we witnessed in direct lending after the global financial crisis, other private credit spaces now appear poised to take market share from more traditional lending sources. 

As is often the case, we believe many of the best investment opportunities are found amid financial difficulties. In fact, post-crises vintages often perform better than pre-crises vintages. We believe that the capital scarcity caused by banks retreating could enable nonbank lenders to be more selective when lending and give private credit managers the upper hand at the negotiating tables. This could give private credit managers the potential to negotiate stronger covenant protections and to selectively invest in higher-quality businesses. 

The private market’s evolving competitive landscape

The shifting macro environment and ongoing banking crisis are also driving a shake-up in key segments of the private credit market. Both the growth lending and investment-grade private placement markets are witnessing a marked expansion with new sources of capital coming to the market. As noted above, the failure of SVB will likely result in new players entering the venture debt market. In our view, lenders with experience working with venture capital and late-stage private companies are poised to grow in the years ahead. In addition, the investment-grade private placement market — long dominated by large insurance companies — has seen new asset managers enter the market, helping to expand the issuer base and improve investor access to private placements. 

Notably, the direct lending market is not witnessing this same diversification of lenders. Instead, the big are getting bigger as direct lending sees consolidation of funds.

As new entrants enter segments of the private credit market amid a more challenging environment, we believe the importance of identifying managers with disciplined underwriting standards and deep experience navigating financial markets will become even more critical to success. 

Bottom line on today’s private credit markets

Volatile and uncertain times create both opportunities and risks across public and private markets. Private credit is experiencing a new regime fueled by inflation, rising rates, a banking crisis, and a rapidly evolving competitive landscape. In our view, the strong virtues of the private credit asset class — such as diversification and downside mitigation potential — can help investors navigate this new environment.


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