Private credit has grown as a significant asset class for institutional lenders seeking yield and looking to diversify their asset base.
In an environment of rising interest rates, the asset class is attractive to investors keen on exposure to credit without the duration risk said JANA Investment Advisors’ general manager, investment strategy Kirsten Temple.
“We do see private credit offering good risk adjusted returns that are a good complement to the more liquid credit markets,” she said at the Investment Magazine Fiduciary Investors Symposium in Healesville last month. “It’s a source of diversification relative to the liquid credit markets.”
Strong US mid-market lending
Notwithstanding the challenging economic outlook, institutional lending into US mid-market companies continues to be buoyant partly as the US syndicated market has shut down. With rising interest rates, investors are getting more attractive yields of over 10 per cent compared to around six per cent a year ago.
“For our investors, private credit is a tremendous differentiator relative to their public equity portfolios as a way to achieve attractive current returns, while investing in high quality US businesses,” said Ken Kencel, chief executive of US-based Churchill Asset Management which has US$42 billion ($62 billion) of committed capital.
Churchill invested nearly US$5 billion in US mid-market companies in the last quarter ending September, one of the most active quarters in the firm’s history.
In the current market, loans have taken on a more conservative risk profile with lower leverage and high interest cover ratios according to Kencel. “The companies that are coming to market for financing generally are of higher quality today and tend to be larger because the broadly syndicated liquid loan market in the United States is essentially closed to new issues,” he said.
Churchill has been targeting companies that have performed well through the Covid-19 pandemic including health care, business services, logistics, distribution and software. “The opportunity today in US direct lending is about as good as I’ve seen in a long time but you have to stay disciplined and conservative,” Kencel said.
Renewable lending
First Sentier Investors is focused on lending to renewables and waste-to-energy projects in Australia due to the risk profile of the projects and the expected increase in supply as the country transitions away from fossil fuels to more sustainable energy sources.
“That’s the part of the market that we’re looking at and it’s growing significantly. There’s obviously a lot of supply of sustainable assets needed for Australia to transition to a more sustainable economy,” said First Sentier portfolio manager Craig Morabito.
“They tend to be quite high quality – for example, operating wind farms have investment grade risk profiles and benefit from long term contracts, both on the cost and the revenue side. The structural features include the benefit of cash flow superiority as well as security over the actual physical assets,” he said. First Sentier works with its relationship banks to source the transactions.
Manager selection
Manager selection will be key as economic conditions become more challenging and more companies become distressed and the debt needs to be restructured.
“There’s a really big gap between your top quartile managers and your bottom quartile,” said JANA’s Temple. “If we go into a more protracted economic downturn, you could see an even wider gap happening there.”
“There is a range between fund managers in terms of how much emphasis is placed on building in the workout experience within their funds. In the event of default, if you’re very skilled at that, you can get a better outcome for investors in a shorter time horizon.”
