A so-called “golden age” of private credit shows no sign of coming to an end, as asset managers continue to fill gaps in a market vacated by traditional lenders, and asset owners become increasingly sophisticated about how they think about the asset class and how they access it.
The Investment Magazine Fiduciary Investors Symposium heard that private credit remains attractive to super funds, but they’re increasingly wary about the weight of capital-chasing opportunities in some sectors of the market.
HESTA investment manager of global debt and credit Sheng Tan said that when he sees managers raising $20 billion or $30 billion of funds for direct lending, “you’ve got to be a bit cautious how they’re deploying that”.
Tan said HESTA’s approach is to develop a view in-house about “which parts of the market is hot; find out which parts is too much money chasing that”.
“And then, try to allocate to areas where you think there is structural opportunities,” he said.
“Where we see opportunities is the low- to mid-market and corporate direct lending, and on the asset-backed side of things.
“And even within asset-backed, that’s loosely used term, it’s finding out particular pockets that will have that structural dislocation opportunities.”
Tan said HESTA seeks to work with managers who can add value and insights beyond its own.
“When we look at our credit managers specifically, [the question is] do I have the better information ratio of saying I want more loans, higher credit, more US, more Europe; or does the manager have the information advantage?” Tan said.
“For us, it’s identifying managers with that information advantage. They gave me the track record of rotating in and out of sectors, adding value, across that.”
Alpha chasing
QIC investment director of strategy and implementation Andrew Whittaker said he’d “love to say that we hate private credit and be really contrarian, but the opposite is true”.
“It’s a high-conviction asset allocation for us, and part of the reason we think it’s a higher-conviction asset class is because we think it’s a target-rich environment for alpha generation,” he said.
Whittaker said the fundamental trend underlying the growth of private credit as an asset class is bank disintermediation. If asset managers are going to step into that breach, then they must prove their worth.
“The first thing we look at when we look at managers who come through our door is: what’s your track record in generating alpha?” Whittaker said.
“If we do that factor decomposition, have you added value and generated returns? We think private credit is one of those few asset classes where alpha exists, and it exists in a relatively cost-effective manner.”
Whittaker said QIC also considers “scale versus addressable market”.
“How big are you in your market and are you still relevant in that market?” he said.
“But we also don’t need [a manager] to be too big. We don’t want to have outsized growth ambitions, so you stray too far from the strategy in which we employed you to undertake.
“We don’t want style-drift from our managers.”
Whittaker said QIC also considers manager incentives and their alignment with QIC’s interests as an investor.
“The incentives we look for are things like, how much capital do you have of your own money invested in the firm?” he said.
“What are your incentives? Are they aligned with ours? What sort of equity stakes do you have in carry structures, and so forth. Is it going to be enduring? Because every man and his dog, it seems, is setting up a shingle with a private credit man mandate at the moment.”
Tan said a further issue super funds need to consider when venturing into private credit is “managers’ valuation and impairment discipline”.
“We as asset owners and managing members money should be very, very careful with how we are valuing things and making sure we’re on top of that,” he said.
“And that’s interrogating managers, interrogating their track record, picking out all the loans that are defaulted, look at the discipline, what they’ve done throughout the timeline of managing that particular investment.”
Meaningful diversification
Private credit asset manager Albacore founder and chief investment officer David Allen said asset owners need to think carefully about diversification in private credit and employing managers that operate outside the mainstream markets of the US.
“Whenever I meet people about private credit, they say ‘we’re starting private credit’, and I’m like, okay, so give all your first money to Ares, to the US private credit [market], because that’s where you start,” he said.
“We think about our business as your European credit manager; we’re never the first allocation, we’re usually the fourth or fifth when they want a diversification. And the other pitch for Europe – a slight pitch – is that the ‘lender violence’…is a much more American thing. I’m an American; I can say it’s a sport in America to screw your other lenders. That’s not the case in Europe.
“That’s one point of diversification. If you’re doing this, don’t do 10 private credit funds that all do US large-cap lending. You’re trying to pick and choose a few different ones.”
Private credit asset manager Polen Capital senior credit strategist Manu George said that as private credit markets have broadened and deepened, “what’s been interesting is there’s been this trend as investors have become sophisticated, asset owners have become sophisticated”.
“They’re asset owners who have taken on capability sets that traditionally sat with traditional asset managers,” he said.
“And so increasingly, you’re seeing this dichotomy of firms, of asset owners … saying [they will] do stuff in the synthetic space, but the stuff where there’s huge information asymmetries, such as private markets, is better sat with someone who specifically does that all day in and day out.”
George said asset owners are now able to choose from “an explosion of new ideas and new product lines and new strategies and different markets that traditionally were just not available even five, six years ago”.
“Investors today have a lot more opportunities to access the liquidity spectrum, from the most illiquid strategies where you lock up stuff for 10 years, to things that can be very reasonably liquid within the private market space,” he said.
George said asset owners need to go into the private credit space with a clear picture of what they want the asset class to deliver to them, not only in terms of returns but also in terms of risks and diversification benefits.
“What do you want from your return structure? What is your benchmark? What’s your target?” he said.
“Today, I can comfortably say we can create a full spectrum of risk-return solutions. [But] what do you give up? Is it credit risk? Is it liquidity risk? Is it a combination of the two?”
“In Latin American private credit, you can hit 20 per cent [returns], but there is risk in that. It’s about the structure and the type of manager that you take on board.”
