Executive summary:
- Private credit is being sought—with the goals of income and capital preservation—to achieve real capital growth and drive portfolio returns among retail and institutional clients alike.
- Many large institutional investors have found themselves overexposed to illiquidity. Some are selling in the secondary markets, and some are holding tight with the hope that liquidity will come back soon.
- Demand for private credit seems very strong across the board.
On Sept. 26, Samantha Foster, managing director and senior portfolio manager for private markets at Russell Investments, moderated a discussion on the private credit markets with panelists Keith Brakebill, director and senior portfolio manager of private credit at Russell Investments, and Brad Colman, global head of healthcare investing at Blackstone Credit.
Following is a recap of some key highlights from their conversation.
Foster began by saying that retail and institutional clients alike have sought private credit to achieve real capital growth and drive portfolio returns. She prompted Colman for an opening comment on his firm’s focus.
“When you think about growing life expectancy or quality of life and the drug development that is kind of underpinning that, those are areas that we think are really investable,” Colman said about healthcare IT and life sciences.
Turning to Brakebill, Foster asked his thoughts on private credit strategies and high-conviction sectors.
“We like to have hard assets and contractual revenues and defensiveness on the downside just as a general rule in private credit,” said Brakebill, who highlighted three areas where he said capital is both needed and is scarcest in the marketplace.
- Energy transition space. “We've seen a lot of capital move in, very-ESG (environmental, social and governance-investing) focused, but if we believe the promises the governments are making, or even a fraction of those promises they’re making, the amount of capital that needs to be put out there and put to work to achieve even part of those goals is far in advance of what we've put out there so far. More money needs to be raised so capital is needed in that space,” he said.
- Energy and natural resources. “There are good opportunities to still have a positive impact, while at the same time, taking advantage of the fact that certain natural resources are still needed today, and you can make investments on a good time horizon,” Brakebill explained.
- Banks. Finally, Brakebill explained that small community and regional banks are experiencing the pressure of federal regulation. “[The Fed is] not just raising interest rates, but they're making the stress tests harder on those banks. Deposits have flown out. They need to shrink their balance sheets,” he said.
The discussion moved to why investors are attracted to private credit, as Brakebill shared two slides depicting risk and return since 2004 and unlevered yields in the double digits.
“It's a compelling place to be from a total-return standpoint as well as from a strategic standpoint within portfolios,” Brakebill explained.
The conversation turned to how most segments of private markets have been struggling to raise capital at the pace they were accustomed to over the past one to two years and the participants explained why they thought that hasn't been true for private credit.
Brakebill started by saying the denominator effect from 2022 has hit other private assets and “it’s not hitting private credit because it's being overcome by the asset allocation effect.” Further, Foster added: “The amount of committed capital to private credit is not as large as it is to private equity, on the whole, so there is more potential room to grow for different types of institutional investors.”
Brakebill then illustrated “dry powder” and the face value of syndicated loans by sharing a few slides on the need for more capital in private credit.
“We're in a position of providing scarce capital to the marketplace right now,” Brakebill said. “Private equity still has dramatically more dry powder, or cash, available and likely to be spent than private credit does. Private equity managers generally like to finance themselves increasingly nowadays out of the private credit market.”
Brakebill then fielded a few audience member questions. The first was about banking in both the United States and Europe.
“I don't know that I would call it a crisis at this point,” he said. “As you start to tighten policy, things break—it's really a feature, not a bug, of tightening monetary policy, in my opinion.” He continued: “We're still seeing those community and regional banks have a limited amount of capital to deploy, of not having to retrace and pull back their balance sheet. That's being created for credit managers to do these credit risk transfers off their balance sheet. It's also creating opportunity in certain sub segments in the U.S. side.”
An audience member asked: “If an institutional investor is managing a pool of assets and does not want to take on more illiquidity, should private credit still be a consideration?”
Brakebill addressed the terms of private credit and the types of vehicles that an institutional investor could partake in as a limited partner. Going forward, he said, private credit managers will offer “a little bit better than the pure vintage style lockups.”
Foster posed to each of the panelists: What do you think it takes to be a successful lender in this space?
“Not losing money is the best way to outperform over time, and nowhere is that more true than with credit,” Colman said.
Brakebill agreed with Colman’s point about loss minimization and added that another important aspect is “having a wide moat around your strategy, so that you're not competing with 20 other vendors.”
“That's where you're able to drive better spread terms, better fee terms for the investors, he said. “Those are kind of the dynamics that we like to see in a manager to avoid that issue because we do worry about it: too much money being plugged into too small a space.”
To wrap up, both panelists weighed in on a final question from an audience member who asked whether a coming recession would impact views on private credit positively or negatively.
Colman began with: “In a private credit instrument, where so much of your return is driven by those elevated base rates that we expect to stay elevated for the foreseeable future, I think that's smart positioning heading into a lower growth or potentially recessionary environment.”
Brakebill concluded: “When we’re piecing together a multi-manager portfolio, one of the things we like to see is flexibility among credit managers, and having at least a portion of our portfolio allocated to managers that have the ability to flex between originating credit versus buying it in the secondary market.”
The bottom line
The conversation closed with Foster providing the results to an earlier poll posed to the online audience: When do you think the first Fed interest rate cut will happen? The poll results showed that 20% of respondents guessed it would happen in Q1, 13% thought it would occur in Q2, 33% voted for Q3, and another 33% selected Q4 as the most likely time.
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