The great re-evaluation?

Investors discuss how they approach private credit against a changing backdrop

Sebastian Schroff, Lead Portfolio Manager, Allianz GI

“We haven’t made fundamental shifts in our portfolio, because we take a long-term view. However, the changing environment has meant we have re-evaluated some of the areas we invest. We had previously moved quite a bit out of fixed income and we’re not moving that back, while private credit looks relatively attractive now. Within private markets, it looks as though we may do a little less on equity and a little more on credit. Areas such as infrastructure debt are interesting and strategies with floating rates and the potential for upside look more interesting now. Every strategy has to earn its place in our portfolio through a premium.

“We have spread our allocations in the US more broadly than in Europe because the market there is deeper and there are many different strategies available, but I see Europe developing over time. We are also more interested in private debt secondaries today – it’s now an established part of the market and we are seeing continuation fund deals come through here.”

You-Ha Hyun, Principal, Perpetual Investors

“We started our private credit programme in 2019. We wanted to create a portfolio with limited overlap with systematic risk, such as you find in private equity. We also didn’t want to create an alternative fixed income portfolio or to gain exposure to financial engineering plays.

“As interest rates have risen over the past few months, the need to generate returns by focusing on simplicity and complexity premia has emerged. So, we are emphasising corporate direct lending and going for strategies that are either less correlated with corporate credit markets or react counter-cyclically to the overall market environment. One area we are attracted to is specialty lending because it is asset-based, it can take advantage of secular/idiosyncratic dislocations and it follows its own cycles. Overall, we are seeking to create a big basket of sub-strategies that are not correlated to each other.”

As the economy has shifted significantly over the past two years, how is this affecting LP allocation decisions?
Here, four investors discuss how they approach private credit against a changing backdrop.

Reji Vettaseri, Lead Portfolio Manager – Private Markets, DECALIA Asset Management

“We create diversified credit portfolios, involving a wide variety of sub-strategies. Within that, we pivot to where the best opportunities lie at any given time. Private credit has evolved rapidly since the Global Financial Crisis (GFC). Post-GFC, there was a huge opportunity to replace banks in the leveraged loan market. Non-performing loans also saw great returns as funds picked up the pieces from the crash. As these segments mature, new growth areas such as lending to technology companies created new sources of outsized return.

“As well as long-term trends, we also react to the cycle. In the middle stages, we lent a lot to high-quality growth companies. At the top, we spent time on uncorrelated strategies, such as litigation finance. Today, credit secondaries and certain types of credit special situations offer value.

“We don't try too hard to predict the future; as credit investors our bias is to just assume the worst. But we do know that over the cycle, the supply-demand balance for credit changes in different ways for each sub-segment. And we keep a very close eye on which segments offer the most attractive conditions for dealmakers.”

Börge Grauel, Partner, Co-Head of Private Debt, YIELCO Investments

“The denominator effect means that many LPs are focusing on core relations and trying to push out re-up decisions. But they are also putting more thought into how to diversify their exposure within private debt – direct lending is well established and resilient, but there are many other implementation options within the asset class that allow investors to play in different areas. So, for example, investors are concerned about valuations on the equity side and so they are looking for return-enhancing credit opportunities, where there is the potential for some upside.

“The US is interesting here because it has a much deeper fund manager universe than Europe. Some interesting strategies, for example, are to be found in specialty finance as these are linked to a bigger ecosystem. Asset-based lending is particularly interesting in today’s market because it is shorter duration and the loans are substantially over-collateralised.”