‘The only certainty is uncertainty’ is a well-known phrase, one that has proved itself true time and again of late as major events test how we cope with an environment seemingly characterised by crisis after crisis. It is just over two years since the covid-19 pandemic began and a few months since Russia invaded Ukraine. Both have added to the feeling that the world has become unstable and have been accompanied by more market volatility than we have seen for some time.
Private markets in general, including private debt, have been on a growth path for several years. Depending on their goals in terms of yield, duration and diversification, investors can choose from a variety of investment opportunities ranging from individual investments to indirect strategies.
The most recent forecasts suggest that the growth of private debt as an asset class will continue to accelerate between 2022 and 2026, with private debt set to become the second-largest private capital asset class in 2023. One reason for the rise of private debt has been the financial crisis, when banks pulled out of several markets, which made institutional investors enter debt markets and launched private debt as an asset class.
Can private debt be regarded as the place to be for investors in times of uncertainty? Looking back, one might think so. When the pandemic started, markets went down but quickly recovered a few months later. This is also true for private debt, which proved quite resilient against covid.
But every crisis is different. How you adjust to a volatile environment can make all the difference. The ability to intervene in transactions and restructure them when necessary is an essential prerequisite for success as a private debt investor, but it requires a high level of expertise. Investors with a long-term view who have experienced several crises will probably be in a better position to cope with uncertainty.
Inflation higher for longer
Over the past decade we have experienced a stable low-interest scenario, which is now changing. Against the backdrop of reduced central bank support, increasing inflation is further driving uncertainty for institutional investors. Inflation may surprise many by staying on the high side for longer, even if the actual year-on-year numbers peak this year. Certain structural forces could keep inflation higher – including significant shifts in the monetary policy of central banks, supply-chain disruptions, high energy prices due to the Ukraine invasion, and deglobalisation.
Private debt investments can offer several hedges when compared with publicly traded corporate debt. It is typically structured around floating-rate notes. As such, it offers some protection against an environment of rising rates and inflation. Also, the duration is typically shorter than public markets equivalents, so managers can be more proactive on inflation.
In investment-grade infrastructure debt, you have longer durations. However, the nature of counterparties being funded – typically heavily regulated – can offer protection against inflation. Furthermore, infrastructure is not exposed to the same risks as other publicly traded corporate sectors. These characteristics and a diversified portfolio across different segments and regions can help fight uncertainty and withstand pressures while offering attractive returns.
There will be more crises in the future, but we should be confident that private debt is well placed to cope. Experienced institutional investors who can rely on long-standing partnerships, a set of relevant data, new ideas and strong teams have proven, so far, that they can actively manage uncertainty.
While there is nothing certain but uncertainty, trust, know-how and experience can help us cope with it.
Deborah Zurkow is global head of investments at asset management firm AllianzGI