1. Pandemic fear

We are now all too familiar with how this story is playing out. Covid-19 is described in this report as possibly the toughest test the mid-market direct lending space has faced in the past decade – one that may tip the global economy into the long-anticipated downturn.

The signs at the time of writing are that this has come to fruition, with a recession a likely scenario. Understandably, there is uncertainty about exactly how this will impact the private debt market, but as EQT partner Paul Johnson says: “The months ahead will be all about understanding the risks.”

2. Deployment challenge

Many funds are sitting on dry powder and eager to put capital to work, which could prove a challenge in the current climate. Merger and acquisition activity is likely to slow up, and companies’ growth ambitions and investment activities put on hold. So, borrowing needs may be more measured.

On the flip side, otherwise sound companies might need to borrow to come through a difficult period. If banks are cautious in coming to the party, opportunities may well open up for funds to plug the lending gap.

3. Defensive positions

Uncertainty is likely to push lenders towards deploying capital in countercyclical sectors – education, healthcare, software and technology, for instance – and away from market segments such as retail, travel, tourism and hospitality, which are set to take a hit as shoppers stay away from the high street and travelers opt to stay at home. “You’re not going to find a lot of overtly consumer-oriented deals in our portfolios”, says Mike Dennis, co-head of European credit at Ares Management. Competition for these assets may also heat up among private equity sponsors and lenders.

4. Special situations appeal

Despite the trepidation in the overall private credit markets, the climate could prove a fruitful one for those active in the special situations and distressed space. Jaime Prieto, founding partner at Kartesia, says the European market is ripe for an uptick: “It is probably the most favourable market that we have seen over the last four years. [We] feel the conditions are there for special situations funds to be pretty optimistic about the year head.”

5. Focus on portfolio management

Portfolios are going to be tested this year with a growing need to analyse and mitigate risk held within them. So, it is not surprising that managers’ portfolio management expertise has risen up the agenda with both sponsors and limited partners.

Twin Brook Capital Partner’s chief credit officer Drew Guyette explains there is now “greater awareness of how important portfolio management experience can be when it comes to effective positive outcomes through both periods of growth and distress”.

Technology and data analytics will come into play much more as managers try to better understand at an earlier stage how these developing trends will impact their portfolios.