How the onset of war in Ukraine affects corporate borrowers in faraway countries is, to state the obvious, of little concern to those on the frontline of the unfolding tragedy. Nonetheless, for the sake of investors who have entrusted them with their money, private debt fund managers must urgently assess how current events are likely to impact them – and it’s natural that their borrowers will be the first thought.
These borrowers have already been exposed to the challenges of higher gas prices, supply chain issues and rising inflation. All of these issues are likely to be compounded by the conflict in Eastern Europe, with profit margins – especially for manufacturing businesses – likely to take even more of a hammering.
To an extent, though, this just an exacerbation of a trend that fund managers have been seeing for some time. Initially prompted by the spread of the covid-19 pandemic, but then further encouraged by negative economic pressures in some industries, capital has increasingly gravitated to a handful of sectors perceived to be insulated from the worst effects of both.
Of course, this concentration of capital in just a few selected areas of the economy – business services, technology and healthcare have been among the most popular – begs its own question about how competitive (and overpriced?) they might become. But even amid a boom in M&A deals in 2021, there was little sign in a recent report from investment banking advisory firm Lincoln International of a loss of discipline on the part of managers. It found the amount of leverage in such deals – a hot talking point – steadily dropping.
There are also no signs of the deals boom losing momentum, with Lincoln estimating that private debt has sufficient dry powder to sustain dealflow for around two and a half years. And that’s before accounting for the capital that continues to flow freely into the asset class from limited partners as keen as they’ve ever been to identify yield-generating options.
It may be, in light of current dramatic events, that there will be a pause in activity. Risk may be in the process of being priced differently and managers will be making inevitable comparisons between public and private markets. We are already seeing renewed volatility on public markets, which could make private markets – where assets are held rather than traded – look relatively attractive for some. On the other hand, you may see another flurry of fundraising for the dislocation funds of the type that popped up in the wake of covid.
One possibility mentioned by a market source to Private Debt Investor is that the situation in Ukraine may end up tipping the balance when it comes to the actions of central banks. Stimulus withdrawal and stepped rate increases have been accepted for a while as the way forward. But as the West gears up to impose potentially punitive sanctions on Russia – sanctions that will not just bite in the targeted country – might the conclusion be that the consumer is simply being handed too great a burden and macro policy consequently revised? It’s only speculation, but speculation is the currency everyone is dealing in today.
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