As US private equity prices reach pre-financial crisis highs late into a credit cycle, concerns over a potential downturn to come have led some institutional investors to pivot towards private debt, panellists at the PDI New York Forum said this week.
Aoifinn Devitt, chief investment officer at Policemen’s Annuity and Benefit Fund of Chicago, said during a panel on Wednesday that the pension plan is in the market to replace its entire private equity portfolio, which includes some emerging market debt and opportunistic credit investments, with private debt.
Devitt said the shift from private equity to private debt comes as the fund is “severely underfunded” and needs to ensure that the pension plan can generate as much cash flow as possible to make benefit payments now and in the future.
Tod Trabocco, managing director and co-head of the credit group at a global investment consultant firm Cambridge Associates, said private equity and private debt returns have started to converge. As this convergence takes place, he has seen more of his clients shift away from private equity investments due to the rise in buyout multiples. “Some clients are looking at equity markets at a peak that is equivalent to the last peak in 1997 and saying ‘where will I be in five years?’” he added.
Buyout deals in the top quartiles of the US private equity market are currently priced higher than the pre-financial crisis levels, at the “scary” premium of 14.9 percent, Christopher Godfrey, senior partner at the analysis firm CEPRES, told a packed conference room on Thursday.
Godfrey added that the combination of highly leveraged, highly priced equity and loose covenants have created a “hazardous market”. However, private debt was more likely to perform well over the next downturn, noting that in 2009 private debt showed some of the asset class’s best returns even though that year showed very few completed deals. “Private debt has shown to be counter-cyclical over the years,” he said.
Stephen Nesbitt, chief executive officer at the advisory firm Cliffwater, agreed that private debt has shown relatively lower volatility than other asset classes like private equity, noting that in the thick of the financial crisis, private credit drawdowns were at a minimal amount of 10 percent.
Now, more investors are attracted to the low volatility of the asset class and its returns comparable to the public markets, he added. “Clients used to ‘poo-poo’ it,” Nesbitt said, “but today…it’s graduating”.