PDI Europe Summit 2023: Private debt must retain strong performance through downturn

While private debt has performed well so far, LPs want managers to maintain a solid risk-return profile.

Private debt continues to be a strong performer in difficult market conditions, but LPs are also expecting more from the asset class, according to speakers at the PDI Europe Summit 2023.

At the event in London today, speakers told the audience that private debt has weathered tough market conditions so far, but will need to continue delivering good risk adjusted returns through the cycle.

Speaking on a panel examining the effects of rising interest rates and inflation on the asset class, Sanjay Mistry, head of alternative credit at the Pension Protection Fund, said: “Private debt has been a strong performer in our portfolio, but as a mature investor in the asset class we have limited capacity to increase allocations.

“Our focus is on risk and return and while a few years ago we would accept returns in the 7-8 percent range for senior debt, today we expect more as base rates have increased and we also need more flexibility to manage our portfolio.”

Leverage levels are in sharper focus today too, said Steve Ruby, senior managing director at Audax Private Debt.

“We have to be asking ourselves; are leverage levels appropriate? It a big focus when we underwrite today and covenants are going to really matter in this environment too.”

Daniel Leger, managing director at MGG Investment Group, agreed: “When you’re at seven turns of leverage and you’re facing rising rates, higher spreads, inflation and a declining economy you can very quickly see that slip to nine turns of leverage or more.”

Despite these challenges, speakers at the even expect loss rates in private credit to remain low.

“We assume default rates will step up if these pressures remain for another year,” said Mistry, “But we don’t expect that to increase loss rates.”

Ruby explained that increases in yield should help to compensate for any uptick in losses as a result of market conditions. “We’re seeing an increase in yield of between 400 to 450 basis points. Even if loss rates creep up to 2 percent, we believe net yield will still overperform.”