The coronavirus pandemic caused unprecedented market volatility in 2020 and provided the first major test for a private debt industry that has grown exponentially in the past decade. But investors concerned about the resilience of the asset class have been reassured by its performance through the crisis, with most portfolios proving to be sufficiently diversified to minimise exposure to the most significantly impacted sectors.
For Private Debt Investor’s LP Perspectives 2021 Study our Research & Analytics team surveyed 100 institutional investors to find out what’s driving them, what’s worrying them and how they see the future of the asset class. Here are six of the most striking findings. The flow of information to LPs helped sustain confidence in the credibility of existing loans, while most private debt managers lived up to their reputation for flexibility and speed, reacting quickly to liquidity demands from portfolios and responding to investor appetite for more distressed strategies.
Seeking a step-up on climate change
Just over 40 percent say GPs are taking the risks of climate change seriously enough in their own investment policies and practices, while 22 percent indicate they are not doing so. Climate change has become an increasingly hot-button issue among the LP community, particularly in the last year, and we anticipate investors keeping up the pressure on their managers throughout 2021.
Distressed and special sits move into focus
More than a third of LPs plan to increase allocations to distressed and special situations strategies this year, the obvious beneficiaries as market distress become more apparent. There is a growing appetite for direct lending, while more capital looks set to flow into speciality finance as LPs seek less crowded markets. Asset-based lending tied to products such as residential mortgages, student loans, credit card receivables and ship financing is dominated by banks outside the US but looks increasingly fruitful for private debt.
Recession becomes a reality
Top of mind for LPs right now when it comes to what could impact performance in the next 12 months is recession in core markets, which should come as little surprise given the volatility of public markets and the increasing certainty that the effects of the pandemic will be felt well into next year. Next in line is the covid-19 outbreak, followed by extreme market valuations. Concern around the US-China trade war has dropped this year, likely as a result of coronavirus worries taking over.
Enthusiasm cools on emerging markets
Investors are showing increased appetite toward the more established private equity markets of North America, Western Europe and Asia-Pacific over emerging markets. The enthusiasm for Asia-Pacific in particular is perhaps a reflection of that region’s economies being further along in their recoveries, and thus far not facing widespread second waves of the covid-19 pandemic. On KKR’s third-quarter earnings call, for instance, the firm credited its relative weighting to Asia as benefiting its performance.
Confidence in private debt stays strong
Despite a challenging 2020 for GPs, there is little evidence of investors losing faith in senior secured private debt and most maintain strong expectations for performance in the asset class for 2021. Coronavirus provided the first major test for private debt after its rapid growth in the past decade, and it delivered: LPs are going into 2021 more confident than they were a year ago. In all, 21 percent of LPs expect private debt to exceed its benchmarks in the next 12 months, up from 13 percent who felt the same at the start of 2020, while a further 34 percent expect the asset class to meet benchmarks.
Most GPs feel positive about existing deal structures
One of the biggest question marks for private debt going into the economic crisis was whether GPs had been structuring deals sufficiently sensibly in the heated run-up to 2020 to ensure they could withstand a downturn. With so much government support available to challenged industries during the pandemic, it is too early to know if structuring will hold up, but LPs are not unduly concerned. In all, 54 percent are either confident or very confident in the decisions made by their GPs going into the crisis, while 29 percent are neutral and 17 percent now lack confidence in the deals that have been done.