Breaking up is hard to do

A hard Brexit and its effects on trade give US LPs one more headache to worry about as their own country picks a trade fight with China. By Andrew Hedlund

Investors may have had almost two-and-a-half years to process and prepare for the UK’s departure from the EU, but that doesn’t mean they aren’t still wary of the end result, data from a Private Debt Investor poll show.

At our annual PDI New York Forum, investors chose the event they most expected to cause volatility in the European credit market, and 58 percent said that a hard Brexit – involving the UK giving up the single market and customs union with the EU – was the most likely catalyst.

Some 26 percent expected contagion from Turkey or Eastern Europe and another 11 percent pinpointed risks associated with Italian sovereign credit and Italian bank risk. The remaining 5 percent expect other factors to be the most prominent.

Limited partners aren’t the only ones given pause over Brexit. Credit guru and Oaktree Capital Management co-chairman Howard Marks recently told The Financial Times that Brexit made the UK too risky a place to invest in.

A study from the German IW institute shows a hard Brexit could disrupt UK-EU trade substantially, by as much as 50 percent. Understandably, US LPs aren’t enthused about that possibility; after all, they live under an unpredictable president keen on continuing a trade war with China.

Mid-market lenders have told PDI that their portfolio companies have yet to be hit from the tariffs the US and China have put in place so far, but the more time goes on, the more the residual effects will be felt.

A report from the National Center for the Middle Market, part of Ohio State University, showed tariffs are worrying mid-market companies. Some 10 percent of mid-market executives are concerned about tariffs; and while one in 10 businesses may not sound like much, that figure is up from 2 percent three years ago.

“Apprehensions over tariffs and other costs associated with doing business abroad have risen considerably,” the report reads, “especially among wholesale trade and manufacturing leaders, pushing costs nearer to the top of executives’ list of concerns.”

Europe-focused funds are seeking a fair amount of capital – some $65.48 billion – as of 1 July, according to PDI data. A separate poll at the New York Forum showed a majority of LPs responding were fertile ground for GPs to cultivate new investor relationships. Some 25 percent of investors polled said they planned to increase their allocation to European private debt by more than 5 percent, while 31 percent said they don’t currently invest in such vehicles.

Cultivating these relationships and ultimately winning fund commitments will require European GPs to bridge the education gap. Some LPs have already begun committing money to Europe-focused funds.

The Maine Public Employees’ Retirement System committed €100 million to the €6.5 billion Ares Capital Europe IV fund, the largest direct lending fund ever, while at least five US pension funds have pledged money to Intermediate Capital Group’s ICG Europe Fund VII, a mezzanine fund targeting €4 billion.

It may seem a tall order, given that the EU consists of sovereign nations rather than an amalgamation of states like the US, but US LPs should be up to the task.