Although the majority of managers went into 2020 anticipating a macroeconomic downturn, no one could have predicted the test that private credit was set to face at the hands of a global pandemic. An asset class that had hardly been tested previously appears to have proved its mettle, with limited partners shifting their strategies incrementally but showing no less appetite for private debt.
One obvious reconfiguration on the investor side has been a move towards more distressed debt and special situations strategies in light of the disruption wrought by covid-19. Some 58 percent of LPs responding to Private Debt Investor’s LP Perspectives 2021 Study say that their appetite for such opportunities has grown.
This may not be entirely the result of the pandemic, argues Richard von Gusovius, co-head of global private credit at placement agent Campbell Lutyens. “Many of the long-term trends we were seeing in the market have been accelerated by covid, including the amplification of the bar-belling of the investor risk spectrum,” he says.
“Lots of people have gravitated towards the most senior piece in the capital structure, even preferring senior-only strategies, and there is certainly some cynicism towards unitranche. Then there are others looking at strategies seeking higher return targets in special sits, credit opportunities and dislocation themes. So, we have seen a bifurcation into super-senior and distressed, with many investors also showing, due to travel limitations, a preference for backing GPs that they already know well.”
More than half of the LPs in our survey (53 percent) say they are now less likely to invest with new GPs, with fortunes for debut managers just one of the casualties of the lack of face-to-face contact between fund managers and their investors.
For the most part, though, the asset class appears to have adapted well to the challenges of virtual meetings. Some 92 percent of LPs tell us they would happily take a first GP meeting virtually, 67 percent say they would conduct fund due diligence virtually and 52 percent say they would be willing to commit to a new manager’s fund without ever meeting
David Allen, managing partner and chief investment officer at AlbaCore Capital Group, says: “At the start of the year, video conferencing was just a back-up system, but by the end of April it was clear that we could maintain decade-long relationships with sponsors, companies and investors entirely through this medium.
“The shift also was successful for communication with new partners and we have been able to raise money from new LPs in 2020.
“We have also seen a frequency shift and are certainly communicating more often with our LPs, due to the removal of travel involved.
“This changes not only the way we communicate but the impact our business has. We measure and offset our operational carbon footprint and this shift will have significantly decreased our carbon
“We still value seeing our partners face-to-face and so travel will return, but maybe only one in three meetings needs to be in-person.”
That is an experience shared by David Golub, president of Golub Capital: “Covid is preventing us from visiting with our investors in person the way we are used to doing, but despite this, we have been very successful in raising additional capital.”
Investor relations have clearly moved up the agenda and most managers report more time spent keeping their LPs informed. Still, there remains some concern among the investor community about the commitment of their peers: on a scale of 1-5, the average score was 2.26 when investors were asked how concerned they are about other LPs potentially defaulting in funds that they have committed to.
Just as LPs have been supportive, so too have sponsors. Golub says: “Sponsors have stepped up. When covid began, we were concerned there would be so many problems in so many areas that sponsors would not know where to focus. That hasn’t happened. Our sponsors have been very engaged and have provided their companies with great advice and counsel.”
Another trend that covid has only accelerated is the growing commitment to environmental, social and governance issues across the LP and GP community. Just 12 percent of LPs intend to relax their ESG policies as they relate to private markets fund investments, and momentum is gathering for far greater commitment to the cause at manager level.
Sabrina Fox, executive advisor at the European Leveraged Finance Association, says: “In 2021, I think more private debt funds will have an ESG policy that they have incorporated from top to bottom into their businesses. That is what is starting to happen: a seismic shift towards thinking about philosophies, values and how those translate into ESG policies.”
Cécile Lévi, head of private debt at Tikehau Capital, says investors in direct lending can take some definite positives from the pandemic: “Valuations of companies have not declined and, on the contrary, we can highlight some inflation in asset prices. So, overall loan-to-value is still quite strong, which means from an investor perspective the asset class has been shown to be extremely resilient.
“Companies supported by private equity and private debt have proven to be well-organised and agile, with courageous and energetic management teams.”
The year 2020 will long be remembered as the one in which covid tested the private debt asset class to its very limits. Nevertheless, investors have not so far been too disappointed with the outcome.