The macro challenges facing GPs

Rates hikes, recession and inflationary pressures continue to weigh heavily on the minds of LPs.

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As investors continue to allocate more capital to private credit, they remain aware of the potential for macroeconomic conditions to impact returns on current loans.

According to Private Debt Investor’s LP Perspectives 2024 Study, interest rate hikes, recession in core markets and high inflation continue to weigh heavily on the minds of LPs worried about their impact on performance over the coming year. Many portfolio companies are struggling under the weight of high interest rates and investors are focused on the ability of managers to navigate those challenges.

Isaiah Toback, partner and deputy co-CIO at Castlelake, expects a growing dispersion of returns over the next few years between managers in the corporate direct lending space and also within asset-based markets. “You have markets that are rapidly expanding and others that are struggling, so it is going to be much more a theme of dispersion in 2024 than the whole market moving in a good direction or a bad direction,” he says.

Emma Bewley, head of private debt and uncorrelated strategies at Partners Capital, agrees: “The more marginal loans originated in 2021 and early 2022 may see challenges and potentially a higher default rate than we have seen historically in private credit.”

A key differentiating factor will be whether the manager has enough levers available in the event of distress and restructuring, and the expertise to work through challenges. “It will call for a skill set that hasn’t come into play as much in the past decade,” she says.

Rising above choppy seas

LPs remain positive on the long-term outlook for private markets investing versus public markets, even if they expect some choppiness in the short run. In all, 37 percent of investors say they are very positive about private markets long term versus 14 percent saying the same about the short term.

Marc Chowrimootoo, managing director at Hayfin, says: “We see near-term pressure in certain subsectors – like construction-related businesses, for instance. And we are still cautious around the macro outlook as we see elevated rates and anaemic growth flow through the economy. But this is the environment when the better managers with more thoughtful credit selection will prevail.”

“The more marginal loans originated in 2021 and early 2022 may see challenges”

Emma Bewley,
Partners Capital

Many managers argue the macro is creating as much opportunity as it is challenge.

Dan Zwirn, CEO and CIO of Arena Investors, says: “You can look at the opportunity set as a massive barbell right now – on the right side is dealing with the consequences of the bubble, which corporate private credit didn’t escape, and on the left side is doing new loans now, taking advantage of lower multiples, less leverage and better structures.

“By the middle of 2024, people are going to realise that leveraged lending is not immune to all the things that have impacted other asset classes. It is going to get a lot more choppy, and as the tide goes out you will see who has a bathing suit on.”

Raphael Schorr, partner and deputy CIO at HighVista Credit, believes investors should look at opportunities presented by the macro environment rather than trying to predict the macro. “For example, so many investors are shying away from real estate, but there are many compelling opportunities in real estate finance today. Real estate has a voracious appetite for capital. It always has and always will,” he says.

“There is going to be a tremendous demand for capital at the precise time that banks and other lenders are pulling back. Commercial real estate credit is going to be a great market to be involved in because the macro is creating a relatively uncompetitive, capital-starved environment and competition and abundant capital are the enemies of great returns.”

One in three investors says that, given the higher interest rate environment, they have pushed for a higher hurdle rate, with half of those that asked saying it was granted.

Jess Larsen, founder and CEO of private credit placement agency Briarcliffe Credit Partners, says putting in a dynamic hurdle rate makes sense for LPs.

“But in practice, it is actually really complicated and there is only pressure for it to go one way,” he adds. “We have seen a bit of adjustment there but it has not been massive; the majority of investors are not pushing that point.”