Our industry panel
president and CEO of
Churchill Asset Management, New York
head of alternative lender
and private credit group,
partner and chairman,
What do you think is the most exciting development or innovation in private debt right now?
KK: I would say it’s the growing acceptance of private debt as an asset class and the significant increase in the number and quality of institutional investors globally that are now allocating to the asset class. Five years ago, it was a real challenge educating investors on the attractive attributes of private debt investments. Today, we now see virtually every major institutional investor working with their investment staff and consultants to identify the most attractive segment of the private debt market to invest.
BB: In the private debt space, fierce competition has led to much innovation in terms of deal structure and product mix. What is most impressive and exciting is the level of flexibility of the private debt funds. They are far more nimble today than they were just a few years ago. Their own leverage has also helped in this regard.
AJ: Private debt investing itself is a great innovation from the financial sector’s stability point of view as private credit funds are typically funded by limited partners’ capital and the funds cannot go bankrupt. On the other hand, private credit provides institutions with interesting investment opportunities.
Where do you think the next greatest challenge for private debt will come from?
KK: Given the amount of private debt capital raised and the competitive dynamics playing out in the financing markets, it will be an increasing challenge to deploy that capital in quality investment opportunities at the pace investors are expecting. I think those firms with scale in their capital base and a strong sourcing platform will be the ones that can best meet that challenge.
BB: When the cycle turns, and it always does, the greatest challenge will be how to best weather the storm. Unlike the last recession, there is a ton of dry powder out there, so the next turn will bring headaches to some debt funds but will present real opportunity for others. Those who are opportunistic and have the appetite to invest into a special situation will be able to ride out this challenge. I’d also add that a lot of unique structures have been put into place that may not have been tested in a down market. Until they’re tested, parties will continue to push the envelope, and when the downturn comes it could bring with it a whole host of new challenges.
AJ: The next greatest challenge for private debt will probably come when we enter a recession after a long growth period in the economy. Usually terms and conditions on transactions get worse during a long growth period and you might enter a recession with a portfolio of deals with weak protection.
Which geographical region do you think shows the biggest promise for private debt growth?
KK: At Churchill, we focus exclusively on companies based in the United States. It’s by far the largest and most robust market for private debt globally and we expect that to continue given the various challenges currently facing the more fragmented European markets.
BB: We already have so much growth and competition in the US as well as Europe, so the natural choice would be Asia, but it’s hard to say for sure. I think it is safe to say that we’ll see continued growth in global funds that can invest in multiple regions when the opportunity is right. That’s in addition to existing US asset managers who are entering Europe and existing European asset managers entering the US market on the direct lending side. Many of our clients fit that description.
AJ: I personally believe in Europe. There is still a big growth potential in Europe when it comes to direct lending in sponsored transactions, but also in sponsorless debt financing, especially in smaller transactions.
Which private debt strategies do you think will be the most sought after in the near-future?
KK: I think private debt managers that have historically stayed highly focused on their investment strategy and have delivered for investors through the economic cycles will continue to be the ones that attract the vast majority of investor capital. Generally, those with a more conservative investment focus will be preferred given the fact that we are clearly in the latter stages of an economic cycle.
BB: That depends on how you define “near future.” Right now, we are seeing a real increase in special situations fundraising as well as deployment of cash. And unlike past cycles, there doesn’t seem to be a single industry that is most likely to see a downturn. There are pockets across a number of areas that will be ripe for private debt investment. Many funds are preparing for all parts of the cycle and those that have an industry agnostic outlook will be well positioned to find opportunities in choppy waters.
AJ: SME direct lending in Europe looks like a promising strategy, as there has not yet been too much money allocated to SME direct lending funds and as the universe of smaller companies is huge in certain countries in Europe, like in the UK and Germany.
Which investor group do you think is most likely to increase its private debt exposure?
KK: We see most investors generally increasing their allocation to private debt. In particular, public and private pension plans have been increasing their allocations most significantly as they look to meet their obligations to participants. They are finding it difficult to get their target returns from investment-grade fixed income or even broadly syndicated loans or high-yield bonds. I think this trend will continue. I also think that high-net-worth and retail investors will increasingly look to alternative assets like private debt given that public equity markets are at all-time highs.
BB: Recent changes to the German Insurance Act have opened up the private debt space to German insurance investors. These investors were typically only able to invest in private equity, so we expect to see an increase in private debt investment from that group.
AJ: I expect pension funds to allocate more money to private debt, as private debt provides very good risk-return characteristics, compared, for example, to listed equities. To pension funds that have long-term liabilities with well predictable cashflows, private debt offers interesting opportunities.
What is one piece of future advice would you offer private debt fund managers?
KK: Stick to your core strategy and maintain your credit discipline. Ultimately, it’s about delivering solid net returns to your investors. While there will continue to be tremendous pressure to deploy capital and grow AUM, doing so at the expense of credit quality will prove to be a big mistake. Those of us who have lived through several credit cycles know this and have framed our approach accordingly.
BB: In terms of managing your portfolio, it’s critical to be proactive in the case of significant performance related issues. Heading into a workout or restructuring, preparation for the unexpected is key. Even if the dynamic seems consensual it’s important to have a Plan B and Plan C. Those plans should be mapped out at the outset of the workout. Putting contingency plans in place and understanding which levers to pull when will also put you on stronger ground to set the tone for your conversations with your borrower.
AJ: To maintain discipline is very important in investing in private debt, especially during good times in the economy. Managers should make their own due diligence and judgment on transactions, not just rely on other parties’ views.