Private debt: not a bad place to hide

Vivek Mathew, Head of Asset Management at Antares, discusses private credit’s role in down markets

Investors are challenged in today’s market in finding a relatively safe haven with attractive ‘real’ risk-adjusted returns.  Worries of recession have been mounting as the pace of anticipated Fed rate hikes has accelerated in the face of high inflation.  Whether the 2-to-10 year yield curve inversion on April 1 proves to be a prescient signal of recession ahead or just an April Fools’ joke remains to be seen, but the stock market’s recent selloff could be discounting trouble ahead. Investors have also been lamenting fixed income’s failure to offer much ballast YTD in a typical 60/40 allocation (i.e., bonds are down sharply too).

Commodities have performed well YTD as they normally do when inflation is running hot late in cycle, but they don’t offer income and can be quite volatile and collapse in the face of recession. TIPS offer an inflation hedge, but still suffer from duration risk. Cash may seem safe but suffers from negative real returns.

Enter private debt. For those concerned about rising interest rates due to high inflation, private debt loans offer floating interest rates (i.e. a floating SOFR base rate plus a spread), as well as a premium spread above broadly syndicated loans. Of course, private debt returns are not immune to recession, and spreads have widened some of late in syndicated markets reflecting concerns of a future pick-up in currently rock-bottom default rates. However, private debt’s performance has demonstrated resiliency through downcycles in the past, as have the US middle market companies that private debt finances – particularly those with PE sponsor backing. Looking at Cliffwater’s direct lending index, since September 2004, the index’s maximum drawdown has been 8% against an average annualized return of 10% which compares quite favorably against most all other asset classes. Taking a little longer-term perspective in its 2022 market outlook, Hamilton Lane in an exhibit titled ‘Worst comes to worst’ shows private credit’s LOWEST trailing five-year annual return since 1995 to be 4.6% in Q1 2020 – a better showing than all other major asset classes, most of which show comparable negative returns.  

Of course, performance can vary significantly among lenders, particularly during times of stress. In order to achieve favorable results, Antares believes it is critical to have 1) strong originations and a large and diversified portfolio of lead-managed incumbency opportunities that allows for selectivity among the best credits with strong sponsor support, 2) a first lien focus at the top of the capital structure, 3) strong credit discipline, portfolio management, and experience through multiple cycles, and 4) a dedicated and experienced workout team to maximize recoveries.  

In short, if you are worried about inflation and an ensuing recession, with the right lender, private debt is not a bad place to hide.

About Vivek Mathew
Vivek joined Antares Capital in 2016 as head of Funding. Previously, he was a managing director at J.P. Morgan, where he led the global primary CLO business. He also served as a vice president of structured finance at Deutsche Bank. Vivek graduated with a bachelor’s degree from Harvard University.