A recent paper from Schroders has highlighted private debt as a robust option for safeguarding portfolios against downturns, especially when compared to other asset classes, during times of economic uncertainty.
According to Schroders head of private debt, APAC, Nicole Kidd, private debt investors have recently benefited from the rising rate environment, enjoying elevated returns due to increases in base rates. Additionally, they have also benefited from credit margin adjustments.
“This is not surprising. Being a privately negotiated transaction, the terms and conditions of private debt lending can adapt to help ensure the underlying resilience of the investment from the perspective of the investor,” Ms Kidd said.
“Additionally, in this uncertain environment, private debt investors primarily focus on the stability and resilience of borrower cashflows, ensuring there is an appropriate cushion within the capital structure.”
She noted that private debt fund managers differ from those in other asset classes by not primarily relying on equity valuations, which can be particularly volatile in times of high inflation and rising interest rates.
“So, for appropriately structured debt where there is enough cushion to buffer cost and revenue pressures, the borrower should be able to continue to meet its interest obligations. These factors make this asset class appealing in the current changing macro backdrop,” she added.
“Borrowers are currently facing a multitude of pressures, however, good private debt managers know how to stress test for them and, via a focus on diversification within portfolios, can find the best-of-breed names in sector classes.”
According to Ms Kidd, the success of private debt investors in uncertain conditions will stem from their investments in superior quality risk profiles and being appropriately compensated for the risk through higher spreads.
Schroders also noted that an ongoing emphasis on climate change and sustainability within private debt markets is anticipated to persist as a long-term trend, particularly impacting businesses that have yet to address these issues.
Moreover, Schroders projected that industries which have breached or are out of favour from a social and governance perspective, such as casinos, could also expect higher priced debt.
“We cannot deny the multitude of additional pressures being faced by borrowers in the current environment, however, we can stress test for them. Ultimately, with a focus on diversification within portfolios, we’ll be investing in best-of-breed names in sector classes,” the firm added.