Linchpin’s third roundtable webinar was held on 27 May 2020 on the subject of Private Credit, Hedge Funds, and Opportunistic Strategies and what COVID-19 means for these asset classes.
We are once again grateful to Aoifinn Devitt for moderating the panel, which consisted of:
Catherine Beard, CFA, Senior Vice President, Alternatives Consulting, Callan (Chicago) Elizabeth Carey, CFA, Independent Investment Advisor Trevor Castledine, Senior Director, bfinance Stephen Isaacs, Chairman of the Investment Committee, Alvine Capital Mark Zucker, CFA, Co-Founder and Chief Investment Officer, Dorchester Capital
We started by looking forward and asking where the opportunities are. While some early birds are making new allocations, the general view is that there isn’t yet much visibility into the future. Generally, while the panellists believed that there will be good opportunities to make money in private credit, they all emphasised that, as with private equity, careful triage will be necessary to separate out the survivors, and it is too early to do that yet.
There is clearly enthusiasm among investors to take advantage of the dislocations, but which asset class should they put the new allocations into? The general view was that the drivers behind returns would be more like private equity than traditional credit, but we came back to the importance of manager selection.
This will be a multi-year process with very large dispersion of returns – one example given was the fortunes of Gatwick and Heathrow, which could probably be an hour’s debate on its own. There was agreement that it will be important to avoid the banana-skins, and so experienced managers who have invested through previous stress events will be at an advantage.
This led to the question of how investors can select new managers when travel to conduct due diligence has become impossible. Some consultants are starting to add disclaimers stating that they have not been able to visit a recommended manager in person, and that may lead to less good investment decisions.
The main opportunities were seen in providing ‘rescue’ financing and in using debt holdings to purchase exposure to underlying assets at dislocated prices. Effectively private credit may take some of the role of private equity.
Direct lending was also seen as attractive, simply because the lower levels of supply and the extra demand will mean better pricing. One panellist, however, described some of the
current direct lending funds as a “horror show” that has not yet been fully revealed –
suggesting that there would be coupons converted to PIK (pay-in-kind), defaults and
particular difficulties with leveraged private debt funds who may face margin calls.
We asked where default levels might reach. During the Global Financial Crisis (“GFC”) they went to around 20% before falling back to about 2%. One estimate was that they might reach similar levels but, as one panellist said, that could be tempered by the money which is already being raised as rescue finance.
Panellists were also very wary of the marks being used for month-end NAVs, particularly in less liquid structures levered with repos. One went as far as to say they wouldn’t buy any existing commingled fund because they couldn’t trust the marks to be accurate, and simply didn’t believe any credit fund which wasn’t down 10% at least in March 2020.
Generally there was a strong belief that the process is only just starting, and it is wise to keep plenty of dry powder. Lockdown will have a much bigger effect in the second and third quarters than the first quarter, and a second dip might well be much larger than the first. Politics will also play its part, and there seems to be an appetite for greater state involvement, and consequently lower returns. Investors should brace themselves for considerably higher inflation following the explosion in debt levels which COVID-19 has led to. Opportunistic strategies in real assets, such as music royalties were proposed by one panellist as a way of finding uncorrelated alpha together with some protection against inflation, but not all agreed.
The main implication of a lower return world is that investors need to look for alpha rather than beta. It was noted that the big hedge funds had delivered good returns so far over this crisis, unlike in the 2008/9 Global Financial Crisis. However, while panellists recognised that this crisis is an opportunity for hedge funds, they were sceptical that this was the start of a long-term revival in the industry. There was caution about using the last three months, an exceptionally short period as a performance barometer, and some thought at least three years would be needed to assess them.
Hedge funds have the advantage of being able to short, but patience will be required, and the point was made that even if there is more market liquidity, the underlying assets are as illiquid as closed end private credit funds. Are they very different animals? Another simply said they would not invest in any hedge funds today.
Panellists views on returns varied. There was broad agreement about the need to be highly sceptical about projected returns. One panellist suggested from his experience the median return for credit dislocation strategies was 13-15% IRR, but he did not believe that any forecasts could hold water at this juncture. Another thought that if private credit could return 5 to 7% it would stack up well against alternatives.
Within the hour there was a lot we didn’t have time to discuss in detail, such as ESG, but please note the latter will be the focus at our 25th June roundtable. Next up is asset allocation on 10th June at 3pm.
Feedback from participants on this event:
Well done on hosting another very interesting webinar yesterday
Many thanks for hosting these interesting webinars and questions with great panelists.
This is now something I really look forward to and a welcome part of my schedule
Thanks for the fantastic organisation and moderating,
Thanks for hosting an extremely interesting conversation on private credit.
Fantastic panel today - count me in for round two!