Global credit funds & CLO's
July 2020
| Issue 225
Published in London & New York.
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direct lending
Randy Schwimmer
Investors take comfort from an active secondary market, but liquidity can be a mixed blessing
Head of capital markets and origination
Churchill Asset Management
July 2020 | Issue 225
One of the most interesting characteristics of credit behaviour during the coronavirus era has been the momentum of junk bonds, with sharp changes in issuer and investor confidence around the asset class driven by technical factors: near-zero interest rates, the Fed’s support of fallen angels and skewed-to-worse ratings for leveraged loans.
How then should investors be thinking of the illiquid market today, particularly in private credit, which has stayed out of the headlines?
Fundraising has occurred in earnest around the notion that providing investors with steady income (and issuers with long-term credit solutions), regardless of market volatility, is a major benefit. Yield-wise, middle market senior secured loans have performed well relative to other asset classes. Post-covid spreads should widen relative to recent performance, thanks to economic uncertainty.

Structurally, direct loans have benefits that compare favourably with high yield. Being senior, secured, with financial covenants leads to better recoveries and lower
Bond managers are leaning into covid-sensitive, yielding issuers such as cruise ships, hotels and retailers. However, these sectors struggle through cycles. Active private credit managers know that playing selectively in healthcare, software and business services allows for more stable portfolio performance in a downturn.
Direct lenders favour fundamentals
For almost a decade before the great recession, leveraged loans and public equities showed little correlation — around 20%. Loans and high yield were somewhat more correlated at 60%. By June 2009, correlation increased dramatically to 40% and 80%, respectively, per LSTA/S&P data.
When the world plunged off the precipice after Lehman, asset values fell in unison, with investors seeing no safe harbour. That dynamic was sustained for years, in part due to the globalisation of asset management, in part due to the velocity of volatility. The search for an antidote led to private credit. There the assets were owned privately, didn’t trade and were valued on fundamentals. Direct lending portfolios behaved as expected through the financial crisis, with defaults and recoveries better than liquid loans.
Middle market debt was modestly correlated to junk bonds and leveraged loans over the past decade, less correlated to equities, and uncorrelated to investment grade bonds. While the current crisis is still in its early days, private credit flow is driven not by technicals, but by PE dry powder and investor appetite.
Valuation of middle market loans is a topic for another day, but prices don’t swing with market moves, unlike those of liquid loans. While correlation is a key factor in comparing asset classes, investors look at fundamental attributes such as risk, returns and consistent performance. That makes middle market loans increasingly prized in a diversified investment portfolio.
As covid-19 marches through populations, markets and economies, the ability to offer a measure of stability against a backdrop of relentless volatility, and to deliver premium returns over time, will continue to be strong selling points for mid-market lenders.
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As high yield bonds ride a rollercoaster, direct lenders have a stable, long-term story to tell investors
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Private credit is less correlated
Fixed income investors take comfort from an active secondary market, though liquidity is a mixed blessing in periods like this past March when prices were caught in a down-draft. News flow can also affect liquid assets: they’re lifted in good times, but bad news sends the roller coaster right back down.
Private credit managers care less about market timing than issuer fundamentals. The 2020 vintage could prove to be the best in over a decade, but leading direct lenders have been actively putting money to work throughout the cycle.
It’s tough to scale a credible origination platform without a consistent deal sourcing strategy, so private credit tends to be more relational than transactional. New deal flow depends on building long-term confidence with private equity firms.
Sponsors certainly try to access public markets when conditions warrant. But when markets back up, they swing right back to their friendly, flexible direct lenders.
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