‘Private credit is in a Darwinian moment and returns are lower’

“By a Darwinian moment, what I mean is that some players will lose some access to capital,” he told host Lisa Lee on the Credit Exchange podcast in July. “Some players will become less relevant to private equity sponsors.”

This is a normal part of an asset class’s cycle, but it may be the first time that many private credit managers and investors have experienced it. Golub describes this dip as a “self-curing” mechanism, where a reduced level of capital in the space will ultimately lead to more favourable conditions.

“There’s a process where winners are distinguished from losers and the winners thrive, they adapt and they grow, and the losers, they don’t,” Golub said on the podcast.

These losers in the industry may slowly disappear, merge with another firm, sell their business or just exit their investments sooner, he added.

“Over the last couple of years, we’ve seen SOFR come down, we’ve seen spreads come down and we’ve seen a period of higher-than-usual credit stress,” Golub said. “This is not abnormal. This is what happens. The sector has a degree of cyclicality.”

“I don’t think this is a software story,” he said. “I think there are lots of different threads here of credit weakness, most of which are not software.”

Companies are facing ongoing inflationary pressures, and some of them have not had the pricing power that sponsors and lenders expected them to have, according to Golub. Oil prices impact everything from gasoline to fertiliser and food, which could present a potential source of weakness for the US economy.

Meanwhile, many investors —particularly those in the private wealth channel — are figuring out the trade-offs associated with investing in semi-liquid private funds that provide exposure to illiquid direct lending assets.

“Investors are learning that there are trade-offs and they’re going to need to make decisions about which trade-offs they prefer,” Golub said.

Perpetual nontraded BDCs solved a lot of the problems associated with traditional, closed-end private funds. Investors got immediate exposure to private credit assets, skirting a traditional ramp-up period. They also did not need to lock up capital for years on end as these vehicles typically offer some limited liquidity, usually the equivalent of up to 5% of outstanding shares per quarter, to investors that want to exit.

But this liquidity feature comes with trade-offs. One disadvantage is that if too many investors submit redemption requests at the same time, funds may not fulfil all these exit requests at once — a situation that has played out publicly across the last few months. At the same time, limiting liquidity in this way protects investors from volatile share prices.

“I’m unaware of a single investment product that is perfect,” Golub added. “I think this one addresses some investors’ needs well.”

Certain private credit managers will be able to differentiate themselves from the pack during this period of negativity, Golub believes. While he expects returns in the industry to be temporarily lower, he noted that the market is already starting to see spreads widen, and terms and conditions are becoming more lender-friendly again.

In the publicly traded BDC market today, investors are already placing bets on select managers, as evidenced by the different discounts to net-asset-value that these funds are trading at. These trading levels are an indicator of what investors think about a manager, Golub said.