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Opinion Direct lending
Private credit should be resilient in a slowdown — but investors have decisions to make
by Randy Schwimmer
Randy Schwimmer
Vice chairman
Churchill Asset Management
Dealmakers are putting on hold transactions that may be hit by tariffs
Private capital is less correlated with headline risk than fixed income and public equities. But one of COVID’s most enduring financial legacies was the higher interest rate regime imposed by the Fed in 2022.
While a soft landing was achieved, the increased cost of financing leveraged buyouts and M&A resulted in a USD 3tn backlog of unrealised value held in businesses to be sold globally. That iceberg would have been slow to melt if the Fed continued its pause on rate cuts. But the question now is whether that dynamic will change amid looming tariff threats.
In part, the answer depends on whether rate direction will be more influenced by higher inflation kicked off by a trade war, or the increased likelihood of an economic slowdown. Experienced executives know that bad news is often better than uncertainty. As we enter the second quarter, many dealmakers are putting on hold transactions where valuations will be affected by tariffs.
Factors affecting deal flow
Investors looking to maintain or increase their exposure to private capital face similar concerns. While macro issues clearly weigh on them, buyer confidence comes down to two things: deployment (“How fast can I put my money to work?”) and risk/return (“If I trade liquidity for yield, will the asset class hold up over time?”). That translates to deal flow outlook, and how that supply/demand equation impacts returns.
Systemic, investment bank-driven M&A helps. But in the middle market, private equity deal flow is driven by operating partners with long experience in niche sectors, which can identify consolidation opportunities. These strategies develop over decades and aren’t easily derailed by macro pressures. But financing costs affect entrance and exit multiples, and right now those are slowing the deployment-to-realisation cycle.
Confidence in markets right now is shaken. If buyers don’t believe corporate growth and earnings are on a positive trajectory, it’s tough to lean into investments with financing costs where they are. And sellers can’t justify to themselves and their LPs that today’s portfolio realisations will help tomorrow’s fund returns.
Relative performance is also critical to how investors choose among myriad public and private options. Private capital never exists in a vacuum. It inhabits portfolios among liquid and other illiquid asset classes, each with their own risk and return characteristics. Most US managers already have credible private credit exposure. To increase that share, they often have to pull from other categories.
Managers ask themselves: how much liquidity are we willing to sacrifice for better yields? Is fixed income more or less attractive now? That does depend on your view of rate direction, or at least the onset of more market volatility. After seven consecutive weeks of strong inflows, cash in high-yield bond funds reversed course in mid-March.
Finally, we hear more from investors about commitment pacing. They ask themselves how quickly they should deploy a specific private credit allocation, given all the macros at play, including the growing risk of an economic slowdown. This is a complex calculation — and one that’s different for every investor depending on the requirements of its beneficiaries.
Sophisticated buyers, and a broad set generally, still have direct lending as a core portfolio strategy. But they are increasingly exploring product extensions in junior capital, equity co-investments, and equity secondaries. This allows for further diversification within the asset class without sacrificing consistent premium returns.
Recession could increase deal flow
One experienced advisor told us the greater chance of a recession was two-edged. Such an eventuality might trigger better deal flow in their opportunistic, special situations and distressed buckets. But it’s also the reason they liked private credit’s stability, particularly in senior credit. “Hard to disagree with the risk/return right now,” they said. “With a little leverage you can be at mid-teens. Hard to argue with.”
As we begin the second quarter, expect to see investors’ underlying assumptions about the economy and markets tested. Uncertainty and volatility will challenge managers across the asset spectrum. While we don’t anticipate a sustained downturn, we do believe skating relatively unscathed through a tariff tantrum will prove to be another example of private credit’s resilience.
