In this PDI roundtable piece, four asset management professionals—including Barings' Ian Fowler—explain that while pandemic-induced setbacks are inevitable, private debt is positioned to emerge strongly from this unpredictable set of events.
The pandemic and ensuing lockdown in March caught markets by surprise, and upended the global economy in unprecedented ways. However, the U.S. government’s stimulus and the Federal Reserve’s moves to flood the credit markets with liquidity by slashing interest rates to zero and purchasing all manner of public debt—including high yield bonds and exchange traded funds—have restored some sense of stability in recent months. Private credit has not emerged unscathed, but the disruptions have created long-awaited opportunities, as Private Debt Investor discovered when it took the pulse of the market with four leading participants.
What stresses has COVID-19 caused in the private credit markets?
Ian Fowler: What’s unique is that you had instantaneous supply and demand destruction. When the U.S. government pulled the switch to shelter in place, all industries were affected. COVID-direct industries like retail, restaurant, and travel and leisure experienced a major impairment to the business model. Some of these companies suddenly had zero or very little revenue. Even non-COVID businesses were impacted, unless they were considered essential services. The flip side is that the government turned the switch back on in 60 days with stimulus and unemployment checks, and states began to re-open. In the liquid market, lenders had the ability to trade through the dislocation, albeit for a few short months. In the private market, lenders with COVID-impacted companies or underperforming investments are kicking the can down the road. Unlike the liquid market, private market opportunities never materialized. Fortunately, we have very little exposure to consumer-facing businesses.
Brent Humphries: The pandemic has had a much greater impact on certain segments of the U.S. middle market and the real economy than the global financial crisis. Nobody could predict large segments of the economy being effectively shut down. Early on, we thought that nearly 30 percent of our portfolio—even names that would typically be viewed as highly defensive and recession-resistant in sectors like health care and quick service restaurants—could be affected. Results thus far have been better than our initial fears, and we now estimate that only 15 percent of our portfolio companies operate in sectors directly impacted by COVID. Within this group, the companies facing the greatest challenges make up an even smaller subset consisting of a handful of names, with the greatest stresses involving businesses that were underperforming before COVID and that are directly impacted by it. That combination is very challenging. Fortunately, it’s been manageable and fairly modest.
Randy Schwimmer: Frontline consumer businesses such as retail, travel, leisure and hospitality have all been negatively impacted. There have also been contrarian effects. Low-cost fitness clubs have historically done well in recessions, but with this iteration members were shut out of gyms. On the other hand, some catalog businesses are growing because people are stuck at home reading their mail. Our long-term strategy of focusing on defensive, non-cyclical businesses carried us through the global financial crisis, and is paying off in this crisis.