by Nicole Kidd, Tim Hallam, Rickard Hoskin
Introduction
There’s no doubt that the last three years have been a tumultuous time for global economies, and we have seen twists and turns which arguably nobody could have predicted. We find ourselves currently on the brink of recession, dealing with economies which have been pumped full of monetary and fiscal stimulus, uncomfortably high inflation and, in Australia at least, the most rapid interest rate increases in history.
Fortunately for private debt investors, private debt instruments are generally floating rate and do not carry interest rate duration exposure, so there is minimal need to take a directional view on interest rates when determining the appeal of the asset class (albeit impact on underlying borrower and therefore credit risk comes into play). As a result, private debt investors have recently benefited from the rising rate environment in the form of higher returns both from base rates, together with an adjustment to credit margins reflecting the current more challenging macroeconomic environment.
Additionally, in this uncertain environment, private debt investors primarily focus on the stability and resilience of borrower cashflows and ensuring there is an appropriate equity cushion within the capital structure. This is a different mindset to other asset class managers who will be primarily focused on equity valuations, which can be more volatile in times like these. So for appropriately structured debt where there is enough cushion to buffer cost and revenue pressures, the idea is that the borrower should be able to continue to meet its interest obligations. These factors can make this appealing in the current changing macro backdrop when investors can be drawn to less volatile asset classes such as private debt.
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