Topic Tags: Alternative Credit

Bracing for Stagflation

As markets swirl and stagflation fears mount, what should investors do?
Our newsletter last week outlined the broad context of President Trump’s new tariff policy as well as the most notable market impacts. Granted, the news seems to change daily, as does the market’s reaction; trying to pen a targeted newsletter is an almost worthless endeavor because by the time the ink has dried, markets have shifted due to another policy pivot. In the short term, the omnipresent cloud of uncertainty will continue to drive market volatility and investor sentiment. The best recipe for investors to weather this storm is patience and discipline, both of which can be difficult to come by in the current environment.

As we step back and take a longer-term view of the future, however, the threat of stagflation is becoming more realistic. Coined as a combination of the words “stagnation” and “inflation,” it is an economic backdrop characterized by high inflation, slow economic growth, and in some cases, high unemployment.

In this edition, we examine which asset classes are most exposed to stagflation and which can offer shelter.

New Year, New President…Same Outlook?

From an investor’s perspective, the current environment feels lot like it did twelve months ago: U.S. equity markets returned over 20% the prior year, fixed income is (still) offering attractive yields, and overall portfolio performance was positive for most programs. Nevertheless, nothing lasts forever and sentiment can shift on a dime. It is also likely that some of President Trump’s policies will have an impact on markets, with the specific impact varying by the policy and asset class.

In this edition:

  • U.S. Economy and Policy Expectations
  • Fixed Income: “If you liked it last year, you’ll like it this year”
  • U.S. Equity: Concentration risk still looms
  • Non-U.S. Equities: Positive earnings outlook, policy uncertainty
  • Real Assets: Real estate bottoms, infrastructure demand robust
  • Private Markets: Private equity on the rebound, private credit still compelling

2025 Market Preview Video

This video is a recording of a live webinar held January 16 by Marquette’s research team analyzing 2024 across the economy and various asset classes as well as themes we’ll be monitoring in 2025.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Featuring:
Greg Leonberger, FSA, EA, MAAA, FCA, Partner, Director of Research
Frank Valle, CFA, CAIA, Associate Director of Fixed Income
James Torgerson, Research Analyst
Catherine Hillier, Senior Research Analyst
David Hernandez, CFA, Director of Traditional Manager Search
Evan Frazier, CFA, CAIA, Senior Research Analyst
Dennis Yu, Research Analyst
Michael Carlton, Research Analyst
Chad Sheaffer, CFA, CAIA Senior Research Analyst

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.

If you have any questions, please send our team an email.

Multi-Asset Credit: Taking Offense From Good to Great

Before the football season began, we authored a white paper that detailed offensive and defensive elements of a fixed income portfolio. For most investors, an aggregate (core) mandate provides defense while strategic allocations to high yield, senior secured loans, and emerging market debt (EMD) are the primary sources of offense. Relative to an aggregate benchmark, this structure has outperformed over market cycles. However, just as championship teams adjust and innovate throughout a season, so too should an investor’s portfolio.

Multi-Asset Credit (MAC) strategies are single portfolios that dynamically allocate across a broad range of global credit markets to provide higher levels of income and a diversity of fixed income exposures. These mandates can serve as a single-solution credit allocation or as a credit alpha overlay in the context of a broader credit portfolio. There is no perfect definition of MAC, but what they do offer is diversification, flexibility, and ease of access and operations. While these markets are not new, investors may be unfamiliar with the mechanics of a MAC strategy and its potential benefits.

This newsletter provides an overview of MAC, including the opportunity set, allocation structure and considerations, diversification benefits, and sample MAC manager performance.

3Q 2024 Market Insights

This video is a recording of a live webinar held October 23 by Marquette’s research team analyzing the third quarter of 2024 across the economy and various asset classes and themes we’ll be monitoring over the remainder of the year.

Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.

If you have any questions, please send our team an email.

2024 Halftime Market Insights

This video is a recording of a live webinar held July 23 by Marquette’s research team analyzing the first half of 2024 across the economy and various asset classes and themes we’ll be monitoring over the remainder of the year.

Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.

If you have any questions, please send our team an email.

Credit Check

Interest in private credit has grown considerably in recent years and the asset class has moved from a relatively small or non-existent allocation in institutional portfolios to a multi-trillion dollar market accessed by a wide variety of investors. Demand for private credit remains high, but the rapid growth of this space has sparked debates about potential bubbles and whether underwriting standards have diminished given intense competition among lenders. However, recent survey results indicate that underwriting standards may actually be more conservative today than in prior years, highlighting increased caution with regard to both borrower leverage and required levels of equity within borrower capital structures.

Based on a survey conducted by Proskauer capturing responses from 178 senior-level private credit executives, lenders have reduced the maximum level of leverage they are willing to underwrite in private credit deals in recent years. In 2021, more than 68% of lenders to U.S. corporate borrowers were willing to underwrite deals with more than 6.0x leverage, as measured by borrower debt-to-EBITDA. That figure increased to over 82% of U.S. lenders in 2022 but has since fallen sharply, with now just 45% of lenders willing to underwrite highly leveraged deals. Today, more than 55% of private credit lenders cap deal-level leverage at 6.0x, indicating a shift towards more cautious standards in the current interest rate environment. At the same time, borrowers are now requiring more subordinated equity exposure in the deals they underwrite. Deal equity, often provided by private equity sponsors, represents the amount of equity subordination in a borrower’s capital structure and offers a degree of downside protection for the lender if stress arises for the borrower. In 2021 and 2022, those lenders requiring less than 35% equity in deals represented 18% and 22% of Proskauer survey respondents, respectively. However, the proportion of lenders willing to lend with less than 35% deal equity fell to 13% in 2023 and currently sits at approximately 12%. Conversely, lenders requiring at least 45% equity in deals increased from 25% to 55% over the last three years, again highlighting the trend towards more conservative deal structures.

In summary, given elevated interest rates, lenders are prudently reducing the amount of leverage they are willing to support for corporate borrowers and are also requiring more deal equity. These efforts are largely aimed at enhanced downside protection and reflect increased caution among lenders in response to broader economic conditions. At the asset class level, private credit remains an attractive opportunity set for investors, offering attractive yields, portfolio diversification, and downside protection.

1Q 2024 Market Insights Video

This video is a recording of a live webinar held April 25 by Marquette’s research team analyzing the first quarter of 2024 across the economy and various asset classes and themes we’ll be monitoring in the coming months.

Our quarterly Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real assets, and private markets, with commentary by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos. If you have any questions, please send us an email.

A Primer on Alternative Credit

Alternative credit, also referred to as private credit or private debt, has emerged as an area of significant interest for investors in recent time, offering attractive returns and distinct advantages compared to liquid credit markets across an array of strategy offerings. Over the last decade, alternative credit managers have stepped in to play a critical role within lending markets as traditional lenders (i.e., banks) have retreated in the face of liquidity constraints, more stringent regulatory requirements, and higher borrowing costs. As bank retrenchment has intensified, non-traditional credit providers have gained further prominence by offering stable, efficient, and long-term sources of funding for borrowers while also generating attractive returns for investors. Indeed, the leveraged credit market has grown rapidly since the Global Financial Crisis, evolving into a return-enhancing asset class with diversification benefits relative to public fixed income. Given current trends related to supply and demand for capital, as well as the efficiency with which providers can supply favorable loans within corporate capital structures, we expect alternative credit strategies will continue to offer attractive opportunities for investors going forward. However, while the broad opportunity set is particularly attractive, it is important to note that there are many types of strategies that fall into the alternative credit category, and each of these strategies offers varied risk, return, and liquidity characteristics. As it relates to risk broadly, investors should understand how the economic cycle, illiquidity risks, default rates, and increasing competition for deal flow can impact the asset class.

While Marquette has been an active participant in alternative credit markets for many years, the proliferation of the asset class and the expansion of offerings available to investors of different profiles serve as an impetus to examine the space in further detail. The aim of this whitepaper is to provide a background on the alternative credit space, highlight some of the key drivers of return and risk across various alternative credit strategies, and outline the prospects of the asset class going forward.

Direct Lending is Eating the World

In 2011, Marc Andreessen famously proclaimed that software is eating the world, meaning more and more industries and businesses are relying on software for their operations. This statement has since proved incredibly accurate, as evidenced by our daily dependence on software applications. What was said about software over a decade ago can be said about direct lending today, supported by the growing percentage of companies that rely on direct lenders or private credit managers to finance their operations. Direct lending is a form of financing where borrowers receive loans directly from lenders, without intermediaries such as banks or financial institutions. In this type of lending, borrowers can access funds more quickly and with more flexibility than via traditional lending channels. The terms and conditions of the loans are typically negotiated directly between the borrower and lender, allowing for greater customization and potentially more favorable rates for borrowers.

A number of different supply and demand tailwinds have contributed to the growth of direct lending, including a shift in banking practices post-GFC, including Dodd-Frank legislation and Basel III, the growth of private equity and its preference for direct lending financing, and the investment premiums inherent to the asset class. From here, Marquette expects direct lending to continue to grow, providing attractive investment opportunities for clients. The fallout from the failure of Silicon Valley Bank and the issues facing regional banks may continue to force small and mid-sized borrowers into the arms of private credit lenders. Private equity managers, who tend to prefer financing provided by non-bank institutions over those influenced by the mercurial nature of traditional capital markets as well as the certainty of execution offered by direct lenders, are armed with a record nearly $2 trillion in dry powder.¹ And lastly, we believe institutional investors will continue to allocate to direct lenders and private credit given the attractive risk-adjusted returns and portfolio diversification benefits the asset class provides, particularly in today’s challenging market environment.

Print PDF > Direct Lending is Eating the World

 

¹Thomas, Dylan. “Global Private Equity Dry Powder Approaches $2 Trillion.” S&P Global, December 21, 2022.

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.