Nicole Kidd

Private debt can provide better downside portfolio protection than many other asset classes during periods of economic uncertainty, like the one we are currently experiencing, according to Schroders head of private debt, APAC, Nicole Kidd.

“Private debt investors have recently benefited from the rising rate environment in the form of higher returns from base rates, as well as from an adjustment to credit margins reflecting the current more challenging macroeconomic environment,” Kidd says in a new private debt paper from Schroders.

“This is not surprising. Being a privately negotiated transaction, the terms and conditions of private debt lending can adapt to help ensure the underlying resilience of the investment from the perspective of the investor.

“Additionally, in this uncertain environment, private debt investors primarily focus on the stability and resilience of borrower cashflows, ensuring there is an appropriate cushion within the capital structure.”

She says private debt fund managers are different to other asset class managers in that they don’t primarily focus on equity valuations – something which can be particularly volatile in times of high inflation and rising interest rates.

“So, for appropriately structured debt where there is enough cushion to buffer cost and revenue pressures, the borrower should be able to continue to meet its interest obligations. These factors make this asset class appealing in the current changing macro backdrop,” Kidd says.

“Borrowers are currently facing a multitude of pressures, however good private debt mangers know how to stress test for them and, via a focus on diversification within portfolios, can find the best-of-breed names in sector classes.”

“For private debt investors, success in this uncertain environment comes from ensuring they are investing into better quality risk profiles and being compensated for that risk with higher spreads,” Kidd says.

When it comes to longer term themes, the paper points out that the focus on climate change and sustainability within private debt markets is expected to continue, with businesses which have not begun transitioning, or have avoided addressing the problem, potentially facing a penalty of higher priced debt.

“Similarly, industries which have breached or are out of favour from a social and governance perspective, such as mining or casinos, could also expect higher priced debt,” the paper says.

Read the full paper.

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