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November 18, 2024 | PIONLINE.COM
David Miller
There’s growth ahead in private credit — both for institutional investor allocations and for Morgan Stanley Investment Management, said David N. Miller, managing director and global head of private credit and equity.
MSIM currently has about $50 billion in private credit assets under management — with two-thirds in corporate private credit, which includes direct lending, mezzanine and opportunistic credit, and one-third in real estate and other asset backed finance — and Miller expects that to double in coming years.
“(W)e don’t think it’s heroic for that number to double in the medium term, in plus or minus five years,” he said during a recent interview with Pensions & Investments. “We don’t set goals on assets. Our view is, if we produce alpha and good performance, and people understand why we’re being successful, that the assets will come, and investors appreciate it.”
MSIM had $1.6 trillion in assets under management as of Sept. 30 and counts two-thirds institutional investor clients and one-third high-net worth. It launched its first private credit fund in 2009. Outside of acquiring real estate credit manager Mesa West Capital in 2018, MSIM has been building capabilities in-house.
Room to grow
There’s a huge variability among pension funds in their private credit allocations, Miller said.
“(O)verall, they’re underallocated to private credit. I think that’s a function of history, right? It is the youngest of the private markets,” he said.
Miller sees the dispersion on pension funds adopting private markets. Some were “really early and have built a very methodical portfolio” while others “are still looking and researching,” he said. Going forward, MSIM projects average allocations to private credit today to more than double and exceed 5%.
“I get a lot of comfort from a growth perspective that we’re nowhere near (the top), even though I'd say we're probably getting close to peak news articles about private credit,” he said with a laugh.
Many investors began with a core direct lending allocation and have added on real estate or mezzanine and then add “satellites with some of these more specialized strategies. Those are the discussions we’re having right now,” Miller said, adding that “we advise our clients to look at direct lending as a through the cycle exposure. It's very hard to time.”
Miller thinks growth will come “across the board, both the senior secure, direct lending, but increasingly, what I'll call opportunistic or hybrid capital, and that’s an area that we see a lot of opportunity today.”
Major concerns for investors are the amount of illiquidity they want in their portfolios and how they approach private equity, a segment where some are over-allocated, Miller said.
Private credit has grown into $1.7 trillion segment, according to Preqin’s count.
The definition of private credit is expanding from direct lending, subordinated debt, mezzanine, distressed and real estate lending to be much more expansive for some investors and now includes investment-grade credit, Miller said. He added that there is “huge” diversity within underlying loans.
“Private credit is not one thing, it is a very diversified set of sub-strategies that have very different characteristics,” Miller said. “And that is, I think, the interesting part of the evolution of the asset class is people really getting smart on how different strategies are and the exposures are and where to put those in their portfolio, and what they do in a portfolio can be very different based on what that institution is looking to accomplish.”
Opportunity set ahead
Miller says MSIM will opportunistically look at specialty strategies, “we feel in most cases, we’ve had success building organically,” he said. “So, there’s nothing on the horizon for us from an M&A perspective.”
He sees private credit growth globally, but MSIM is not actively looking in Asia.
“I think Europe is going to be part of our growth, but the U.S. is still the biggest market, and we anticipate growing there as well,” he said. MSIM projects private credit, excluding investment grade, to grow to $3.5 trillion to $4 trillion by 2030.
An area that Miller is spending time on is investment-grade asset-based finance — something that the firm has pockets of across strategies.
For MSIM to add a strategy, Miller looks at three things where the answer has to be yes: do they have the expertise and talent to add alpha, do clients want it and does being part of Morgan Stanley add value?
Miller sees opportunities in areas of opportunistic credit including providing flexible capital for deals that were done when rates were low, especially in the middle market. Other areas include the unsponsored deal segment, growth companies and real estate lending.
“There are a lot of borrowers that are over levered relative to the value of the real estate, and as they look for refinancing, they will not be able to refinance at the same levels as they initially did,” he said. “And so creative capital coming in and helping them to find that solution is where we're seeing really good opportunity.”
One area Miller watches is the use of payment-in-kind (PIK). It’s a tool they’ll employ on rare basis, but Miller said how it is employed is critical. “It is something to watch… industry wide, because there there's good PIK and there's bad PIK.” It all very much depends on the specific reasons for its use, the underlying capital structure and the business, he said.
But overall, Miller sees a healthy private credit landscape from his vantage point.
“Right now, portfolios are quite healthy, and I think it will be tested in a downturn of who underwrote properly, who had the right strategy,” he said. “So, for example, there will be huge dispersion across direct lenders, I believe.”
A path through government
Miller’s career journey took him through the heart of the 2008 global financial crisis. He was working at Goldman Sachs in the special situations group, including on what wasn’t yet known as private credit: making private loans to private equity and other firms.
As the financial crisis unfolded, Miller reached out to the U.S. Treasury Department offering help, not expecting to hear back. The next day Neel Kashkari, who in 2008 served as assistant secretary of the Treasury, replied. Miller ended up serving as chief investment officer of the Troubled Asset Relief Program (TARP) at the Treasury. “What I thought would be three months, turned out to be three years,” Miller said.
After leaving government, Miller said, “I didn't feel comfortable going to work for any large financial institution, be it a bank or asset manager, because they were so intertwined with the TARP program.”
He went to work at a private partnership that bought, fixed and rented out single family homes and eventually took Silver Bay Realty Trust public. After connecting with MSIM’s Daniel Simkowitz, currently co-president of Morgan Stanley, to discuss alternatives investing, Miller joined Morgan Stanley in 2016.
Miller’s background has given him a view on how regulators may approach the growing private credit sector. Questions have been raised on risks associated with the fast-growing asset class and the potential for more regulatory oversight.
Miller said loans moving into an asset management format with locked up capital that is unlevered or lightly levered is “actually healthier for the system vs. it being held on a bank balance sheet. I think most of the regulators agree with that.”
But he does expect there will be a greater transparency push.
“I do think there will be a push for more transparency of who holds what assets, and how do those assets and those loans interplay with the banks,” he said. “So, there are many strategies where banks are actually providing back leverage, so understanding and quantifying the risk there, that’s a much safer position for a bank to hold than holding the underlying asset.”
As more private credit retail 40 Act regulated products come online, Miller said investors will need education on liquidity.
“I think as that industry grows, there’s going to be more scrutiny on how (strategies) are run, how they provide liquidity, and it has to be done carefully. So far, it’s worked, I think, as advertised, but they haven’t been tested in a downturn,” he said.