Private credit investments were sold as lower risk than equity strategies, with some types of credit such as distressed debt considered defensive, but the COVID-19 crisis makes those performance expectations an open question, industry sources said.
Credit managers today are having to deal with investments predicated on the good times continuing in a growing economy awash in cash. Such firms had competed for deals by requiring fewer — if any — covenants, offering looser fund terms and lowering their own return expectations. Now, for the first time, they are talking with borrowers, many of which are private equity firms' portfolio companies, about forbearances, restructuring loans and covenant waivers, and making other accommodations to lessen the likelihood of defaults.
"For some time now, we have been saying the next downturn would be a liquidity-driven downturn and COVID made that true in ways we never expected," said Kipp deVeer, director, partner and head of the credit group at Ares Management Corp. Ares had $110.5 billion in credit assets under management as of Dec. 31.
"Across the market, we see companies running into liquidity challenges," said Mr. deVeer, who also is director, CEO of Ares Capital Corp., the firm's business development company.
Many investors are in a good news/bad news situation. While the dislocation and illiquidity in the markets offer some attractive near-term private credit investments for their portfolios, existing credit portfolio returns have likely fallen as much or even more than those of their liquid credit investments.