2021 predictions for private markets
One of the many lessons of 2020 was that the world of COVID-19 inhabited a parallel but different universe than the global markets. It certainly impacted everything that involves the economy and capital flows. Nevertheless, once central banks flooded liquidity into the system, investors were able to look beyond the pandemic to a post-vaccine world. And they liked what they saw.
To get a sense for what lies ahead in the coming year, we divided our forecast into three categories: what’s in store for the economy, how will this affect capital markets and what does this mean for private credit specifically?
Injections and projections
Last March many would have thought that with at least three major pharmas rolling out their vaccines, nine months later the crisis would be winding down. Unfortunately, a combination of underestimated virus contagion and overestimated vaccine distribution makes it look like 2021, at least through the first half, will be a continuation of 2020.
Suggesting that the U.S. economy will bump along for a while. Economists, including Nuveen’s own Brian Nick, expect an up year relative to 2020. Once vaccines and the $1.9 trillion rescue package fully take hold, not to mention some political stability, the recovery will indeed be a “bright light” at the end of a “dark tunnel.”
Will pent-up consumerism, as Fed chair Jerome Powell suggests, drive growth as we emerge from hiding later in the year? It’s all about confidence. If unemployment ratchets down and consumers don’t worry about other shoes dropping, a 4% GDP seems achievable.
For the broadly syndicated loan (BSL) market, the balance of 2020 was one of restoration. Secondary prices came back from the depths of last March’s "selloff to par-ish by year-end" approach. Financings and re-pricings for a wide range of industries came to market.
At the same time, the supply/demand dynamics for liquid loans swung around in favor of institutional investors. Collateralized loan obligation (CLO) managers, representing some two-thirds of overall large loan appetite, found asset spreads wider than historic measures. Structures were also tighter with issuers representing the stronger, less COVID-19- sensitive sectors.
Concurrent with a general sense of economic recovery for the year ahead, retail money began to flow back into the asset class. Since January 1, over $4 billion has returned to funds, compared to over $30 billion of outflows for all of 2020.1
One of last year’s surprises was how detached capital markets became with the course of COVID-19 and the economy. We predict this trend will continue; in particular, private credit will move more in concert with the amount of dry powder raised for the asset class than any headlines or general market moves.
At the margin extremes in BSL technicals, such as big swings in fund flows can sway direct lending terms. As a relative value matter, if liquid loan yields widen dramatically, illiquid loan yields should follow, directionally if not in lock-step.
High-yield bonds enjoyed their best year ever in 2020, thanks to Fed support early on. Bizarrely, as the world was stuck at home, one of the highest risk credit assets was thriving. Single-B rated new issues are yielding about 6%. For private credit investors who are secured and earning at least 100bps north of that, relative value is favorable and expected to remain so.
Terms for private credit
Manager selection aligned with sponsor expertise provides better outcomes
With supply/demand in private credit driven by dry powder, won’t 2021 be a continuation of the frothy market we saw at the end of 2019 (and early 2020)? Hard to recall a time over the past four decades when direct lending wasn’t competitive.
But several post-COVID-19 trends favor certain managers. First, businesses less impacted by the virus are earning purchase price multiples above pre-COVID-19 levels. Second, volatility as measured by the VIX peaked above 69 last April. While it’s down from there to the mid-20s, it’s still 10 points higher than 2018 and 2019. That should provide some yield support on the upside.
Private equity fundraising fell sharply in the U.S. last year to $231 billion from $375 billion in 2019 according to Pitchbook. Nevertheless, dry powder remains over $500 billion. That’s sufficient to drive new buyout activity and greatly outweighs the $100 billion or so of private credit capacity.
As economic conditions strengthen, will bull loan market features such as middle market covenantlite return? It’s inevitable that competition among direct lenders will drive weaker investor terms. But residual pandemic drag on some portfolio companies may prompt risk managers to keep the foam off the latte.
For patient investors with a long-term time horizon, middle market debt offers a compelling relative value proposition
With a recovery underway, are we in a new business cycle? Or was 2Q 2020 just a bump in a decade-long expansion? The former, we think. COVID-19’s influence over commercial activity and consumer behavior will last for many years. But our experience over the past twelve months suggests the Fed will do whatever it takes to keep things rolling along.
Inevitably the economy, capital markets and private credit are intertwined. Hard for large moves in one not to impact the others. But improved vaccine distribution should lead to a tipping point for reopening of commercial activity. That will lead to better further value restoration in the capital markets. And ultimately, enhanced valuations should open up the M&A market – the lifeblood of private equity and private credit investing.
All good news. As one financial columnist put it succinctly, “A stronger economy…and higher interest rates. It’s called a recovery.”
Investments in middle market loans are subject to certain risks. Please consider all risks carefully prior to investing in any particular strategy.
These investments are subject to credit risk and potentially limited liquidity, as well as interest rate risk, currency risk, prepayment and extension risk, inflation risk, and risk of capital loss.
The views and opinions expressed are for informational and educational purposes only as of the date of production / writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Churchill Asset Management is a registered investment advisor and an affiliate of Nuveen, LLC. “Churchill Senior Lending” refers to the senior secured loan investment team and portfolio of Churchill Asset Management.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Financial professionals should independently evaluate the risks associated with products or services and exercise independent judgment with respect to their clients.
A word on risk
Investments in middle market loans are subject to certain risks such as: credit, limited liquidity, interest rate, currency, prepayment and extension, inflation, and risk of capital loss.
Nuveen provides investment advisory solutions through its investment specialists.