Increased fluctuation in the performance of private credit managers foreseen by JP Morgan
In a recent report titled "Hybrid fund models attracting 'growing interest' from managers", JP Morgan Private Bank has predicted an increase in variation in the performance of private credit managers. This variation is primarily due to macroeconomic factors and the evolving risk environment.
According to the report, an economic slowdown could lead to pockets of stress in over-leveraged companies with tight cash flows, particularly those sensitive to cyclical downturns, importers, or those vulnerable to higher tariffs. This could result in more divergent outcomes among private credit managers depending on their portfolio exposures and risk management.
About half of private credit lending is to sectors less exposed to economic cycles, such as software and healthcare. However, the underlying strength of economic growth and the level of default activity remain crucial indicators influencing performance. There is also caution on public business development companies (BDCs) with lower quality assets compared to private non-traded BDCs, which could further increase performance dispersion.
Historically, outcomes in private credit have been "extremely tight", according to JP Morgan Private Bank. However, as the private credit market expands and credit risk increases, manager dispersion in returns is expected to widen. This emphasizes the importance of careful due diligence and manager selection to identify those with proven track records and strong risk controls.
JP Morgan Private Bank has highlighted weaker fundamentals in private credit relative to public markets (e.g., lower interest coverage, higher leverage), which necessitates greater selectivity. Additionally, JPMorgan CEO Jamie Dimon has expressed concerns that credit spreads are very low, which means the compensation for risk is insufficient. Looser underwriting and higher leverage could lead to increased default risk, indirectly contributing to greater performance variability among managers.
The private credit sector is also bracing for increased regulation, which could further impact performance. It's important to note that the report does not specify any specific companies or industries that may be affected by the predicted increase in variation in private credit performance, nor does it provide details about the specific macroeconomic factors that may contribute to this increase.
In conclusion, increased economic risks, sectoral differences in exposure, weaker credit fundamentals, and compressed credit spreads are key reasons JP Morgan Private Bank expects growing variation in private credit manager performance going forward. As investors, it's crucial to stay informed and vigilant in our investment decisions, particularly in this evolving market landscape.
- With the expected widening of return dispersions in the private credit market, proactive investors might find it crucial to meticulously assess managers' finance strategies and risk management practices when investing.
- As the private credit market continues to grow and credit risk increases, discerning investors could benefit from focusing on managers with a demonstrated track record of strategic investing and strong risk controls in response to potential performance fluctuations.
