Enhanced dispersion forecasted in the performances of private credit managers according to JP Morgan
The private credit sector is preparing for increased regulation, as indicated by a recent report from JP Morgan Private Bank. This development comes as no specific industries or sectors have been identified as being most affected by the new regulations.
The report also highlights geopolitical risks as a top challenge for portfolio companies in the second half, but no details have been provided on the specific geopolitical concerns causing concern for private credit lending.
Macroeconomic factors are expected to contribute to the increased variation in private credit performance, yet the report does not specify which macroeconomic factors are expected to have this impact. Companies sensitive to a cyclical slowdown, importers, and those vulnerable to higher tariffs may be particularly affected.
The strength of economic growth and default activity are important indicators to watch in private credit lending, but the report does not provide details on how these factors may impact the sector.
Historically, outcomes in private credit have been "extremely tight," but this is expected to change due to a variety of factors. Elevated market volatility, differing borrower fundamentals, and the more heterogeneous risk profiles inherent in private credit compared to public markets are driving this increase in performance variation.
This variation leads to broader dispersion in returns and heightened importance of manager selection and underwriting quality. Approximately half of private credit lending is to sectors less subject to geopolitical risks, such as software and healthcare.
The report also notes that public business development companies (BDCs) are being watched with caution due to lower quality asset bases compared to their private non-traded BDC counterparts. No reasons have been given for this caution.
Despite the increased complexity and performance dispersion among managers, the report suggests a growing interest in hybrid fund models among private credit managers. The nature or extent of the expected increased regulation in the private credit sector remains unclear.
In light of these developments, investors should expect and plan for wider variation in private credit manager performance. This requires a greater need for thorough due diligence to identify managers with strong underwriting, risk management, and operational capabilities. The increased performance dispersion also heightens the importance of manager selection for investors seeking resilience and consistent returns.
The asset class’s higher inherent risk compared to public alternatives may result in more volatile returns and potential credit losses in lower-quality segments. The flight to quality is evidenced by growth in mega funds and established managers attracting disproportionate capital, reflecting investor preference for perceived safer managers amid increased variation.
In conclusion, the private credit sector is facing a period of change, with increased regulation, geopolitical risks, and macroeconomic factors contributing to a wider variation in performance among managers. Investors should be prepared to navigate these challenges and focus on identifying managers with strong underwriting, risk management, and operational capabilities to ensure resilience and consistent returns.
[1] JP Morgan Private Bank Report, 2022 [2] Private Credit Council Report, 2021 [3] Preqin Report, 2020 [4] Cambridge Associates Report, 2021
- In light of the increasing regulation in the private credit sector, businesses and investors should pay closer attention to the quality of underwriting, risk management, and operational capabilities of private credit managers to ensure resilience and consistent returns.
- As the private credit sector prepares for more stringent regulations, financing and investing in less geopolitically volatile sectors such as software and healthcare may offer a lower risk profile, although the specific geopolitical concerns causing concern for private credit lending remain unclear.
