Artisan Credit Opportunities Fund | Private Credit: Capital Cycles and Convergence
- 3 days ago
- 4 min read
As private credit has grown, so too have concerns around leverage, lending standards and risk. In this discussion, Bryan Krug explores the capital cycle, why some parts of the market have become overheated, and how a flexible approach across public and private credit can help uncover attractive opportunities while managing risk.
Transcript:
Meaghan Mahoney:
You always say that when investors ask, 'What's in the crystal ball?', your response is, 'I don't have a crystal ball, Meaghan.' However, you were one of the first people I heard ring the warning bell about excesses in the private credit market. For years it felt a little like the boy who cried wolf, but those concerns are now starting to come home to roost.For those of you who have attended this event over the years, you've probably heard us discuss this since the 2023 forum. We also recorded a podcast more than three years ago highlighting what we saw as growing excesses in the market. Can you explain what led you to take that out-of-consensus view, and perhaps provide some historical context?
Bryan Krug:
Sure, and it's great to be here and to see so many familiar faces.When we looked at the market several years ago, we viewed it through the lens of capital cycles. When large amounts of capital chase a particular opportunity, excesses inevitably develop. Those excesses typically lead to lower returns, and eventually booms give way to busts.Direct lending is a strategy that can work well over the long term. However, when the market becomes overheated—particularly in a relatively small market—valuations and lending standards can become stretched. One of our biggest concerns was software lending. We reviewed publicly announced transactions and found businesses with little or no positive cash flow, many of which were EBITDA negative. The expectation was that these companies would grow rapidly enough to support increasingly large debt burdens. In some cases, interest payments were deferred for several years, meaning companies effectively had to grow into their capital structures simply to afford servicing the debt.We believed those were inherently risky and non-traditional credit characteristics. That's largely what we're seeing unfold today. Companies have had time to execute, but where growth has fallen short, equity investors have become reluctant to provide additional capital, leaving lenders to take control of the businesses.We also observed leverage levels that we felt were excessive. In some transactions, debt reached as much as seven times EBITDA, which is very high. While those leverage levels were becoming relatively common in parts of the direct lending market, we didn't believe the spreads on offer adequately compensated investors for the risks being taken.Over the long term, we continue to believe direct lending is an attractive strategy. However, periods of excess need to be worked through before the market can reset and new opportunities emerge.
Meaghan Mahoney:
One topic we've discussed extensively is the blurring of markets and the convergence between public and private credit. This was actually the focus of our discussion three years ago. What do you mean by convergence, and how has it changed your investment opportunity set?
Bryan Krug:
Companies increasingly don't distinguish between public and private markets. Their primary objective is simply to secure the lowest cost of capital. Whether the funding comes from a public bond, a private loan or another financing source is largely irrelevant to them.We've invested in companies that initially used private financing before moving into public markets, and we've also seen the reverse, where businesses have shifted from public to private funding because it offered a lower cost of capital. This flexibility is becoming increasingly common.Generally speaking, smaller businesses often find private financing more cost effective, while companies with higher leverage may also benefit from private solutions. Larger businesses with lower leverage are more likely to access syndicated public markets.My view is that investors will increasingly adopt the same mindset. Rather than focusing on whether an investment is public or private, they'll focus on the return stream it generates. Ultimately, the wrapper matters less than the underlying opportunity, and I believe that's where the market is heading.
Disclosure:
This video has been prepared by Copia Investment Partners Limited (AFSL 229316) (Copia) for general information purposes only. Copia is the issuer of the Artisan Credit Opportunities Fund (ACOF), an unregistered managed investment scheme available to wholesale clients only under an Information Memorandum (IM). The IM is available upon request to eligible wholesale investors. Interests in ACOF are not available to retail clients. The information contained in this video does not take into account the investment objectives, financial situation or particular needs of any person and is not intended to constitute financial product advice, investment advice, a recommendation or an offer or invitation to invest. Viewers should consider the appropriateness of the information having regard to their own objectives, financial situation and needs, and should seek professional advice before making any investment decision.
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