Coronavirus impact on credit funds
Dear monkeys,
I will be interning at the credit arm of a PE MF. I know that equity funds have suffered a huge impact, but I guess that credit funds are in a better position. I guess that there will be a lot of work at the distressed funds, but I don't know about the overall situation.
Given the current state of panic in IB and AM, could someone shed some light about that? Will credit be as affected? Less affected at all? Or even benefited?
thanks.
Congrats on the internship, exciting summer to join a credit team. The short answer is credit is the best place to be right now if you want to see deals getting done. Relative to other asset classes, capital is flowing into credit as the PE/M&A market is drying up. You have a bunch of business looking for rescue financings. Credit pros like the ones you’ll be working with will be busy structuring products to fill liquidity gaps. I’ll note that the types of deals will have higher return thresholds than what you’d see during normal market conditions in vanilla credits (ranging from mid single digits to low double digits). People in all markets need to be compensated for the uncertainty.
You kind of touch on this in your post but yes different areas of credit are being hit differently now. I’d encourage you to try to think through why during your internship. Just good learning experience. For example, look at how the first dollar of debt investments got hit by this shock vs middle of credit stack vs bottom vs the CLO, etc etc.Your shop will probably have all of these products and rewarding to get a grasp on each of them early in your career. Hope this helps.
Maybe I'm not the right person to answer this since I'm not a credit investor myself, but on CLOs, would be surprised to see an implosion in the CLO market. CLO structures fundamentally protect investors from capital impairment and even during the peak of the GFC the highest loss rate in a single vintage was ~5%, while the greatest five-year cum loss rate was 10% in 2012 (so includes both the 2008 and 2009). Meanwhile BB CLO liabilities do not experience impairment until losses reach ~10%, BBBs at ~15%, As at ~20% and AAs at ~25%. And all that assumes entry at par; now you can acquire CLO liabilities at a significant discount due to the broader market selloff so there's an even greater embedded loss cushion. And even when assuming a three-year time horizon for prices to recover back to par, yields on high quality CLOs (including AAs) are in the double-digits. A more aggressive recovery assumption of two years would result in mid-teens returns for AAs and low 20s returns for As, both far in excess of what could be achieved in normal market conditions, and pretty nuts when you think about the underlying quality of what you're investing in and what that risk / reward profile entails