Alternatives

Opportunities in private credit and direct lending

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Key takeaways
Market growth and segmentation within direct lending
1

We tend to focus on direct lending in the core middle market defined as companies with enterprise values less than $750 million in size. This particular segment of the market has historically demonstrated some of the most consistent returns as well as yield

The growing importance of ESG
2

We work with companies to engage and educate them around disclosure, and the importance of developing healthy policies and procedures. Many of the ESG considerations are – ultimately – credit risk.

Helping companies achieve their potential
3

We spend time working with asset owners to understand what their needs are – we then take those requirements back to the companies to help them change their behaviour, whether it’s related to disclosure or operations.

Given today’s challenging macro environment, asset owners are turning to alternative investments in greater numbers as they navigate increasing uncertainty and address the impact of rising interest rates and inflation. Private credit and, more specifically, direct lending have attracted their attention because they offer yield, income and attractive returns.

In this short Q&A, Scott Baskind, Invesco’s Chief Investment Officer and Head of Private Credit, and Ron Kantowitz, Invesco’s Managing Director and Head of Private Debt, discuss opportunities in private credit and direct lending, as well as the growing role ESG is playing in this space.

What are the opportunities you're seeing in the private credit and direct lending?

Ron Kantowitz: The market has grown exponentially, and now you can start to see real segmentation within direct lending, with each offering different risk/return characteristics.

From our perspective, we tend to focus on direct lending in the core middle market defined as companies with enterprise values less than $750 million in size. This particular segment of the market has historically demonstrated some of the most consistent returns as well as yield. And it also has some of the strongest credit protections in the market. So from a risk and return perspective, direct lending is really compelling. It’s also where we see some of the best opportunities.

We skew towards senior secured credit. We like to be at the top of the cap structure. We want to have that security; it mitigates risk. We're a private equity oriented direct lending strategy. We want to work with world class private equity firms where we know we have experience.

If we do our work and we identify what we think is a great opportunity, and we're aligning with some of the best equity investors in the world, and they're willing to contribute 50% of the value of those businesses and first loss equity, from a risk perspective we think we're in a pretty strong position.

What about ESG? Is that difficult to do in the direct lending space?

Scott Baskind: You really can't get through a conversation with asset owners without ESG being a critical component. Many of the ESG considerations are – ultimately – credit risk. For example, governance. With all of the corporate entities we’ve worked with, we have sought to understand their governance structure and the risks involved when there's not independence, when there's not diversity. These different components of governance have really been ingrained in the credit underwriting process for years.

There has been a really healthy shift in underwriting related to environmental and social considerations; particularly as you start moving down the spectrum into small- to mid-cap companies. Relative to large-cap public companies, the sophistication level and resources of these small to mid-cap companies are very different. We work to engage and educate them around disclosure, and the importance of developing healthy policies and procedures.  

What we're most focused on is baselining where companies are today and then helping them to develop that engagement level on a go-forward basis. What are their expectations and where can they get to over the next one to three to five years?

Ultimately what we're looking to do is to measure the company's potential for success, or lack of success, on a go-forward basis. We spend time working with asset owners to understand what their needs are – we then take those requirements back to the companies to help them change their behaviour, whether it’s related to disclosure or operations.

To help, we’ve built a framework for analyzing each and every company in our due diligence process. We then rate each and every investment that we undertake with a completely separate ESG rating that really helps us align where companies are and to help us set a framework to help them develop in the future.

To hear more from Ron and Scott on direct lending, check out the full Q&A