Deglobalization, driven by trade protectionism, deregulation and reshoring, is reshaping the investment landscape, with the US undergoing its most significant policy shift in four decades.
However, private credit remains one of the most resilient asset classes, offering predictable returns and attractive yields, as well as inflation hedge, said Theodore Koenig, chairman and founder of Monroe Capital.
Private credit is the fastest growing alternative asset class, well-positioned to capitalize on tighter bank regulations and ongoing public market volatility, thanks to its low correlation with traditional markets.
In particular, direct lending in the lower middle market is expected to remain a top-performing segment within private credit, Koenig said at The Korea Economic Daily’s CIO Roundtable in Seoul on Nov. 7.
“The lower middle market … is more highly fragmented and less competitive despite offering significant lender benefit. The high degree of fragmentation in the lower middle market results in inefficiencies, which offers disciplined lenders the opportunity to earn.” the chairman explained.
“Floating-rate lending is a very good place to be, predictable returns, higher-for-longer environment, no J-curves, all current return.”
DURABLE FUNDAMENTALS
Companies in the lower middle market category have average earnings before interest, tax, depreciation and amortization of $35 million or less, according to Monroe.
Their fundamentals remain “durable” in a high-rate and inflationary environment.
“While spreads have compressed across the credit landscape, middle market direct lending continues to deliver higher all-in yields than experienced over the past 10 or longer years.”
Their average spread ranges from 475 to 600 basis points above benchmark rates, whereas upper-market loans typically carry a spread of 425 to 475 basis points.
Monroe Capital expects the US Federal Reserve to lower its benchmark rate by about 100 basis points over the next year, bringing the Fed funds rate to around 3%.
Monroe Capital is one of the largest managers in the US lower middle market, with about $25 billion in assets under management.
It focuses on direct origination, modest leverage and technology-linked sectors, including software, logistics and advanced manufacturing.
A rebound in M&A activity is expected to boost the private credit market, driven by pent-up demand for private equity exits and a growing stockpile of dry powder.
However, Monroe Capital cautioned about persistent market volatility, inflation pressures and labor market uncertainty.
“We’re seeing credit card charge-offs, subprime auto defaults and mortgage defaults,” Koenig said. “It’s a dichotomy from a very strong business to a weakening consumer.”
The firm also warned that traditional sectors such as hospitality and restaurants may face structural challenges.
“We have to be very focused today on where we’re investing … Some of the historical industries are going to be at risk.”
RETAIL MONEY INFLUX
Koenig, an accountant with a Juris Doctor degree, also warned that the influx of retail capital into private markets could heighten risks for institutional investors.
He advises institutional investors to maintain a disciplined approach amid the rising flow of retail and retirement capital into private credit.
“You don’t want to invest side by side with all that retail money coming in. Asset managers that don’t have high standards are going to take a lot of that retail money and invest it very quickly.”
