Josh Matthews on Private Debt and ‘Sea Change’ at Recent Citywealth UHNW Forum

Written by Josh Matthews, HBA

Josh spoke on the subject of ‘Private Debt – Refinancing and Restructuring: Commercial property in focus’. Within this talk, Josh referenced Howard Marks and his recent memo titled ‘Sea Change’ (click here to view the memo in full and here to view his ‘further thoughts’ on Sea Change), stating that there is an argument to be made that Private Credit is entering its golden age after struggling for so many years. The main message from Marks’ memo is that the changes he sees today aren’t just cyclical fluctuations rather taken together. They represent a sweeping alteration of the investment environment calling for significant capital reallocation.

“In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes.  I think we may be in the midst of a third one today.” Howard Marks, Oaktree Capital

In addition to this, Josh touched upon the consequences of higher interest rates, should the declining and/or ultra-low interest rate environment period not persist in the years ahead and shared the following points of consequence:

• Economic growth may be slower
• Profit margins erode
• Default rates may head higher
• Asset appreciation may not be as reliable
• The cost of borrowing won’t trend downward consistently
• Investor psychology may not be as uniformly positive
• Businesses may not find it as easy to obtain financing

Josh also shared an example in that 5 years ago, investors went to the bank for a loan and the banker said “I will give you $800 million at 5%”.  Now that loan has to be refinanced and the banker now says “I will give you $500 million at 8%” which means the investors cost of capital is up. His net return on his investment is down or negative and he has a $300 million hole to fill.

In addition to the above, Josh also discussed which strategies have performed the best historically, as it seems obvious that if certain strategies were the best performers in a particular environment (declining or ultra-low interest rates), it must be true that a starkly different environment will produce a dramatically different list of winners.

Who have been the historical winners in a declining interest rate or low interest rate environment?

• Equities & Real Estate: Declining discount rates and the associated reduction in the competitiveness of bond returns led to substantial asset appreciation. Asset ownership, specifically in companies, equities or properties performed well.
• Long Duration Bonds: As interest rates fell and brought down the cost of capital for borrowers, debt holders with fixed interest coupons also performed well.
• Private Equity: With the cost of borrowing falling, any investor who bought assets with borrowed money also performed well. It is worth noting that almost the entire history of leveraged investment strategies have been written during a period of declining and or ultra-low interest rates.  Almost 100% all private equity invested capital has been put to work since interest rates began their downward move in 1980.

As well as discussing which strategies have performed well historically, Josh also touched upon which strategies may perform well in the future. For example, Josh shared that in 2021, high yield bonds paid interest in the range of 3%, and today, they yield more than 6.5% and have the potential to make a greater contribution to portfolio returns.  The same is generally true across the entire spectrum of non-investment grade credit.

To summarise, Josh’s message to the attendees of this talk was very much one that there are opportunities for Private Debt in and outside of the Real Estate space, with a lot of banks pulling out of the category, which is leaving an opportunity for Private Debt to come in and replace them. The main reasons? A number of banks will be nursing losses due to delinquencies and defaults on their loans, especially in the US Office category, where vacancies have gone up.

To view Josh’s CityWealth Leaders List profile, please click here – Josh Matthews | Citywealth Leaders List