Performing, direct lending or stressed/distressed – which strategy is right for you?

Subtitle

James Wallis takes you through some of the key things to consider

People

James Wallis

A natural step many people in banking want to make is to move to the credit buy-side.  Having almost spent 10 years at Babson (now Barings) – ultimately on the investment committee for European HY funds – I understand the appeal.  However – a discussion we often have with candidates is what type of credit investing suits them best.

I have therefore put together some thoughts based on my experience as both an investor and recruiter and from conversations with people at various levels in the industry, about the various strategies.

Whilst some roles will combine elements of more than one strategy and the lines between strategies are blurred, most will have a particular focus so it’s important to think carefully.

But credit’s credit – right? 

Sort of.  The fundamentals of credit investment run through all of these strategies so make sure that it is right for you.  A keen interest in the fundamentals of a business and wider business and macro environment are key.   An attention to detail, ability to identify risk and an interest in the legal position of lenders are also highly relevant.

There are endless nuances between the strategies – however some key areas to consider when deciding which works best for you should include the following:

What’s your risk mind set?

Remember in credit – a lot of time is spent focussing on the downside.  Unlike equity your upside is capped so whilst the prospect of massive expansion into new geographies is exciting for the equity investor – for the average performing debt investor it’s far less appealing.

A seasoned PM at a liquid strategies fund summed it up “The way you outperform in credit is by not getting it wrong – being right 90% of the time is not good enough.” 

The further you go into the distressed space – the more upside there is.   Equally investing in businesses that are already in trouble clearly comes with risk.  Don’t assume you’ll always be on the right side of that trade and the difference in personal development and compensation can be far more variable (both positive and negative) in the distressed space.

Depth vs breadth

Key for any investor is the number of deals they look at and ultimately do.  This is especially important for more junior candidates making their first move out of banking – doing little for the first couple of years can be terrible for career development.

In performing liquid credit you’ll generally be looking at the greatest number of deals - gaining a broader understanding of the market.  It can be a great way to hone your credit skills and learn about a range of industries.  However, in large syndicated deals by the time you are looking at them – they’ll generally be mostly agreed and your time with management and ability to shape the deal will be limited.

In the direct lending space you’ll look at fewer transactions - spending more time with the sponsor, management team, due diligence providers and lawyers and will have more of a say in how the deal looks.

Depending on the strategy – truly distressed debt investment processes can be much longer. You’ll have the initial investment assessment and then the process of restructuring and potentially taking ownership of the business and all that entails.  Be prepared for long legal fights, fraught negotiations and all the highs and lows that go with it.   

Do you like the markets?

The leveraged loans and High Yield markets have matured significantly in the past decade or so.  A key element in liquid strategies is trading and relative value analysis.  A good liquid strategy analyst is constantly understanding the return on their investments versus other opportunities, how they will react to market news, what’s the outlook for the coming year and so on.  Staying close to their credit - they’ll be making constant recommendations to their portfolio managers on buy and sell recommendations – looking for market opportunities.

In the truly distressed space - the buying in price is clearly key so understanding the market dynamics is important – although ultimately markets play a smaller part of role.

In direct lending there is very limited opportunity for trading the debt once the investment has been made – with investors typically long term take and hold.

Is origination your thing?

Developing market relationships is important across all of the strategies.  However – origination is particularly important part of a role in the direct lending space.  In time – to build a successful career and create value to a direct lending fund you’ll need to build a network of contacts with private equity and debt advisors who want to deal with you. 

In distressed debt – an ability to build relationships with management teams and other investors is important to getting a deal done and people wanting to work with you can be a deciding factor in this.

Where are the market opportunities?

Think about current market conditions and where you’ll get most opportunities to develop. Think about where there are opportunities and where there is over-supply of capital.

Look at which funds are raising money and in what form.  What has been raised in recent years.   Look at secondary market pricing – is there a growing distressed opportunity or is everything close to par?  What are the banks doing and what does that mean for the private credit space?  What is happening with CLO liabilities?  All of these things and more shape the market opportunity.  Try to get a real understanding before you make your decision.

Summary

Each of their strategies have their advantages and disadvantages and we do see people move between them.  However – the first move from banking is important so make it count.

I’ll leave you with a few comments from candidates:

“I think distressed is probably my ultimate goal but I wanted a performing loan opportunity to learn how to be a good credit analyst”

 “Private credit offered the right balance of breadth of deals and depth of analysis for me”

“Lifestyle was a big factor for me so understanding the culture of the organisation was as important as the strategy”