In the face of declining interest rates, loans could remain as a source of strong, steady income as historically the loan market has managed to retain investor capital when rates decline.
We believe we are able to target attractive return potential relative to prior vintages, with materially less risk in the distressed credit market.
All-in yields in direct lending could remain well above historic levels and offer a compelling risk and return value proposition.
Over the last decade private credit markets have been one of the fastest growing segments in the asset management industry. As 2024 draws to a close, our experts have provided some market commentary on the next era of private credit. We are looking at some of the biggest opportunities, risks and key themes in the private credit space for 2025.
Kevin Eagan, Senior Portfolio Manager, Co-Head of Credit
In the year ahead, we expect another year of above average loan returns given a benign risk environment benefitting from lower inflation and interest rates. With the Federal Reserve pivoting to lower rates, it is worth revisiting the history of loan market flows during easing cycles.
The loan market tends to retain investor capital reasonably well as rates decline (outside of the exogenous shock levied by COVID), reflecting that loans offer more than simply a way to play rising rates. Lower rates tend to buttress loan issuer fundamentals as interest expense declines, mitigating risk of default and credit loss.
Moreover, assuming policy rates decline to the current fed funds futures-implied terminal rate of approximately 3.5%, the implied coupon would remain above the historical loan coupon average.
Thus, loans can remain a source of strong, steady income even in the face of declining interest rates.
Paul Triggiani, Head of Distressed Credit & Special Situations
As was the case in 2024, we believe 2025 is setting up favourably for our target small capitalisation distressed credit and special situations opportunity set. Importantly, we believe our pipeline is distinctly different and unique relative to the last quarter century. Almost half of our target market is burdened with greater cash interest expense than free cash flow generated by their operations. This imbalance is the product of leveraged buyouts capitalised in a zero-base rate environment which have been subsequently impacted by the COVID-19 pandemic, significant and global inflationary trends, and finally a significantly higher rate environment. Interestingly, many of these businesses are strategically and operationally sound, managed by excellent teams, with backing from highly respected sponsors.
Moreover, we are working with these companies both seeking to provide incremental liquidity on attractive terms in structurally advantaged, senior secured positions, as well as replace high cost, cash-pay debt, with creative capital solutions transactions that include payment-in-kind coupons, call protection with minimum return multiples, equity warrants, covenants, and governance protections. Companies are then able use this liquidity to accelerate growth, thereby allowing the private equity owners to monetise their investments.
Within these capital solutions opportunities, we believe we are able to target attractive return potential relative to prior vintages, with materially less risk.
Ron Kantowitz, Head of Private Debt
We remain constructive on the backdrop for direct lending in 2025 given meaningful macroeconomic and anticipated deployment tailwinds. Following its historic interest rate hiking cycle, the Fed pivoted to a more accommodative monetary policy in the third quarter of 2024. Market participants are not only expecting inflation to continue to moderate, but also for the economy to achieve a “soft landing”. This outcome bodes well for corporate borrowers who will benefit from lower interest expense burdens coupled with improved financial performance.
We also see a favorable setup for improved M&A volumes in 2025. Private equity firms are facing mounting pressure from their limited partners to generate liquidity as depressed M&A activity over the past 24 months has led to a dearth of transactions. Moderating financing costs and better visibility into economic conditions should support an uptick in volumes, which will in turn drive direct lending financing opportunities and deployment.
Lastly, we expect all-in yields in direct lending to remain well above historic levels and offer a compelling risk and return value proposition. Core middle market direct lending continues to prioritise asset selection, strong documentation and moderate leverage.
We offer an extensive range of alternative investments. Our scale, combined with the breadth and depth of our offering, means we have the flexibility to meet your needs as markets evolve.
With high and persistent inflation, rising interest rates, widening credit spreads, and significant equity market volatility, investors are facing a barrage of macroeconomic challenges. Given these headwinds, we believe that alternatives remain attractive for their diversification benefits.
In our assessment of the alts investment universe, our Solutions team offer some insight to areas of opportunity within private markets in 2023, while investment teams share asset class specific views.
In the second half of 2022 volatility in financial markets has persisted amid global inflationary pressures. While our European base case is for a short period of mild recession in key European real estate markets, we believe that real estate returns will continue to exhibit increasing asset-specific divergence with markets and sectors. This could present opportunities for investors with local market knowledge.
Persistent structural tailwinds are also likely to continue to shape long-term demand, with urbanisation being a core driver of growth in key European cities. Market disruption, particularly around financing events, is already starting to drive attractive investment opportunities across our European markets.
As we head into 2023, we continue to invest in our conviction opportunities, which we believe are insulated against inflationary pressures and offer protection against future interest rate increases. We maintain our approach to conviction-aligned environmental, social and governance (ESG) improvement opportunities. In particular where we can supply well-located Grade A assets into structural demand, or where the current market dislocation offers opportunities to acquire at a discount to the long-term value.
As we head into 2024, the market consensus is generally that interest rates have peaked – which is exciting news for bond investors. We explore the implications across a broad range of fixed income asset classes.
Investing through market corrections has historically driven outperformance for real estate investors. We believe this will continue into 2024.
It’ll be a challenging backdrop for equities in 2024. From an investment perspective, company fundamentals are likely to become more important. Read our investment outlook for more.
i Revenue per available room
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
This marketing communication is exclusively for use by professional investors in Portugal. It is not intended for and should not be distributed to the public. Investors should read the legal documents prior to investing. Data as at 05 December 2022, unless otherwise stated. By accepting this material, you consent to communicate with us in English, unless you inform us otherwise. This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. Views and opinions are based on current market conditions and are subject to change.
Invesco Management S.A., President Building, 37A Avenue JF Kennedy, L-1855 Luxembourg, regulated by the Commission de Surveillance du Secteur Financier, Luxembourg.
