How have attitudes to credit changed over time? Pension funds in general have broadened and deepened their exposure to credit since the end of the financial crisis in 2009-10. A broadly benign credit cycle since then has encouraged investors to expand their exposure as they ‘go back for more’.

Current economic conditions, which PIMCO recently described in a research note as being “as good as it gets”, mean many investors and managers have not yet experienced a downturn. Are investors right to be concerned about dislocations in the market and stretched valuations? And to what extent will a downturn change investor behaviour?

Increasing focus on valuations means investors want to know more about how managers of private lending strategies will deal with distress situations, according to Deborah Zurkow, head of alternatives at Allianz Global Investors, even if they are not expecting an immediate downturn.

Zurkow was speaking at an event in London to mark the launch of a new report on private credit by the Alternative Credit Council and the Alternatives Investment Managers Association. It predicts that the global private credit market overall is set to exceed $1trn (€850bn) by 2020. It also notes that this is a borrowers’ market, in which managers must show flexibility as borrowers exercise greater influence over covenants and coupons.

As lending terms have softened and coupons become more competitive, managers have had to increase focus on lending standards and risk analysis, as the report finds. According to the research, managers are also more increasingly targeting smaller borrowers, including those with EBITDA of less than $25m. This group accounts for 435 of the total market share in private credit, according to managers participating in the survey.

Targeting this group of borrowers also means smaller target loan sizes as a proportion of the total, with a third of loans less than $25m. It also means greater education on the part of borrowers, as well as managers and pension funds, who also need to understand the changing dynamics of the markets to which they are supplying capital.

Dry powder, increasingly a concern in private markets, has become less of an issue in private credit. Levels are at their lowest for several years, according to the research.

As projects like the EU’s Capital Markets Union come into play, and there is greater familiarity among all economic actors of the benefits of private capital, activity is also likely to spread beyond the US and the UK. Continental Europe should be a key beneficiary of the expansion of private lending activity.

While current conditions may or may not be “as good as it gets”, in PIMCO’s words, an economic downturn will come. Investors who come out of the cycle well will be those who take a long-term approach; managers who come out of it well will be those attuned to the needs of investors, including in the areas of client communication and service, as well as those with the core capabilities.

Pension funds and other institutional investors now have a firm foothold in the credit markets, and their influence as end investors is set to grow. Their underlying need for competitive yield will remain, even as central banks taper QE and rates normalise. With a plethora of asset types and classes, a range of approaches and little comparability across markets, credit continues to offer a wealth of opportunities suited to the needs of long-term investors and for managers to adapt products to investors, particularly pension funds.

Liam Kennedy, Editor, IPE