KKR & Co is looking past the angst in public and private credit markets for chances to snap up high-yielding debt and strike favourable deals in the coming year.
As the private investment giant sees it, “fear in the market” about a wave of defaults and a breakdown in the private lending sector is overblown. Even as weakness mounts in some corners of the market, lenders are likely to benefit from still-scarce capital conditions to make deals with high-quality borrowers, according to KKR’s co-head of credit and markets Chris Sheldon and Rory O’Farrell, director of the client and partner group.
They say there’s also opportunity in asset-based financing and in junk bonds, which have become far less risky over the past decade.
“We think that investors who are waiting for their Global Financial Crisis moment of rock-bottom valuations may be disappointed,” Sheldon and O’Farrell wrote in a Thursday letter to investors. “Looking ahead to 2024 and beyond, we think the opportunity for attractive vintages is exciting.”
Concern has been rising that the Federal Reserve’s tightest monetary policy in a generation is causing corporate fundamentals to deteriorate. For some on Wall Street, the question is whether higher-for-longer interest rates will ultimately lead to widespread defaults — across credit markets — and undermine the case for private asset classes.
To KKR, an uptick in defaults is likely in both liquid and private credits. But an improvement in the overall quality of the junk bond market will help prevent a deluge of defaults, while private lenders who focused on quality borrowers will be fine.
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That makes for opportunity in portions of the credit market that other investors may overlook, Sheldon and O’Farrell wrote. KKR is starting to build exposure to duration by buying high-yield bonds, while keeping an overweight to floating-rate debt, such as leveraged loans and collateralized loan obligations.
The firm is also seeing more demand for private junior debt as an alternative source of funding as public credit investors remain selective on quality. And while debt-fueled private equity transactions could still face challenges in 2024, there are other forms of buyouts that could be more successful, particularly if they require less leverage, according to KKR.
KKR also sees the chance to lend privately against assets like mortgages and aircraft leases. The asset-based finance asset class could grow from US$5.2 trillion to US$7.7 trillion by 2027, according to the firm’s estimates, a result of the pullback by banks in funding collateralized loans after bank failures earlier this year.
“One thing the Global Financial Crisis taught us is that when investors are paralyzed by fear, they often overlook opportunity,” Sheldon and O’Farrell wrote. “And the opportunity cost of this oversight can be very painful, indeed.”
