HYH Interview - Private Credit Allocator

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Welcome back!

We’ve got an exciting new interview today. Instead of hearing from an Investor - we need to hear from the people that keep the lights on - our LPs and the people who allocate us capital.

Today we’re lucky enough to have a very candid perspective provided by one of those folks.

A quick reminder though, my job board, Buyside Hub, runs various buyside recruiting searches at given time - in addition to having hundreds of jobs automatically flow onto our job board as well. I wanted to highlight two Private Credit Origination roles in DC and LA. Student & IB Analyst Access: If you are 1) an IB Analyst or 2) a student heavily involved on campus and want extended full access of our Comp Analytics, then please reply ASAP while the offer stands.

Let’s get into it.

Our Interview with an Anonymous Allocator

The Interview questions are being asked by me, while the answers are supplied by our anonymous allocator!

Can you give us a general anonymous sense of your background? I have spent my career in credit, starting as a credit analyst and putting my two years of hard work in before moving over to a distressed debt fund with about $2bn in assets. I worked at this fund before private credit was “cool” and it was also a benign credit market, but we still won our fair share of deals, and I got to work with amazing partners and colleagues. After several years on the direct credit side, I moved over to my current allocator role. I also serve as a board of director for a very large corporation’s asset management entity and manage several CRE investments and passive interest small business investments.

What is the career path needed to become an allocator? My career path is like many of my peers where I was on the direct side for years for my respective asset class and moved over to being an allocator. Most all my colleagues also have either an MBA, CFA or both. It is a hard seat to break into as there are only so many seats to go around. I never intended to be an institutional allocator as I always enjoyed being on the deal/GP side of the relationship but this opportunity came up and it allowed for a different work / life balance (and also no trading restrictions / blackout periods in my PA which is important to me). But what I am also seeing a lot of is now the allocator going to the GP and becoming a hybrid capital raiser, partnership formation, product specialist. I can understand why this is appealing to many as the allocator can use their network to get into the doors of their old peers and allocator network.

I would imagine there’s geographical pros/cons without being an allocator outside of NYC right? Basically you get a pretty high paying job in a lower cost of living area but wouldn't be sure what to do in ___ city if things change? The advantages of where I live and the potential remote availability of work allows my team and I to work from wherever we want. We are paid decently as an allocator and myself along with most of my colleagues have made some change and are very well off from being on the direct investing side prior to their role. There is only so much golf you can play, but the ability to travel is one of life’s greatest joys (in my opinion). But having to travel to NYC and London for manager meetings and conferences does get very tiresome and why an allocator might wish they were on the east coast. It is also very invigorating to go to these cities and AGMs, which frankly is lost in my current location.

What does your typical hours, work life balance, and day-to-day look like? Typical workday starts around 7am checking email and logged in by 8:30am/9am. At a certain level you certainly control your calendar. Typically work til around 3:30pm/4:00pm before things get quiet. I once had a colleague tell me they don’t even keep their work email on their personal phone and basically shut it down when their day is done. I am always available, but I do know peers who will not even respond to emails past a certain time. The work life balance is incredible. There are frankly very little careers in finance that offer this work life balance.

Can you give us a sense of career path pros and cons? The tools and people access that an institutional allocator gets are what makes the career path a fine choice. Our institution pays for hundreds of thousands of dollars of expensive research reports and subscriptions that we have full access to. Additionally, we obviously have Bloomberg terminals, broker access (like GS Marquee, Barclays Live). The stress levels and anxiety, I have found, are significantly less than how I felt working on the direct side. The cons of the role is that your all in compensation will be significantly less than if working at a GP. It is also a much slower lifestyle. We are constantly getting bombarded by fundraisers for meetings.

How you view allocation across large managers/middle-market/LMM/first time funds and how do you see things trending? Internally, we are really allowed to invest in anytime manager or fund that we believe will also pass a consultants operational and financial due diligence report. But what this really means is that we tend to stick to managers who at least have one other institutional investor relationship before we go ahead and start the underwriting process. The fact of the matter is that our job is made easier by large managers and established managers in the MM and LMM with track records that span multiple funds and overhead that can oversee the commitment of large check sizes from an institutional investor our size. The joke that I see on Twitter that “you never will get fired for investing in an Apollo / KKR” fund does hold a lot of truth to it. These are managers and funds that will not get you fired and allow the portfolio manager to allocate to in size. The best way that I can allocate to a first-time fund or a new manager is through a fund of funds type vehicle. What I mean by this is that say that a bank like JPM or GS offers a fund where we commit to them and then they due diligence and manage smaller fund investments, so it acts as a fund of funds type investment.

Which private credit firms are "winning" in the space right now? Which type of PC firms are "losing?" What do the top quartile managers do that others don’t? For brand name managers, Ares continues to be a winner in my opinion. They have built out a great platform and really are a machine, with many different offerings and verticals. Their teams seem to have little turnover vs other managers, and they also are a leader in the Euro private credit market as well. For less household names, there are so many groups or small firms that are finding alpha or have strong tailwinds for their specific niche. Hayfin in London has a niche income strategy backed by real assets that we have heard has generated fantastic returns since the fund start date and might be a firm that not everyone is aware of who isn’t one of the names mentioned on Bloomberg every day.

The PC firms that are losing are the ones who were price takers and did not have restructuring teams or workout teams already within the firm. Believe it or not, some of these firms with billions of AUM do not have a dedicated restructuring team that has went through workouts of all types. One manager we are invested in was caught in this scenario and had to go out and hire an entire team to gear up for the idiosyncratic risk now within a well-diversified fund with 2% position sizes.  Distressed debt PC firms are also losing right now and need to expand verticals and business investment lines because distressed debt is receiving very little to no allocations from institutions right now.

And this pains me to say, but PC firms that are not raising money from the retail / RIA wealth channels are losing right now. And by losing, I mean with regards to their own enterprise value, vs being a good and astute investor. There is so much capital being raised in the retail space from your asset gatherer firms that is creating a ton of enterprise value for that firm.

Can you give me some color on the fundraising environment? Fundraising is tough right now for all private credit managers, and even more so if you are not a Blackstone, KKR, Ares type firm. In fact, there was just an FT article that said private credit allocations have scaled back to an estimated 18% from last year. At my own firm, we are reducing our allocations to credit and shifting the allocation to public equity. I have friends who are in capital formation for firms in the $1bn-$10bn size range and one has told me he does not believe they will hit their fundraising target for the year. And this is a firm that has generated what I would consider strong returns for over 5 years in direct lending. There are so many direct lending competitors, and now asset-based finance competitors, that when institutions scale back allocations, fundraising targets are not going to be met. So, this leads me back to my last point about the retail / RIA wealth fundraising channel. We have seen that firms are raising records amount of cash from accredited investors so this can help fill the gap where the institutions are shying away from.

How do you view credit managers having different marks on the same loan? Or in general how do you view the way managers mark holdings? Too conservative or too little too late on declining stories? It is alarming when credit managers have different marks on the same loan. It happens occasionally, so it is important for the reader to note that it doesn’t happen all the time. LPs now get transparency reports, and we can track a lot of different loan level data and marks via some systems that we pay for. You would think that private credit managers would be on the same page where they are marking a loan they are all syndicated within, but like I said, there are occasionally different marks.

Every manager has a valuation policy and uses third parties like Houlihan Lokey who will evaluate a loan portfolio, sometimes quarterly, and give third party marks. I believe that managers do a decent job of marking a loan appropriately, as it is in their favor to not mislead an LP who they want to establish a decades + long relationship with. Where I believe private credit managers fail is when a loan goes to the watch list or starts to see trouble, they wait a quarter or two too long before starting to mark the position down. In our view, we would prefer the manager to start marking the loan and get it down to a conservative recovery value as quickly as possible.

And what really grinds our gears is that after a private credit manager has stepped into the equity of a position via a workout, they think they can do a better job than the original sponsor to turn the credit around. We would prefer for when debt turns to equity to sell the company as soon as possible. Most of the time these situations are just a drag on performance since no interest is being paid, and the companies are zombies.

Alright time for the big question. Is Private credit "a bubble"?  When people use the term bubble, I believe that word is used as a substitute for catastrophic events when referring to financial situations. I do not believe that the private credit market is in a place where there could be systematic blow-ups that take down a large part of the private credit universe. I do believe that there is idiosyncratic risk in portfolios that will cause bad returns for investors. Something that is true is that way too much money was raised for private credit strategies and there are not enough deals to invest in. The term “golden age of private credit” was said often over the last 24 months. We are clearly behind this period as spreads have tightened to their tightest in a decade and it’s really the base rate (SOFR) that is allowing for a double-digit yield to still be achieved. But overall, I do not see systematic risks and a bubble popping that causes the downfall of many funds and institutions.

Do you worry about PIK or Covenants loosening? What are the biggest worries in the space? Yes, this is certainly a huge cause for concern. We have started asking our managers on every transparency report and quarterly update to identify the number of credits on cash pay vs PIK, and to notify if any amendments were made that changed cash pay to a PIK interest. Covenants are loosening as well. Due to the amount of private BDC fundraising that is happening and the inflows from retail capital, we are hearing stories where a bank will call 5 private credit managers on a Monday and the deal being committed too by the end of the week. Little to no underwriting or due diligence is being done and the covenants are not actually covenants that are meaningful. Between PIK and covenants, the bigger worry is the standard of covenants going away and private credit just turning into the BSL market but with private credit firms. Investors are much more observant of the loan being PIK or not vs the number of covenants (if any) within a lending transaction. We continue to hear about LME’s and lender on lender violence which is the result of bad loan documentation.

Anything we missed that's worth talking about? I am already starting to hear of headcount reductions at private credit funds due to deal pipeline activity and fundraising goals not being met. Readers who are looking to break into private credit should confirm fundraising targets are being hit, consultants have signed off on the GP’s strategy, and that the new deal pipeline is robust. Another item to monitor is with the rise of asset-based finance funds, that the counterparty and servicer risk is being monitored and managed. Many of the platforms receiving financing from funds that have raised an ABF fund need to be regularly monitored as there is considerable counterparty risk with these companies that are relying on the financing from a credit fund to keep the lights on, which can cause alignments to not be aligned. Speaking of platforms, asset managers continue to fund people and new platforms where they can have total control over the origination of assets, and this helps them grow their asset base. This can be a differentiator and one that grabs an allocator’s attention if a firm has multiple proprietary origination platforms in which the private credit manager has control over.

That’s all for this edition! Until next time!

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