It is difficult to speak of opportunity during a pandemic that is causing such significant human tragedy globally. But private debt has a critical role to play in financing the recovery from the global slowdown caused by Covid-19. For lenders, this is an opportunity to demonstrate to our various stakeholders – including investors, regulators, asset owners and governments – that we can support sustainable and inclusive growth.

Make no mistake: this will be a significant challenge. The speed and scale of the crisis caught investors off-guard, as asset classes were hit by an unprecedented combination of a global supply-and-demand shock and extreme pressure on cash positions. Private debt was no different. Portfolios were stressed in unforeseen ways: who would have thought that previously uncorrelated toll roads across the globe would simultaneously see a reduction in traffic?

Still, the industry has already shown it can put large pools of capital to work in real economies globally – across wide-ranging asset classes, from core infrastructure debt to small and medium-sized enterprise (SME) and venture debt.

After the financial crisis of 2008-2009, lenders responded with flexibility and speed when regulatory changes forced banks to deleverage their balance sheets. Private-debt funds emerged as alternative loan providers to fill the void, while enabling end investors to support economies in domestic markets and internationally.

So in a sense, the Covid-19 pandemic is a familiar test for the industry. Throughout the pandemic, we have demonstrated a spirit of partnership in working with borrowers as they seek to manage the business impact of a unique crisis where outcomes may still be uncertain. This spirit should reassure those observers and stakeholders who have long feared the “predatory potential” of private lenders and their ability to manage through a crisis.

Expanding the horizons of private credit

One reason we believe that private lenders will play a major role in the recovery is their financial firepower. They are sitting on a record USD 1.5 trillion in cash, according to January 2020 data from Preqin – a figure that is the highest on record and more than double what it was five years ago.

SMEs are set to be a beneficiary of this funding. Globally, these enterprises represent around 90% of businesses and employ more than 1 in 2 people. Yet they increasingly struggle to access traditional lending – a situation that may be exacerbated as those lenders become even more risk-averse in the current environment.

The challenge is particularly acute for SMEs in developing nations that have been hit disproportionately by the pandemic. According to the International Finance Corporation, the unmet financing needs of SMEs in emerging economies stands at USD 5.2 trillion a year. 

Given the current environment and challenges, the private-lending industry has an opportunity to position itself as a strong partner for post-crisis long-term growth. Stepping up will require vision, purpose and innovation – not to mention some “outside-of-the-box” thinking.

It will also mean reflecting the importance of issues such as climate change, social inclusion and “just transition” in a post-pandemic world.

While the focus on governance and environmental issues continues, we have learned through this crisis that social inclusion is not solely the preserve of specialised impact funds. For example, investment in improved digital infrastructure can help “level up” some of the disparities revealed by the lockdown period – such as the inequalities that exist between “town” and “country” or between private and state-funded education – while creating a much-needed economic boost. 

At Allianz Global Investors, we believe strongly that these issues can’t take a back seat as the world focuses on recovery. Rather, they need to be an intrinsic part of that recovery. The horizons of private debt can expand significantly as capital markets recognise that it’s possible to generate financial alpha while helping to address key societal challenges. This will spur the inclusion of environmental, social and governance (ESG) factors into lending criteria – a trend that is being accelerated by the UN Sustainable Development Goals, the EU focus on a green recovery and increasing appetite from millennial investors.

Partnering for long-term growth

The scale of funding needs goes beyond the capacity of any one sector – whether it is the banks or the public or private sectors. The solutions will require partnerships that divide up the risk-return rewards and societal benefits according to the needs of the respective stakeholders.

With governments making more finance available to SMEs and infrastructure projects, it’s important that private-sector capital isn’t “crowded out”. Our experience in structuring blended finance deals – where development capital spurs private-sector investment – shows it is possible to work with public-sector entities to provide investable opportunities for institutional investors. In effect, taking these steps helps ensure that private capital is “crowded in”. 

At Allianz Global Investors, our expansion into new markets is being driven by our commitment to innovation and by investors’ appetite for new sources of alpha – particularly in the context of sustainable finance. Growth areas include our Asia private-credit business, infrastructure financing – where blended finance has potential – and trade finance.

In summary, private lenders are demonstrating the critical role they play in the post-pandemic recovery as partners and drivers on the journey to a sustainable future. Forward-looking and inclusive relationships across the entire universe of market participants – and a deep understanding of the interdependencies across an economy – will be key to unlocking the full potential of private debt.

A version of this article first appeared in privatedebtinvestor.com on 22 July 2020

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