The recent market volatility has created both challenges and new prospects, says Ian Jackson, Head of Strategic Opportunities at Permira Credit
What opportunities has the recent volatility in the markets created for opportunistic credit investors?
I think it’s important to start by taking a look back at what the market saw coming and what it didn’t, because that all feeds into the volatility we’re seeing today and the resulting opportunity set for investors.
Looking back, it’s clear that markets didn’t take the tariff noise too seriously prior to President Donald Trump’s announcements on 2 April. We had started to anticipate that something might be coming down the line – probably as early as January of this year – following discussions we’d been having with investors about their levels of exposure to certain geographies and sectors off the back of announcements that were coming out of the White House at the time regarding Canada, Asia and so on. It became clear on 2 April, however, that the wider market should have taken that early messaging more seriously. Even those who anticipated the tariffs were surprised by the levels at which they were imposed.
It is also worth highlighting how credit spreads reacted. Standard & Poor’s European Leveraged Loan Index had started to widen prior to Liberation Day, but dropped the following week, though it has since nearly recovered to its pre-April levels. Not all credits were treated equally though; there was some dispersion where we saw telecoms and financials perform much better than consumer, materials and automotives, in line with our expectations.
Regardless of whether or not it was anticipated, these developments have generated a huge amount of uncertainty for investors. For us, uncertainty can often mean opportunity as well as increased risk. We decided to put some of the deals we were looking at on hold as a result, at least until we saw more clarity. We are still waiting for that much-anticipated clarity to appear, but we are confident that the opportunity will come.
What is happening behind the scenes?
Many in the market felt we had a reprieve from the tariffs when the pause was announced. In reality, though, President Trump simply reverted to the tariffs that were broadly in place beforehand. The 10 percent universal tariff still exists, and the markets have learned to see this as a positive relative to what could have happened. There appear to be positive signs coming out of the talks between the US and China, but nothing has yet been agreed, and it would be foolish to expect no tariffs going forward.
Today, management teams will be examining their supply chains at a granular level, considering factors such as the source of imports, applicable tariff rates, and the costs associated with adjustments, instead of focusing on growth. They will be trying to determine whether they are able to seek cheaper alternatives or shift production domestically, weighing considerations of capital expenditure against what they are hearing in the news.
On the primary side, we are a lot more cautious when evaluating companies that have exposure to manufacturing in countries like China, Thailand, Cambodia, and Vietnam. Prior to Liberation Day, we were close to signing a deal with a business that manufactures in China and exports a relatively high proportion of goods to the US.
At the time, we felt positive because they also had manufacturing capacity in three other Asian countries. However, following the US announcement on tariffs being extended to other Asian countries, we decided not to progress with that transaction – at least for now.
What additional underwriting considerations are now required?
We didn’t previously spend a lot of time looking at a borrower’s supply chain, except to note whether they were overexposed to a particular jurisdiction or subject to sanctions. One of the key factors of the latest tariffs is that they have forced some lenders to confront how ‘stuck’ some companies’ supply chains are—something which is very unlikely to change in the short to medium term. While companies may think they can relocate manufacturing from, for example, China to Vietnam, this may not actually be possible. China benefits from its own internal network of supply chains, giving it an advantage over other nations. This is the reason why China’s manufacturing output was so high in the first place.
Investors are often spooked by not being able to fully assess and articulate the unknown, which makes it challenging to price opportunities. Nowadays, company supply chains are so vast and complicated that it can be very difficult to accurately gauge risk, and until recently, I don’t think anyone was looking closely at this issue. But we have been focused on this for a while now, and our ability to tap into years of deep sector expertise and supply chain analysis from across the Permira network helps us to price credit prudently in these uncertain times.
How have you seen opportunistic credit investors reacting to these markets?
We can assume there will likely be tariffs in some form going forward. The margins of many businesses are likely to be impacted as a result, as well as the buying habits of the consumer for certain products.
There are also second or third order effects that investors like us should keep front-of-mind. For instance, assuming the tariffs between the US and China stay in place, China could look to distribute products into the EU, which then raises questions about how European manufacturing companies will react. Would the EU introduce its own tariffs in response? And if it didn’t, how would European industries cope with competition from often cheaper and abundant Chinese products? There are numerous knock-on effects to consider.
Identifying opportunities and reacting with speed in the current market environment is challenging as we simply don’t know what will happen next. However, as a firm, we have invested through a number of economic cycles and periods of turbulence over the last 18 years and have learned to adjust and flex our investment focus and horizons accordingly. For example, my team is currently looking more at services-type businesses, with little in the way of cross-border trade.
If they do have any of the latter, we try to build a better understanding of the supply chain footprint, and we are generally focusing more time on understanding that exposure because of tariffs. We are also carefully considering how certain sectors might fare in a recession, given that the probability of that is now higher.
We think the key to success is to be flexible, to not rush into making decisions, and to use our experience and the broader intelligence across Permira to be ready to move quickly when we have high conviction.
What is required to make the most of such periods of volatility from an opportunistic credit perspective?
How you approach deal origination is critical in this environment, and we’re fortunate that our team is part of the global Permira platform, which invests across credit and private equity. That means there are several avenues through which we can access deal flow.
We bifurcate between what we call offensive and defensive deals and have the mandate to invest in both the primary and secondaries markets. Offensive transactions are those where we provide capital for businesses in a growth phase or with the opportunity for M&A, for example. Defensive transactions are more about funding a business’s day-to-day operations or helping to prepare the company for upcoming maturities. In the last several months, we have seen more offensive opportunities than defensive, but this could start to change over the summer as the potential fallout from market uncertainty becomes more apparent.
Finally, we think success for opportunistic credit investors will depend on which part of the market you play in. For instance, if you are a large corporate and currently find yourself needing to pay extra for the goods you are buying, you probably have access to credit lines you can easily draw upon. A smaller business, however, may not have that same level of access, which is where we can provide support. We think these businesses, predominantly those in the lower and mid-market, will require more of the solutions we can provide on both the primary and secondary side, and it’s also a space that remains less competitive than the large-cap arena.
What is your general outlook for the market, in terms of volatility and the opportunities this can present?
Despite the apparent pause in tariffs, we maintain that the damage has been done and that the priority now is to determine the severity of that damage. It’s going to take some time to better understand and extrapolate the effects of tariffs, so we expect the opportunity set to be much clearer towards the end of this year. For now, we are taking a patient approach but continue to deploy capital in a targeted way.
It’s also important to remember that a lot of the numbers published today, such as the economic statistics around employment and corporate earnings, are based on historic data. We need to focus instead on financial metrics that are forward-looking, as these numbers tell a very different story. Given what we know about the market right now, our view is that we should expect more volatility, which we believe will result in greater opportunities.
In terms of where those opportunities will come from, we think it’s likely that the secondaries market will pick up moving forward. Primary deals will continue to be a focus, given they allow lenders to have more control in terms of documentation and covenants—which is arguably even more important in this kind of market—but we expect to see more secondaries opportunities coming through as potential dislocation in the market plays out and generates some attractive pricing.
And finally, the lower mid-market is frequently underserved when there are periods of uncertainty like this, so we feel it’s a good place to be. The onus is now on understanding what that risk/reward balance will be in an environment that is constantly changing.
