Dynamics of the private debt market: Assessing risks, opportunities and ESG developments
Global Investment Insights
with J.T. Munch, Principal, Capital Solutions, Neuberger Berman
J.T. Munch is a Principal of the Capital Solutions team at Neuberger Berman, which specialises in making junior capital investments.
In this exclusive interview with Global Investment Institute (GII), J.T. shares his investment experiences and where he sees greatest investment opportunities currently, the key pitfalls investors face and how to manage associated risks, along with the key developments occurring in the asset class with respect to ESG, in pursuit of net zero targets.
Q. What are the main areas of focus for you currently in your role as Principal at Neuberger Berman?
Most frequently, our investments come in the form of preferred equity, convertible equity, and/or minority equity, and they are designed to help companies and their majority shareholders achieve their objectives. We typically structure our investments to have some sort of downside protection.
In my role, I am responsible for sourcing and executing new investments, as well as monitoring our existing portfolio. I have spent most of the past decade investing in healthcare companies, and that continues today. In addition, I spend time covering specific verticals within the Business Services and Industrial Services end markets.
On the sourcing side, I spend a lot of time working with my colleagues to develop investment theses and then identifying companies that we believe have attractive investment characteristics. Significant time is spent conducting industry research as well as interacting with investment bankers and business executives.
On the investment execution side, my time is spent trying to answer key diligence questions to help assess the growth characteristics and competitive positioning of a given company, as well as negotiating the specific terms of our investment to help drive compelling returns for our investors.
Q. What are the main drivers of the growing investor appetite for private market opportunities and how is this impacting private debt markets, more specifically?
Particularly in the United States, there has been a steady increase in the number of private companies (and a corresponding decrease in the number of public companies). This shift has expanded the pool of potential private investment opportunities, and that is likely part of the reason for growing investor appetite.
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In the United States, there has been a steady increase in the number of private companies. This shift has expanded the pool of potential private investment opportunities.
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In addition, companies that operate in a private setting can (in theory) operate with a longer-term perspective instead of managing to quarterly earnings targets. This longer-term approach should (again, in theory) result in better managerial decision making that could lead to higher growth rates, increased profitability, and higher investment returns.
As interest in private markets has grown, it has not stopped at just private equity. For every private equity buyout, there is almost always a debt financing to support the transaction. Increasingly, private equity firms have found it highly efficient to work with private lenders to support their transactions, which has created significant opportunities.
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For every private equity buyout, there is almost always a debt financing to support the transaction.
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In our business (Capital Solutions), we are typically subordinate to senior private debt and can help facilitate a broader transaction. We benefit from many of the same themes described above, and in today’s volatile macroeconomic climate have found that our creative, flexible capital is more in-demand than ever.
Q. Where are you seeing greatest opportunities in private debt and how do you expect the opportunity set to evolve over the coming 12-24 months?
After a prolonged stretch of increased allocations into traditional private equity and private debt strategies, we are seeing considerable demand for flexible, hybrid capital.
It is increasingly common for companies to need capital providers to offer a solution beyond a traditional first-lien loan or common equity investment, and in those situations we believe there is an opportunity to be helpful and also generate attractive returns.
For example, for us it is rare for a week to go by without receiving a call from an executive in need of capital to complete a strategic acquisition. In industries with higher valuation multiples (e.g., healthcare, software, technology), a new acquisition typically requires more capital than a traditional lender is willing to provide. In situations like these, we are able to create bespoke securities that enable the strategic acquisition to occur, while generating compelling returns for our investors.
We believe situations like these present tremendous opportunity, and we expect to see more and more of them over the coming years.
Q. What are some common pitfalls investors face when participating in private debt markets and what do they need to focus on when evaluating deals to manage risks?
Private investing (whether it is senior debt, junior capital, or equity) is competitive, and it is easy to be tempted to pursue an investment in a lower quality company and/or industry to generate a slightly better potential return. In a bull market, this may even be a successful strategy. But, it is our strong belief that market timing is challenging (if not impossible) and that a relentless focus on quality is essential.
We have a very strong bias toward large, leading businesses that participate in predictable, growing industries. In periods of economic distress (like the one we suddenly find ourselves in), it is much easier to sleep well at night knowing that you have invested in quality, stable businesses that can weather the storm.
In our minds, one of the best ways to mitigate risk is to invest capital with well-positioned, durable companies.
Q. What developments are occurring with respect to ESG in private debt markets and what practical solutions can investors implement into their portfolios to achieve their net zero targets?
ESG is a topic of increasing focus for many of our clients. We at Neuberger Berman have a dedicated team focused on ESG investing in private markets.
In addition to a comprehensive review of business and industry fundamentals, we also consider material ESG factors as part of our investment analysis, simply because we believe it is good underwriting to better manage risk from a credit standpoint.
More generally, we have seen and supported an industry-wide push to improve ESG and climate-related data collection from private companies, especially those owned by private equity sponsors.
We believe that aligning with industry standards for ESG data and reporting, private lenders can encourage greater consistency and streamlining of information to help inform clients’ net zero objectives.
J.T. Munch, Principal, Capital Solutions, Neuberger Berman
J.T. Munch is a Principal of Neuberger Berman and a member of the Private Equity Credit Opportunities investment team.
Prior to re-joining Neuberger Berman in 2021, J.T. was an Associate Director at OMERS Private Equity, a $12 billion private equity fund where he was responsible for thesis development, sourcing, diligence, and execution of private equity investments across multiple industries. He also served as a board observer to several portfolio companies. Prior to OMERS, J.T. worked at Neuberger Berman, focused on diligence and execution of private equity co-investments. J.T. was previously with Beecken Petty O’Keefe & Company, a $500 million healthcare focused private equity fund based in Chicago. He began his career as an investment banker at Centerview Partners in New York.
J.T. earned a M.B.A. from Columbia Business School and a B.S.B.A. in Finance from The Ohio State University.
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