BDCs: The Cyclical & Structural Outlook

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This is a podcast episode titled, BDCs: The Cyclical & Structural Outlook. The summary for this episode is: <p>Business development companies (BDCs) continue to garner increased investor attention driven by demand for income and access to the growing private credit asset class. Barings' Matthew Freund discusses the cyclical and structural trends shaping the market opportunity today.</p><p><br></p><p><strong>Episode Segments:</strong></p><p>(02:29) – Defining our terms: BDCs</p><p>(04:08) – The structural trends underpinning private credit’s growth</p><p>(06:10) – Understanding the types of BDCs: public, private &amp; perpetual</p><p>(08:20) – How fees play an important role in BDC investments</p><p>(12:06) – How “peak rates” may impact BDCs</p><p>(16:50) – Why the BDC IPO market is so active at the moment</p><p>(19:11) – What to make of all the new entrants in private credit</p><p>(24:40) – The implications of managers moving up market with larger deals</p><p>(26:34) – How documentation and structures look in today’s market</p><p>(29:14) – Is this the “golden age” for private credit?</p><p>(30:43) – Trends to watch in the months and years ahead</p><p><br></p><p><br></p><p>Certain statements about Barings LLC made by the participants herein may be deemed to be “testimonials” or “endorsements” as those terms are defined in rule 206(4)-1 under the Investment Advisers Act of 1940, as amended. Participants were not compensated in connection with their participation in this program, although in certain cases they are investors in Barings LLC sponsored vehicles. These investments subject such participants to potential conflicts of interest in making the statements herein.</p><p><br></p><p>IMPORTANT INFORMATION</p><p><br></p><p>Any forecasts in this podcast are based upon Barings’ opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Any examples set forth in this podcast are provided for illustrative purposes only and are not indicative of any future investment results or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this podcast. No representation is made that an investment will be profitable or will not incur losses. </p><p><br></p><p>Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Barings Real Estate Advisers Europe Finance LLP, BREAE AIFM LLP, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).</p><p><br></p><p>NO OFFER: The podcast is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This podcast is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy.</p><p><br></p><p>Unless otherwise mentioned, the views contained in this podcast are those of Barings and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. Parts of this podcast may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this podcast is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information</p><p><br></p><p>Any service, security, investment or product outlined in this podcast may not be suitable for a prospective investor or available in their jurisdiction.</p><p><br></p><p>Copyright in this podcast is owned by Barings. Information in this podcast may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.</p><p><br></p><p>24-3368985</p>

Greg Campion: Business development companies, commonly known as BDCs, have seen a massive amount of growth in their popularity in recent years, and that's really been driven by a few different factors. One, the attractive yields on offer. Two, the growing appeal of the private credit asset class, and three, BDCs becoming a more institutional asset class. But what does the future hold for BDCs when it comes to the cyclical and structural forces driving the asset class? Is this a golden age for private credit or is that way too optimistic?

Matthew Freund: Is it the golden age of private credit? I feel hard- pressed to necessarily agree with that. Maybe it's the Bronze Age, maybe it isn't. But I would have to say that as we think about an investor who has an intermediate to long- term time horizon who wants to enjoy the benefits of a strategy with high income distributions and a compliment to a fixed income portfolio, it's really hard to argue that it's not a good time to invest.

Greg Campion: That was Matthew Freund, a portfolio manager within Barings BDC platform, and this is Streaming Income, a podcast from Barings. I'm your host, Greg Campion. Coming up on today's show, BDCs, the Cyclical and Structural Outlook. Before we get into the conversation, if you're not already following us and you're interested in our latest views on asset classes ranging from high yield and real estate to private credit and more, just search Streaming Income on Apple Podcasts, Spotify, YouTube, or wherever you get your podcasts. With that, here is my conversation with Matthew Freund. Matt, welcome to the podcast.

Matthew Freund: Greg, thank you for hosting me. Happy to be here today.

Greg Campion: I'm excited to have you here. This is your first time on the podcast, so hopefully will not be too painful for you and maybe we can even set up a second discussion.

Matthew Freund: Yeah, we'll find out after the fact, if it was successful, I'll be invited back or not. Time will tell.

Greg Campion: Okay, sounds good. Sounds good. So we're talking today about BDCs and there's a lot to that discussion. There's so much going on in the space right now. It's a super interesting time to be following BDCs and private credit more broadly. But before we dive into all the cyclical and structural trends and everything that's going on, why don't we just start and can I ask you to define our terms upfront, especially for folks who maybe are less familiar with the asset class or maybe haven't looked at it in a while? Just broadly define for us what is a BDC and why don't we establish that and then we'll get going?

Matthew Freund: Yeah, it's a great question and it's certainly top of mind for a lot of investors who are looking at the asset class for a first time. And so to start off by defining what is a BDC? A BDC is a business development company that is effectively a pool of capital that has been raised from a series of investors. In some cases they may be individual investors, in some cases they may be institutional investors, but a group of investors who have committed to invest in a certain strategy and then they are of course investing with an asset manager who is going to turn around and use the capital that has been raised to make specific kinds of investments across specific kinds of asset classes. What we're seeing most commonly in the marketplace today is going to be investments in credit securities. And then the topic du jour of course is going to be private credit, and so it is illiquid non- traded credit securities. But if you look across the landscape of business development companies today, a lot of them are investing in private assets and private credit in particular.

Greg Campion: Okay, cool. Thank you for that. And we'll come back... I know there's different types of BDCs, so we'll come back to that in a minute because I know the market has been developing pretty rapidly in the most recent years, and so there's a lot of different options out there. And this won't be an exhaustive discussion of those, but I want to give our listeners a sense of what's out there, what are the different types of BDCs and who they're for.

Matthew Freund: Of course.

Greg Campion: But maybe before we kind of dive into that, let's talk about some of the big structural trends. So we know that this is an asset class that has seen a lot of growth, and when I say this asset class, I'm talking about two things really. I'm talking about private credit broadly, which we generally think about in this sense as middle market loans, private middle market loans I should say, but also BDCs in general, which are obviously the investment vehicle that you just described. There's different flavors of that, but it's been a massive growth area and there's some big structural trends that are driving that. So tell me about that. What have been some of those big tailwinds that let's say over the last decade or so have driven growth in this space?

Matthew Freund: Of course. And so I think if we look at the asset class that is private credit, illiquid, non- credit credit securities, I think that the rise and demand from an investor's perspective really grew out of the great financial crisis. And so on the backs of fixed income performance in 2008, 2009, 2010, what was really led by institutional investors at that time was a search for yield. So there was an opportunity to invest in illiquid non- traded credit that had a yield premium to the broadly syndicated market of somewhere between 200 and 400 basis points. And as we think about the evolution of the market over the course of the past 10 to 15 years, what's really started to happen is a migration of what was back in 2010, an institutionalized asset class into an asset class that's more accessible for the individual investor throughout the ecosystem. And so as you think about really what has driven the growth, it has really been access to what has historically been an institutional product and also a relative value argument in favor of private credit to get slightly more return for comparable units of risk just in a private market.

Greg Campion: Yeah, okay. So big demand for yield that we've seen in that. I think that improving access part is really interesting point. Specifically when you look at BDCs, and maybe that's a good segue into talking about different types of BDCs because obviously you know probably better than anyone, there are lots of different investor bases that are looking at this asset class, and there's lots of different ways into the asset class ways to gain access. So tell me about some of the different types of BDCs that are out there and maybe why they exist and what the kind of pros and cons are for investors.

Matthew Freund: Certainly. And to your prior point, just around the growth of the asset class, I think that it's very important that an investor consider the appropriateness of private credit for their portfolio, and if an investor believes that private credit could be complimentary to their existing portfolio, the next logical question is how do I access that private credit asset class? BDCs are a very common way to do that. The three most common structures for BDCs today are going to be a public, a perpetual and a private strategy. The public strategy, of course, you have publicly traded business development companies, they're listed on some of the major stock exchanges. You can go and buy and sell them today and tomorrow. Another flavor of business development company is going to be a perpetual structure that often provides some form of intermediate liquidity. You cannot buy it tomorrow, you cannot sell it tomorrow, but there are windows of redemption where if an investor chooses to purchase and chooses to sell, they can do so on an intermediate basis, and then you have what is referred to as a private BDC. Those are very similar to a conventional GPLP drawdown structure where after the investment is made up front, you don't see a return of your initial principle until the vehicle is completely wound down. The theme that you, I'm sure have surmised of those three different structures is going to be the liquidity profile of the underlying product. And so for an investor that needs daily liquidity, the logical option would be publicly listed security. For an investor that has perhaps a more indefinite period of time, often we find them to be institutional investors, they may be more interested in a private BDC, and then of course there's a very large and growing space for the intermediate need for liquidity, and that's where we've seen a tremendous amount of growth over the course of the past to call it two to four years. Okay,

Greg Campion: Awesome. That's a great overview. Okay. Now one of the related topics when I think investors are looking at different ways into the asset class, you hear a lot about fees and alignment of fees, right? So I'm not sure if there is a massive difference between the different types of BDCs that you described when it comes to fees, but tell me a little bit about just high level how you're thinking about fees when it comes to these different types of structures.

Matthew Freund: It's a great question. I think that whenever an investor is considering the appropriateness of any asset class, they have to ask what it costs them to get it. And so I think it's a very educated view. I would also be remiss not to mention that BDCs historically... And I'm talking about 20, 30 years ago, have a very poor reputation on the fee front. They were very fee heavy products, and I imagine that some listeners actually have some reminiscence of that, either having invested in them in the past or perhaps being burdened by the fee structures that existed circa 30 years ago. The reality of what has happened over the course of the past decade is that the BDC fee structure holistically has directionally moved towards an institutional style fee structure. And so what we have seen is that management fees for BDCs have come down over time, and along with that, the returns that are available to investors have increased over time. I think that that has a lot to do with the accessibility of the asset class, and it also has a lot to do with the accessibility of the underlying collateral, i. e, the investments that the managers are making. As private credit has grown in terms of recognition and prominence in the ecosystem, the cost to everybody is just coming down.

Greg Campion: Okay, well, that's a good trend. Yeah, I mean it does seem like the asset class, for lack of a better phrase, is kind of growing up so to speak, and I think that seems to be a reflected both in this kind of fee discussion, but also in terms of the access and the different flavors that are available for people depending on their unique circumstances.

Matthew Freund: Absolutely. The other thing that I would point out when it comes to fees is that there's often a couple of different components of the fee structure that managers are going to offer. One of them is going to be a base management fee, and of course there'll have different flavors in that regard, but then there's also going to be performance related fees that to the extent certain performance hurdles are met, that the manager may enjoy a disproportionate amount of the economics after certain performance thresholds. It's very important to note that some managers offer greater degrees of alignment than others. And so as investors are evaluating different managers that are providing different flavors of business development company offering, I think it's very important that they review how aligned the individual investor is with the underlying manager. And if you dig into the fee structures, I think that you'll often see that some create significantly more alignment than others.

Greg Campion: Okay. And is there any kind of guide or rule book for trying to uncover which ones are more aligned than others?

Matthew Freund: Whenever you're investing in credit and fixed income securities, I generally believe that you only generate alpha by outperforming on the loss, and that's to say that I would ensure whenever investors are doing their diligence that they try to understand how managers treat losses because there are certain fee structures out there that effectively ignore losses, and whenever you ignore losses in a credit security, it of course seems a little offsides. And so I'd say that as folks are evaluating different structures, that would be the biggest topic to focus on for me. And then of course, lower is generally better, but depending on the manager you talk to, I think everybody's going to tell you their fee structure is the cheapest.

Greg Campion: All right. That's great insight. Thank you for that. I think that's really helpful just level setting in terms of what are we talking about here and what are some of the key both drivers and considerations in terms of things like fees. I might want to just shift the discussion to some things that are maybe a little bit more timely in terms of what's going on in the market right now from a cyclical perspective. So probably the most obvious one is interest rates, and I'm sure this is something that's on investors' mind. It's obviously been a massive theme in recent years as we saw rates rise very quickly and dramatically, but now we're sitting here in early 2024 in kind of a different situation and where it appears that the next move in rates, at least here in the US is likely lower. And the main conversation in markets as we sit here today is kind of how many times is the Fed going to cut this year as opposed to further rate hikes? So that's a very different environment. Now we've seen a tremendous amount of interest in private credit obviously over the last five, 10 years. That market has just grown tremendously. I think the latest estimates I've seen are 1. 5, 1. 6 trillion, but it's really showing no signs of slowing down due to some of the trends that you kind of mentioned upfront. But if you think about if we're at this kind of inflection point in rates and if the previous rate regime has been so good for private credit and BDCs basically because of the floating rate exposure and the underlying loans, should investors be concerned now if the rate environment is going to change, is that a risk? How are you kind of thinking about that broadly?

Matthew Freund: It's a great question and it's one we get asked a lot from existing investors of all kinds, I think that the most important thing to consider whenever making any investment is the time horizon that you're going to be investing in the asset class. That's true for BDCs. That would be true for public equity. It would be true for private equity, and I believe that BDCs offer a very compelling relative value compliment to broadly syndicated loans and other fixed income securities. And so what I mean by that is that we have in the current terms, yields ranging between 11 and 12%. They are floating rate loans for the most part, and as a result, investors are getting paid more with interest rates being higher. But I think the most important thing to do is to compare that 11 or that 10 to 12% against what you might get in other comparable asset classes. So if you're going to look at BSL index or if you're going to go buy a BSL ETF, then you're going to be looking at yield somewhere and call it the 7 to 10% range. And if you're looking at investment grade, you're going to be talking about something in the context of five to 7%. And so as interest rates fall, I think that they're going to fall across the ecosystem. They're not going to fall exclusively for BDCs of course, they're going to fall for investment grade corporates, they're going to fall for broadly syndicated corporates, and then they're of course going to fall for some of the private credit corporates. And as you think about the BDC asset class and the compliment that it can provide to your portfolio, if you have a long- term horizon or even an intermediate term horizon and you believe that you want to out earn what's available from a public security perspective, then BDCs can be very compelling places to invest. Admittedly, if you think about the asset class as an absolute return vehicle, if you only need a 12%, and if you don't like the asset class, if it's anything inside a 12%, I think that it may be a challenging time to invest, but if you are an investor who believes that I want to be invested in fixed income, then I think that this is a very compelling asset class to be in now, and I think that it could be a very compelling asset class to be in five years from now because it will continue to earn on an income basis what broadly syndicated loans and what investment grade corporates are going to produce.

Greg Campion: Okay. I like that relative value angle, and I think obviously given where we are in terms of the rate cycle, you're obviously at a very attractive starting point in terms of the current yield that you're earning, and I don't see a ton of forecast out there today that are saying rates are coming down dramatically, so I think that's another kind of potential feather in the cap of the asset class.

Matthew Freund: Yeah. I mean, look, we see... Different economists are arguing about what the terminal rates are going to be at the end of 2024. We see anything from... Or the quotes that we get from the advisors we have are anywhere between 3% and 4. 5%, no one really knows, but the reality of it is that in a zero base rate environment, BDCs are often earning high single digits or even up to low double digits whenever you think about origination fees, prepayment fees, and other charges that the managers are charging to the underlying issuer. And so even in a zero base rate environment, we saw returns in the high single digits. And so as we think about the differential between where we were three years ago, where we are today and where we could be three years from now, organizationally, we feel like it's a very compelling place to invest.

Greg Campion: Yeah. Okay. Another current theme that we're kind of seeing a lot of headlines on right now is a very active IPO market in the BDC space. For those who are not following this super closely, what's going on here and why is it so active at the moment?

Matthew Freund: Yeah, there have been a number of new listings that have come to market over the course of the past quarter or so. I think that the reality is that there are private pools of capital we talked about earlier, private BDCs that were originally raised with an expectation of going public whenever that opportunity arose. The reality of it is that whenever you take a private BDC and you take it public, the fee structure often increases in some cases dramatically. And so it does accrue to the manager's benefit to take private BDCs public and flip them into a more favorable fee structure for the manager themselves. That said, that was the deal and the expectation whenever those pools of capital were raised, and that was in many instances, call it four to seven years ago. And so as private credit has grown as an asset class, the access point that is the private BDC has seen a lot of activity, and I think that those managers are largely following through on what they had previously guided their investor base to do. I think it's a net positive for investors, more choice is a good thing for investors. You can see kind of additional differentiation from manager to manager to manager, but there's certainly a lot of IPO activity on the BDC front.

Greg Campion: And why do you think they're choosing this very moment to come to market? Is it just that things are pretty good and the IPO market happens to be open? They think they can get a good valuation or what is the driver behind that?

Matthew Freund: Yeah. I think there's a couple of things all coming together. The rate dynamic that you mentioned earlier is certainly part of it. The reality is that BDCs are earning higher net income just because of where rates are, and that looks more compelling from an issuance perspective. I think that there's also a lot of underwriting appetite in the financial services industry, particularly from investment banks that are looking to place more of these companies into the public markets. And honestly, I think that folks are looking at this window as being very opportune. So if they miss it now, they may not have another chance for a few years. We know of some BDCs that have been in the queue for more than 12 months, and so now that the opportunity has presented itself, I expect that we'll see a lot of activity.

Greg Campion: Yeah. Really interesting. Back to the growth of the private credit asset class for a minute, there's a lot of different implications of that growth and some things that we're seeing right now in terms of market dynamics, I wanted to get your view on, so a couple of things specifically. So one is we're seeing a lot of new entrants into the market. Now, I'm not talking about EDC specifically here. There may be new entrants there. You'll know better than me. I'm talking about private credit overall, and what's been interesting to watch is that not only have you seen more managers like Barings pop up in terms of being asset managers who are in this direct lending space, but you're also seeing investment banks open up new divisions and hire big teams of people. I mean, it's really been incredible to see the amount of activity there. So that's one big trend. The other one is that we've seen this continued move of private credit or direct lenders into larger and larger transactions, right?

Matthew Freund: Yes.

Greg Campion: I was reading an article earlier today, where one of the interviewees was predicting that 2024 is the year where we see the first$ 10 billion loan taken down by the private credit market. I think the previous record was 4. 5 billion. So lines are blurring between traditional syndicated markets and private markets, and that's a very interesting theme to watch, but let's talk about those two trends, the new entrants and the larger deals, because bringing it back to an investor's perspective, if I'm sitting here and trying to look at the landscape of BDCs and trying to figure out if this is a good time to invest, et cetera, these are things I want to kind of have a view on. So let's hear an informed view on both of those.

Matthew Freund: Yeah. So as it relates to new entrants into the market, I think that this is a byproduct of the tremendous amount of growth that private credit has seen. As we think about the demand for the asset class, I think that it's really barbelled in terms of who's looking for it. We have issuers, so companies that need access to corporate credit, and they have historically, if you roll back the dial 15, 20, 25 years ago, they had historically tapped banks to do that. Now, some of the banking activity has tapered off over the years, started with the great financial crisis, and over time, I think that more and more of the lending has moved out of the banking sector. That said, at the same time, we have started to see with the rise of private credit, the desire for investors to start providing that capital where they're able to charge a very reasonable rate of return with respect to corporate loans. And so as we think about what has happened in the ecosystem, loans that were previously provided by banks are now being provided effectively by investors, and there's a growing number of investors that have a desired access that capital. What does that do is it really forces other asset management firms to take a look at it. There aren't a lot of asset classes that are growing this quickly. And so as we think about what is driving the new entrance, it's really just the growth of an asset class, and I think everybody wants to try and catch that wave. The important thing that I would point to that I think investors have got to do the work on is to understand two components. One, how long has a manager been doing this? Because Greg, to your point, people are hanging shingles left and right claiming to be experts in private credit, that may have in fact very little familiarity with the asset class itself. They may not really understand the risks and how to underwrite and how they need to manage a workout when things ultimately go sideways. And so I think it's very important that people understand how long has a manager been investing in private credit, be it in a BDC structure or any other structure. The other thing I would encourage investors to look at to really understand this dynamic about growth and new management is going to be what's the alignment look like? We know of a number of managers out there that have very little proverbial skin in the game that aren't actually committing their own capital to the transactions that are being financed. They're committing investor capital and with that investor capital, they're hoping for good returns, but unfortunately hoping for good returns doesn't actually produce good returns. And so as we think about evaluating the competitive landscape and trying to figure out where we're really" concerned" from a competitive perspective, it's honestly the same group of organizations that we've been thinking about for the past five years because there is an established cohort of firms out there that have been doing this for a long time. A number of them are very good at it. Barings happens to be one of those organizations. But the reality of it is that we will continue to see new entrants pop up. Some of them will be successful, most of them perhaps may not. Over time, rising industries, rising asset classes are going to attract more competition, and that's all we're seeing right now.

Greg Campion: Yeah. Yeah, that makes a ton of sense and I think it's a great point to bring it back to... This is a credit asset class. This is all about credit underwriting.

Matthew Freund: Absolutely.

Greg Campion: It's not about chasing the latest shiny thing, but it's about preparing for when, let's be honest, that we go through cycles.

Matthew Freund: Absolutely. I mean, at Barings, we believe that we're closer to the next cycle than we are to the last, and as a result, we underwrite the transactions to prepare for that. For folks that have only been in business for two years, it's hard to show a demonstrated track record of what a workout really looks like, and as a result, it just creates a different risk profile.

Greg Campion: Okay. How about on the deal size? Are you concerned on that front or what are your thoughts there?

Matthew Freund: The deal size is definitely a big topic in our space right now. And so to level set, I think you need to understand a manager's strategy. Baring strategy tends to focus on true middle market issuers. We define that as companies with EBITDA between 15 and 75 million, the private credit ecosystem however, to your point around the 10 billion unit tranche, the private credit ecosystem is growing and it has been growing pretty dramatically over the course of the past five years. It is not difficult any longer for an issuer with a billion dollars of EBITDA to be financed in the private credit markets. It's not a transaction that we would typically look at, but it is a transaction that the proverbial private credit market and BDCs in general have certainly started looking at. And so as we think about what is really happening, we believe that the large cap private credit space, which is how we would define the transactions that you just described, the large cap private credit transactions are effectively competing against the banks. They're competing against Goldman Sachs and JPMorgan and Deutsche Bank to underwrite these transactions that would historically be distributed to a broad investor base, a broad retail investor base, and instead they're taking what might be 500 million, a billion dollars of exposure and putting it into a single fund. It's not a bad strategy, it's just a different strategy than private credit was five or 10 years ago. It's a different strategy than what Barings manages today. We stick with the core of the middle market because we believe that there are structural protections afforded us to the companies that we lend to. We also believe that the economic terms tend to be more favorable to our organization. But with that said, we wouldn't criticize and certainly don't believe that there's a flaw in lending to big companies. It's just a different approach and honestly, an evolution of what private credit has been doing over the course of the past five years.

Greg Campion: Okay. Now, if you think about the structure of some of these deals, I'm curious right now, one of the questions I think we get is around what is the attractiveness right now of documentation, so things like financial covenants, structural protections, et cetera. And I know this can kind of ebb and flow depending on market conditions, depending on a lot of different factors. But as we sit here in early'24 today, what does that look like from your perspective?

Matthew Freund: Every lender will tell you that they have financial covenants in their transactions, and that is an accurate statement. The important nuance, however, is that where we draw the line is what we call a financial maintenance covenant. And a financial maintenance covenant means a financial test that is tested often on a quarterly basis to validate compliance with our credit agreement in our middle market business, our underwriting transactions with a maintenance covenant in every deal. That is not true of the large corporate transactions. Many of them are competing against a covenant light execution that lacks a financial maintenance covenant. And as a result, what you'll often see in these large corporate transactions is a document that looks remarkably similar to what the issuer would've gotten in a broadly syndicated deal executed by your... Choose the name investment bank. And so it is true, we believe at Barings that the documentation matters. It matters the most whenever things start to go sideways. And the reality is that in the middle market, we have an opportunity to document transactions in a way that we feel like really protects our investors. Whenever you're competing for that$ 10 billion transaction, you can rest assured that there are going to be remarkably similar terms to the issuer. Otherwise, the issuer is invariably going to choose the more flexible of the two. That's often how issuers decide. And so I think that I would encourage people to evaluate the manager's style and understand exactly what kind of assets they're investing in because private credit as nomenclature itself is not descriptive enough to inform an investor of to what underlying risks actually reside in the portfolio.

Greg Campion: Yeah, okay. You need to understand what types of covenants are on the deals that you're investing in.

Matthew Freund: Exactly.

Greg Campion: And I think for anyone who has gone through the CFA program, you got to dust off those books and remind yourself of the different kinds of covenants.

Matthew Freund: That's exactly right.

Greg Campion: Matt and I-

Matthew Freund: inaudible materials.

Greg Campion: Matt and I have both suffered through that.

Matthew Freund: Indeed.

Greg Campion: I think I probably suffered through it a few more times than you is my guess. Well, okay, a couple of quick things to wrap up with. Just kind of zooming out. If you look at a lot of the media coverage that this asset class gets private credit or BDCs, but let's take it from the private credit angle. You see a lot of headlines out there, and I think the common phrase you hear is this is a golden age for private credit, right? And so let me just ask you that question directly. Is this a golden age for private credit or is that way too optimistic?

Matthew Freund: Yeah, I think that it is a great time to consider investing in private credit for individuals who want to compliment fixed income exposures in their portfolio in a slightly uncorrelated way. I admittedly am biased. I don't believe that there has been a bad time to invest in private credit over the course of the past five years, and it's hard for me to see a series of economic variables, be they interest rate or GDP or FX that creates an unfavorable set of variables to invest over the next five years. And so as I sit here today, is it the golden age of private credit? I feel hard- pressed to necessarily agree with that. Maybe it's the Bronze Age, maybe it isn't, but I would have to say that as we think about an investor who has an intermediate to long- term time horizon who wants to enjoy the benefits of a strategy with high income distributions and a compliment to a fixed income portfolio, it's really hard to argue that it's not a good time to invest.

Greg Campion: Yeah, that's very well put. Okay, so Matt, to finish up here, I actually just wanted to ask you what you're keeping an eye on. As we've established, I think in this conversation, this space has changed dramatically over the last decade or so. My inclination or guess is that it's probably not done changing yet, but from the seat you sit in today, I'm curious, as you look out over the next 12, 24 months, whatever the time horizon, what are you going to be keeping an eye on and what do you think investors should be watching for?

Matthew Freund: Yeah, so I think that the comment around how the large cap, private credit investors really interact with the investment banks is going to be a very interesting thing to see unfold. Large banks have built huge business models on leveraged loans and the distribution of leveraged loans and making markets and leveraged loans. They're not going to let it go easily. And so I anticipate that as large credit managers focus on the large end of the market... Again, that's not a space that Barings is actively participating in, but as large credit managers focus on the large end of the market, it's not going to be a free lunch. And I think that the evolution and the tug between the banks and the large credit managers will be something that'll be very interesting to watch. From an economic perspective, we're of course interested to see how this political cycle is going to impact both the economy as well as confidence more broadly. I'll tell you that when speaking with private equity professionals who happen to drive demand for a lot of private credit, they are growing a little bit concerned around the velocity of transaction activity that they would like to see happen in the back half of 2024. The reality is that elections create a little bit of uncertainty regardless of anyone's political leanings. Elections create uncertainty, and investors tend to be a little more skittish whenever there is uncertainty on the horizon. And so those are the two things that I think we'll be watching over the course of 2024, but who knows, anything else could pop up between now and then it may garner even more attention.

Greg Campion: Well, if this conversation has not been too painful for you, we may have to get you back later in the year to-

Matthew Freund: Would love to.

Greg Campion: Maybe we'll get your post- election rundown and what it all means for the asset class.

Matthew Freund: I won't have a lot of knowledge then, but I'd be happy to come back all the same.

Greg Campion: All right. Sounds good. Matt, this has been awesome. Thanks so much for your time.

Matthew Freund: Really enjoyed it. Thank you, Greg.

Greg Campion: Thanks again for listening to or watching this episode of Streaming Income. If you'd like to stay up to date on our latest thoughts on asset classes ranging from high yield and private credit to real estate debt and equity, make sure to follow us and leave a review on your favorite podcast platform. We're on Apple Podcasts, Spotify, YouTube, and more. And if you have specific feedback, you can email us at podcast @ barings. com. That's podcast @ B- A- R- I- N- G- S. com. Thanks again for listening and see you next time.


Business development companies (BDCs) continue to garner increased investor attention driven by demand for income and access to the growing private credit asset class. Barings' Matthew Freund discusses the cyclical and structural trends shaping the market opportunity today.