2019 Knowledge Brokers

Patrick Adelsbach

Title: Partner
Firm: Aksia
Assets under advisement: $85 billion
Number of consultants at firm: 172 professionals, including 33 portfolio advisory professionals.
Client type: Corporate and public pension plans, insurance companies, government-related institutions, endowments, foundations, and superannuation funds

Patrick Adelsbach is one of the six founding partners of Aksia LLC, a research and advisory firm, where he heads the private credit strategy and walks clients through the evolving industry. Despite the frenetic demand for private credit, Adelsbach notes many of the challenges the industry faces.

“Everything in the credit markets is difficult right now,” Adelsbach said. “Leverage is high, covenants are disappearing, EBITDA addbacks are rampant, poor documentation allows for hidden leverage…and you’re getting paid less.” Ouch. “But the reality is that those are the terms if you want to invest at the top of the capital structure,” he says.

His concerns about the “private credit beta trade” extend beyond the typical critiques of loan structure. “It’s not just the quality of the documentation or the amount of leverage you put on a company, it’s whether or not they’re actually good companies. The problem that arises when there’s so much capital is that poor quality companies are being financed alongside the good. It doesn’t matter if the documentation is strict or the leverage is low, if you’re financing a bad company then you’re going to lose money.”

Adelsbach says it’s more important than ever to be the first call on an opportunity rather than choosing from loans that others have already passed on.  This environment “favors GPs with deep borrower relationships and proprietary sourcing; underwriting ability alone is not enough,” he says.

The Next Opportunities

At the same time, Adelsbach points out that diversification is particularly helpful late in the cycle, when opportunities to make money are less clear. “We don’t know where the next disaster will come from,” Adelsbach says, and “the best defense you can have is a portfolio that is truly diversified by both geography and underlying return drivers.” As an example, he points out that “we think many Asian strategies have higher return potential than their US and  European counterparts, but Asia remains under-owned by most institutions because it is cumbersome to diligence. Our research teams in Hong Kong and Tokyo help to bridge this gap for our clients.”

He’s also anticipating a sort of “gold rush” of distressed opportunities in the private credit industry–forecasting that investors may not be keen to stick with private credit funds that have underperformed, extended their timelines or where the investor relations groups have gone AWOL. He points out that private credit is still a nascent asset class and when hard times hit, many of these funds may have lost their internal champion or new management may not understand the investments, exacerbating the tendency to sell into the secondary market.

“When fund investors start selling into an illiquid market, Aksia will be chomping at the bit to go on the offensive because our research will be supported by a large quantum of data. Our loan-level database includes detailed characteristics and performance information from almost 10,000 loans across hundreds of GPs. We believe the depth and breadth of our data will provide us with a distinct advantage over other secondary buyers,” Adelsbach says. 

A Supply-Demand Mismatch

Outside of general fund commitments and secondary transactions, Adelsbach’s team is navigating through the growing market to identify other avenues for potential returns, including co-investments. The Aksia co-founder discussed the mismatch between supply and demand. 

 “In theory, LPs want to make co-investments and GPs are willing to provide flow, but in practice, few LPs are able to make decisions quickly enough to set up meaningful programs. To overcome these governance challenges, we can structure partnerships with clients so that decisions can be made quickly.”

Part of the under-resourcing to private credit co-investments is just due to the immaturity of the market, as wary investors wait to see how the asset class performs over an extended period.

“Private credit has to prove itself through a cycle,” Adelsbach noted. “Private credit skeptics point out that most of the returns have been produced post-financial crisis, so they are skeptical that the asset class will survive the next crisis.”

“Logically speaking, post-2008 private credit investments should be more resilient than unlevered equity in a downturn because they are at the top of the capital structure. But that has yet to prove itself in a credit downturn.”

Time will tell if private credit will gain the same acceptance as private equity and other mainstream alternative asset classes, but individuals like Adelsbach are ready to invest in sound opportunities across the spectrum, albeit cautiously.

“We want to be forthright with our clients about the risks of credit but also want to make sure that they are holding other asset classes to the same standard,” he said.

But a lot of the sentiment on the attractiveness of private credit boils down to a long-term macro view. “Private credit wins if you’re talking to a chief investment officer who is skeptical of the market return going forward. Private credit loses if the CIO has a more sanguine view.  Our role is to help each client sort through the web of choices to make the decision that is best for them,” he says.

By Steffan Navedo-Perez

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