The Fed Giveth And The Fed Taketh Away

The US Federal Reserve has raised the federal funds rate again, this time to a range of 5% – 5.25%; it is now at its highest level since 2007.

The move was widely expected, but there was much chatter in finance circles ahead of the announcement, because if the Fed had held rates at the previous level, they could be accused of not doing enough to curtail inflationary pressures. Raise rates, and regional banks come under even more pressure.

Those backing a raise won. And in private debt, that means two things.

On one hand, it means that the current slowdown in fundraising is likely to continue, due to investors being able to park their money in more liquid, less risky debt assets that are now generating a compelling yield. For many funds in the market now, and those that are looking to get out on the fundraising trail later this year, this means a longer sales cycle and a more difficult one, as they will also have to allay fears in some quarters that the economy is set for something of a hard landing; lower revenues and profits means a decreased ability to pay back loans, after all.

But on the other hand, funds that have closed and that are armed with cash should be able to charger higher rates of interest, which means, all things being equal, higher rates of return. Indeed, some industry participants are certainly bullish. And opportunities are opening in private equity circles, as banks retreat even further from sponsor-backed buyout lending.

As I mentioned in a previous post, my view, having reviewing hundreds of private debt funds, is that managers of these strategies really do earn their ‘two and twenty.’ They will need to work harder than ever before on due diligence to ensure that they are lending to the right company – right in the sense that the portfolio company can sustain its apparent health through a potential hard landing and pay off any debt at the same time – but for those that get it right, recent vintages could indeed end up being among the industry’s best.

**The above reflects the personal opinions of the author and is not to be considered investment or legal advice or advice of any kind.

Greg Poapst, “The Fed Giveth And The Fed Taketh Away” (Essential Fund Services International, May 2023)

https://www.essentialfsi.com/the-fed-giveth-and-the-fed-taketh-away/