Partners Group has boosted its outlook for private markets, following the latest cut to US interest rates by the Federal Reserve, with private credit set to benefit from lower interest expenses and an improvement in M&A activity.
The Fed announced a 25 basis point rate cut on 17 September, and is expected to make two further 25 basis point rate cuts this year.
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In a Private Markets Essentials report, Anastasia Amoroso, chief investment strategist for Partners Group’s private wealth and retirement business unit, wrote that the anticipated rate cuts should benefit private markets assets by lowering the cost of financing, allowing for greater use of leverage.
Other benefits include a boost to valuations of assets given the lower discount rate, and making new transaction economics more attractive, helping boost overall investment activity, she wrote.
Private credit, specifically, will likely benefit from lower interest expenses and higher debt service coverage ratios, according to Amoroso.
“Given the floating rate nature of the loans (most typically tied to a three-month term Secured Overnight Financing Rate Data (SOFR)), rate cuts would have an immediate positive impact on borrowers’ debt servicing costs,” she said.
“This impact hasn’t yet been felt but could quickly take effect after the cuts materialize. This could alleviate the financial burden on the borrowers and put them in stronger liquidity positions, while also helping alleviate investors’ concerns about default risk.”
She noted that lower rates and higher borrower liquidity could help to “reverse” the trend of an “increase in payment-in-kind interest in the market” seen in recent quarters.
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Amoroso added that “lower cost of debt would likely lead to a pick-up in M&A activity, increasing the supply of direct lending transactions in the market”.
She said that while US leverage ratios declined as rates rose, this trend could reverse “with the share of leverage used in transactions reverting to higher levels, increasing the opportunities for private credit lenders”.
“We could see potentially modest upward momentum in spreads – since the increase in transaction supply could encourage modest spread widening. This move could partially offset the decrease in base rates, helping to keep all-in private credit yields attractive,” Amoroso wrote.
Other private markets assets likely to benefit from interest rate reductions are private equity, private infrastructure, real estate, and royalties, Partners Group said.
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