Rising interest rates will trigger a shift in the balance of value from equity to debt over the next few years, according to Apollo Global Management Chief Executive Marc Rowan.
Rowan noted that every time refinancing occurs, debt holders are not only receiving higher rates, but are also in a position to demand equity holders contribute more capital to maintain ownership stakes in assets.
Rowan's remarks, made at the Global Financial Leaders’ Investment Summit in Hong Kong on November 7, point to pressures building on asset valuations as monetary policy tightening works through refinancing deals globally.
“It's a reason that you see so much capital in private markets, but none of it being spent,” Rowan said during a panel discussion alongside Goldman Sachs chairman and CEO David Solomon, Barclays CEO CS Venkatakrishnan, and Schroders CEO Peter Harrison.
Apollo Global Management is one of the largest alternative asset managers in the world, boasting about $631 billion in assets under management at the end of September.
The value shift from equity to debt underscores complex challenges for asset owners and managers in balancing asset allocations.
A rising number of asset owners across Asia Pacific have shared bullish views on private credit over the next year, even as others expressed concerns over what the heated market will look like when refinancing risks mount, especially for loosely underwritten loans.
Firms are stockpiling extra capacity as they weigh how much more equity may be needed to refinance and deleverage balance sheets in an environment of higher borrowing costs.
“I think until that works through, we're not going to see really robust deal activity because I don't know that a 5% base rate really is impactful. It kind of feels normal,” Rowan told the annual event organised by the Hong Kong Monetary Authority.
He believes the world economy may be at a point of regulatory overreach where too much financing needs are flowing into the marketplace, which will lead to an eventual course correction, particularly in Europe
That's because the financial system, particularly in Europe, is not adequately equipped to absorb the rush into private credit.
Decreasing public market liquidity means private and public risks are closer than perceived, he said. The 2022 liquidity crunch in UK pension funds highlights how sudden disruptions can emerge.
“Just like there's regulatory overreach as it relates to assets and capital, there's been regulatory overreach on the penalty associated with trading capital. Therefore, the provision of orderly markets makes public and private much closer than people have ever thought of them. And we haven't adjusted our mentality of how we allocate assets yet,” he said.
PUBLIC VS PRIVATE
The Apollo chief also said public markets have become too concentrated in large companies and indices, limiting the space to carry out fundamental analysis.
He said private markets now provide more alternatives for alpha.
“We used to think public was safe and private was risky. Well, I think we now know public is safe and risky and private is safe and risky. They're just differing degrees of liquidity,” Rowan said.
Private credit is increasingly filling the credit needs of small-medium businesses through securitisation and investment funds, replacing credit provided by banks due to regulatory pressures on them.
Rowan noted that moving credit from banks to largely unleveraged asset managers reduces systemic risks compared to concentrated banking systems.
“The banking system is a safe system, but it borrows short and lends long. And it is levered. When you move something from the banking system to the asset management system, for the most part, you're moving it from a levered system to an unlevered system,” Rowan said.
“That does not mean investors will not lose money, but investors could just as easily lose money on the S&P 500 as they can on the credit system.”
Hence, he stressed the importance of democratisation of credit, and finding the right balance between banks and investors.
Rowan said it is “fundamentally good” for the financial system to have credit moving from the balance sheets of banks to unleveraged investment funds.
When asked a question from the audience about whether private credit will become more regulated he responded: "Yes and no."
He noted that as far as risk is concerned, there's possibly more in the public markets and singled out mutual funds as an example.
Mutual funds, he noted, can offer daily liquidity by offering investors immediate redemptions yet hold assets that might not be highly liquid or traded frequently.
“That is where you build up systemic amount of risk through a mismatch of the underlying assets that these institutions hold.”
Apollo Global Management has about $450 billion in AUM in credit, covering both public and private markets.