We kick off the interview by asking Shaun Mullin to look back and frame the current market in order to understand where we are right now, and why we are here.
“Taking a step back, we view the current environment for European direct lending as being very constructive. The market has grown significantly over the past decade as capital supply in the form of bank lending has continually retrenched from the middle market due to a combination of factors including more stringent capital regulations, which has resulted in middle market companies becoming somewhat underserved. When you combine this with increasing demand from private equity funds that are sitting on significant amounts of dry powder, plus the increasing demand for bespoke and flexible financing, we expect to see continued, strong demand for direct lending as a product,” he says.
He continues: “We are very focused on supporting the most resilient businesses operating in non-cyclical sectors. We prioritize companies that have durable cash flow profiles under differing market conditions and have demonstrable performance through economic cycles. We want to see meaningful equity contributions from top-tier sponsors that possess specific domain knowledge in the underlying sectors, and we want to see appropriate lender protections. Our aim is to deliver attractive returns for our investors with strong downside protection across cycles.”
Asked about where they’ve seen the biggest change given the shift in the macro environment – going from zero interest rates to having an interest rate – Shaun Mullin said his team has been focused on how borrowers performed through differing market cycles and the ability of their business models to absorb these differing economic conditions. He says borrowers, their shareholders and his team have been very focused not only on leverage but interest coverage and debt serviceability.
“One of the benefits of the Morgan Stanley platform is that, holistically, we have insights into a massive array of companies, sectors and geographies. Being able to observe how they perform through different periods of volatility, whether it was COVID, the onset of the war in Ukraine, or through the financial crisis, is incredibly powerful from an underwriting perspective. We’ve been somewhat fortunate that we have a very nascent platform that we’ve been able to observe ahead of investing through different periods of stress,” he says.
Talking about the challenges of balancing investment opportunities with investor willingness to allocate capital to private credit, Mullin says that it’s simply a feature of the industry.
“If I consider it very specifically from a Morgan Stanley perspective, we have something of a unique selling proposition in the sense that we are a very broad institution which has multiple touch points across the ecosystem. This means that we can leverage multiple parts of the broader Morgan Stanley institution to help not only originate and source what we consider to be the most relevant lending opportunities to our strategy but also follow that through into our underwriting processes and investment selection. We also have the resources for portfolio monitoring to make sure that we’re thinking about these events and the first, second and third order implications as they happen. Collectively, the Morgan Stanley franchise is incredibly powerful in helping navigate and manage those ebbs and flows between what investors are seeking and the market opportunity set at any one given time,” he says.
Having a broad exposure to the wider market for origination of assets and underwriting also means that the platform can remain disciplined around where they deploy capital.
“If I was to quantify it, we invest in less than 5 per cent of the opportunities we see. Morgan Stanley creates a lot of proprietary angles for our platform to originate and underwrite opportunities, but that also means that we need to be more disciplined and selective around where we choose to spend our time and invest our stakeholders’ capital,” Shaun Mullin says.
Asked if the growth of the asset class, and the potentially greater dispersion between differing managers, creates headline risks and discourages investors from investing, Shaun Mullin says the dispersion of returns and performance between differing managers will most likely continue.
“The headline risk is still to be determined and will only play out over time. On that basis, we do believe that you will continue to see a dispersion in returns and manager selection, and that will be of the utmost importance. I’m sure that investors are thinking very carefully about who they have allocated capital to, who they believe is maintaining their underwriting discipline and who they allocate capital to going forward,” he says.
Asked about some of the key questions he gets from investors, Shaun Mullin says that different investors obviously focus on different aspects.
“However, when investors think more holistically about private credit and direct lending as an asset class, they focus a lot on the platform’s underwriting discipline applied around credit selection, the monitoring of investments and portfolio construction. They really want to assess how your underwriting processes work and ensure that they align with your investment and credit philosophy. An extension of this is that they also want to ensure that the manager can source these opportunities. The more relevant opportunities, combined with extensive underwriting discipline, should result in better outcomes, assuming you maintain your selectivity,” he says.
Asked if there are questions that investors should prioritize, Shaun Mullin says that the investors he interacts with have an extensive process. He always recommends, however, that investors spend a significant amount of time on their due diligence. “Investors really want to understand an investment manager’s processes as I outlined earlier. But of course, it’s difficult because nuances exist among managers,” he says.
