Parallel lending: Built to withstand market storms

April 25, 2025

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In a world where financial volatility is inevitable, evergreen parallel lending strategies could offer a compelling model for resilience. Gianluca Oricchio and Gianpaolo Pellegrini explain why their approach is positioned for whatever the market throws next.

The only certainty over an infinite time horizon is uncertainty itself. In our view, any evergreen parallel lending strategy must be built with the inevitability of a financial crisis in mind. This means designing a strategy not for ideal conditions, but for resilience in the face of disruption.

Unlike closed-end vehicles, evergreen strategies do not have a built-in exit date. Sooner or later, they will face an extended period of uncertainty or even a global crisis. This makes the structuring phase critical. Managers cannot afford to improvise during a storm.

We approach design backwards, starting with the kind of portfolio that can survive worst-case scenarios and work in reverse to define the necessary parameters: credit risk, leverage, liquidity, volatility and diversification. If a portfolio can weather extreme stress, it stands to reason it can perform robustly in benign periods, too.

An ex-ante approach to risk management

The greatest risk for any private credit strategy is assuming you can adjust in the middle of a crisis. But by that stage, it will likely be too late. This is why our risk management approach is embedded at the design stage.

Take credit risk, for example. We use historical data to understand how default rates correlate with leverage. Companies with debt above 4x EBITDA are far more vulnerable during downturns, as Figure 1 illustrates. By lending to companies with significantly lower leverage, we can reduce our exposure to this risk.

Figure 1: Leverage is a key driver of defaults

Risk: Forecasts mentioned are not a reliable indicator of future results.

Source: Muzinich analysis using data from Moody's and European Central Bank, as of 01/01/1983 to 31/12/2023 and forecast for 2024. In the category of companies with leverage below 4x, we have included only companies rated BBB-/BB-/BB+/BB/BB-/B+ and have excluded those rated AA/A/BBB+/BBB.  In the category of companies with leverage above 4x we have included only companies rated B/B- , while companies rated CCC+/CCC/CCC-/D are excluded. The forecast data is based on our elaboration on Moody's Default Forecasts (November 2023). Period represents the longest available. For  illustrative purposes only. Not to be construed as investment advice or an invitation to engage in any investment activity.

Stress testing also plays a key role. We examine what could happen to interest coverage ratios under dual shocks: falling EBITDA in a recession (the numerator) and rising interest costs from inflation (the denominator). This helps us assess whether companies can still meet their debt obligations during severe economic conditions.

Our approach to concentration risk is similarly conservative. Typically, no single position will exceed 0.5–1% of the portfolio. This granularity can help protect against tail events and sector-specific shocks.

Liquidity is another key factor. Unlike banks, asset managers cannot rely on central banks to intervene during a crisis. But we can utilise tools from the banking world, like the Net Stable Funding Ratio (NSFR)¹ and Liquidity Coverage Ratio (LCR),²  to model short-term and long-term liquidity under stressed conditions.

Finally, we take a cautious approach to leverage. Not all of a vehicle’s net asset value (NAV) should be treated as equity; some of it may be subject to redemptions, particularly in turbulent periods. We typically reserve 20% of NAV as a potential short-term liability, ensuring we maintain the liquidity flexibility required in uncertain times.

Built for volatility

We believe parallel lending is well-suited to today’s challenging environment. One of the core reasons is the structural buffer provided by the interest coverage ratio. We seek to lend to companies with a meaningful gap between their EBITDA and cost of debt, providing a cushion against recession risk and inflationary pressures.

Strategies exposed to highly levered borrowers (e.g., with debt around 6x EBITDA) do not have the same buffer. If earnings fall and interest costs rise, the margin for error erodes quickly. In contrast, our model of lending to companies with more conservative leverage (around 3x) is intended to withstand shocks more effectively.

Moreover, we are not chasing the same shrinking pool of deals in the overheated, upper-middle unitranche market. That part of the private credit universe has grown rapidly in recent years, and spreads are compressing, especially in large-cap deals.³ Furthermore, many larger loans are covenant-lite, more akin to broadly syndicated loans than traditional private credit.⁴ 

We believe our parallel lending strategies are largely insulated from this dynamic. European banks, constrained by strict Tier 1 capital requirements under Basel III,⁵ cannot expand their loan books endlessly. This makes them natural partners for asset managers like us. We co-lend alongside them on equal terms, not as competitors, but collaborators. And since bank lending appetite is not driven by investor demand, we do not face the same supply-demand mismatch that exists in some other private credit strategies.

Lessons from recent crises

Volatility is not hypothetical; we have experienced multiple episodes of turbulence in recent decades. During the COVID-19 crisis, we had around 90 active portfolio companies in our parallel lending book, 11 of which breached debt covenants due to a fall in earnings. But thanks to short-term liquidity facilities provided by our banking partners, no portfolio company defaulted or required a payment holiday. Within 18 months, all covenant breaches were resolved.

We saw something similar during the energy shock that followed Russia’s invasion of Ukraine in 2022. Companies experienced 15–25% EBITDA declines due to inflation. But our conservative starting point meant this was manageable and no significant solvency issues arose.

These experiences reinforce our belief in rigorous upfront selection—we invest in only 15% of the deals we review—and in the importance of economic alignment with banks. While legally pari passu with our loans, short-term credit lines provided by bank partners can act as a buffer, providing our parallel lending strategies with an additional layer of protection.

Figure 2: Minimising sensitivity to economic cycles of invested evergreen parallel lending strategy 

Source: Muzinich analysis, as of April 2025. For illustrative purposes only, subject to change and not to be construed as investment advice.

Muzinich reviewed each invested company in its evergreen parallel lending strategy to assess US revenues, business model, and specific industry.

Muzinich defines revenues-at-risk as sum of the revenues towards the United States. Based on revenues-at-risk, we have stress tested each invested company under a scenario that assumes a 33% reduction in turnover-at-risk and material impact on EBITDA (equal or higher than the stressed percentage reduction in revenues, according to the composition of vs. variable costs). The impact of the first shock on revenues-at-risk is illustrated in the second column, and added two further scenarios: +1% inflation and +2% inflation, both increasing the cost-of-debt. The outcome is presented in terms of the interest coverage ratio (defined as the EBITDA on cost-of-debt ratio).

Active management of leverage

One of the most important characteristics of our model is how we approach leverage. Many private credit strategies combine high borrower leverage with additional fund-level leverage, leaving little room to manoeuvre in more volatile periods.

We do the opposite. By investing in companies with around 3x EBITDA leverage, we retain flexibility at the strategy level. In strong markets, we might raise fund leverage to 1.7x in an effort to enhance returns. In volatile periods, we will reduce that to 0.8x or lower to preserve capital.

Crucially, our portfolio’s amortizing nature and 14% annual prepayment rate mean we consistently generate cash. This provides the liquidity to either reinvest or deleverage without needing to sell assets, a particularly valuable characteristic during periods of higher redemptions or downturns.

Navigating redemptions in evergreen structures

Evergreen structures bring unique challenges in terms of liquidity and leverage management. You cannot seek to wait out the cycle like a closed-end vehicle.

By aligning portfolio construction with the liquidity profile of our liabilities, and by maintaining cash reserves and flexible leverage, we seek to ensure the strategy is protected at all times. When redemptions happen, we do not need to liquidate illiquid assets at fire-sale prices. Instead, we manage redemptions naturally through amortization and prepayments. This gives us the adaptability to reduce risk when needed, while staying fully invested when the opportunity arises.

A selective and defensive approach to allocation

Sector selection is another pillar of our strategy. We look to avoid potentially more volatile or cyclical areas like real estate, retail, construction, startups, public administration and financial institutions. We prefer defensive and resilient sectors where cashflows are likely to be stable throughout the cycle, such as healthcare, medical technology, pharma, telecom infrastructure, digital services and food retail.

We also prefer business-to-business over business-to-consumer models. Even within sectors, we remain selective. For example, avoiding the tourism and hospitality sector helped us mitigate downside risk during the pandemic.

A strategy for all seasons

Parallel lending is not immune to economic cycles, but it is purposefully designed to navigate them. By starting with a conservative approach, applying rigorous risk management, and aligning ourselves with the lending practices of the banking system, we have created a model that is resilient by design.

Furthermore, we believe the combination of low leverage, granular diversification, adaptive liquidity and sector discipline makes parallel lending a viable option for investors in a world defined by volatility.

 

References

1.Bank for International Settlements, June 2018. The NSFR was introduced as part of Basel III reforms to incentivise banks to fund their activities with more stable funding sources on an ongoing basis. It measures the bank’s available stable funding relative to its required stable funding.
2.Bank for International Settlements, January 2013. The NSFR was introduced as part of Basel III reforms, and aims to ensure ensuring that a bank has an adequate stock of high-quality liquid assets that can be converted into cash easily and immediately to meet its liquidity needs for a 30 calendar day liquidity stress scenario.
3.S&P Global, ‘Private Markets: How Will Private Credit Respond To Declining Yields?’ December 4, 2024
4.S&P Global, ‘Systemic Risk: Private Credit’s Characteristics Can Both Exacerbate And Mitigate Challenges,’ February 18, 2025.
5.Bank for International Settlements, ‘Definition of capital in Basel III,’ January 2015.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of April 2025 and may change without notice.

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