Direct lending in a fragmented world

May 13, 2025

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Tariff and macro uncertainty present risks and opportunities for private debt investors. Kirsten Bode, Rafael Torres, Andrew Tan and Michael Smith explain how these trends are manifesting in Europe, Asia Pacific and the US, while identifying common themes that cross borders.

The global economic order has shifted dramatically in 2025. New tariff regimes threaten long-established trading patterns and could further complicate an already delicate business environment. For private debt investors, this necessitates a reassessment of risk, opportunity and portfolio construction.

The impact of tariffs and economic uncertainty could reverberate beyond simple trade data and touch every aspect of the lending ecosystem: from underwriting assumptions and covenant structures to sector preferences and regional allocations. Yet amid this complexity, patterns are emerging that could provide a roadmap for navigating these uncharted waters.

In this article, we highlight common themes and regional nuances that could shape the private debt universe over the coming quarters and beyond.

Common themes

1.Structural shift in global trade

Recent policy shifts signal a realignment of global trade relationships. Across all regions, this could have lasting impacts on supply chains, cost structures and revenue models. What potentially makes this cycle unique is the uneven distribution of these effects: while US businesses face mounting cost pressures due to tariffs,¹ Asia-Pacific companies could be confronted by revenue challenges as export demand shifts.²

In contrast to previous periods of volatility such as COVID-19, where the nature of disruptions and the policy responses to them were more uniform across regions, today's tariff and macro uncertainty points to increasing fragmentation. This could be particularly challenging for businesses with sizable cross-border exposures on the cost and revenue side.

2.Domestic focus

A common thread across all regions is the growing appeal of domestically-focused businesses. Companies with primarily local or regional customer bases are emerging as safer bets in a world of trade barriers and geopolitical tensions. In Europe, our portfolios have limited exposure to tariffs due to their focus on smaller, locally-oriented, service-based businesses in the lower-middle market. Similarly, in the US, we see refuge in companies with domestic supply chains and customer bases, while in Asia we increasingly see opportunities in businesses serving local and regional markets rather than export-dependent models.

Our approach is both defensive and strategic. Lower-middle market companies are typically more domestic than their larger counterparts,³ making them potentially more resilient to trade disruption. We believe this approach will become increasingly valuable to portfolio resilience as uncertainty persists.

3.Sector selectivity

Across all regions, sector allocations have never been more critical. We prefer areas such as healthcare, education and essential services due to their defensive characteristics, localised nature and relatively limited exposure to tariff impacts. Conversely, consumer discretionary, electronics, and sectors exposed to complex global supply chains look more vulnerable.

Our selectivity extends beyond broad sector classifications. In the US, for instance, we have identified specific niches within aerospace, defence and healthcare services we believe can provide greater insulation from broader economic pressures. Meanwhile, in Europe, we prefer sectors such as software, critical services and healthcare over more cyclical areas.

4.Diversification becomes investor imperative

It may be premature to call this a clear trend, but based on our discussions with investors, we detect a shift in sentiment across markets. International investors we have spoken with, who previously concentrated allocations in North America, are increasingly seeking diversification by market segment and geography.

Within the US, for example, more investors are beginning to recognise the opportunity in the lower-middle market. Through prudent origination and underwriting discipline, we believe value can be found in attractive, relatively insulated niches that offer a viable alternative to large companies.

Outside the US, international investors may look to re-calibrate regional allocations. European private debt, with its perceived lower exposure to tariff impacts, is attracting interest. Similarly, investors recognize the Asia-Pacific region's long-term growth potential could present ample opportunities. If a significant rotation of capital materialises, it could benefit managers with international platforms.

Regional nuances

Europe: The new safe haven?

European direct lending might be a beneficiary of the current environment, particularly in the lower-middle market segment, where companies tend to have less exposure to global supply chains.⁴

In assessing portfolio companies in our European strategies, we see minimal direct exposure to tariff risks, largely due to our focus on service-based businesses with domestic and regional customer bases.

The European market's relatively limited exposure to US trade could also reduce the second-order effects of tariffs. While not immune to global economic conditions, we believe lenders can protect portfolios through robust covenant structures and documentation standards.

From a fundraising perspective, Europe may benefit from increased demand as investors seek to diversify away from predominantly US exposure. Though this is not yet reflected in capital flows, our conversations with investors suggest growing appetite for European exposure The key appeal of European strategies appears to be geographical diversification within the continent itself – avoiding overconcentration in any single market could emerge as a preferred approach.

United States: Adjusting the playbook

The US direct lending market faces a more complex adjustment to the new tariff regime, given the direct impact on both import costs and domestic business sentiment. Unlike COVID-19, when government stimulus supported consumption despite disruptions, today's landscape features mounting cost pressures without clear signs of coordinated policy support.

To mitigate this, the onus is on managers to be discerning in their origination and sector focus. Consumer discretionary businesses face particular scrutiny, as do companies with complex international supply chains. Instead, we gravitate toward niche areas like specialized healthcare services, aerospace and defence, and business/ infrastructure services we think will be less affected by trade disruption.

A case can also be made for value-add technology/ software companies; however, these need to be evaluated on a case-by-case basis depending on individual business’s capital budgets.

We do not believe this environment is supportive for buyout-related financing, with uncertainty likely to keep buyers and sellers on the sidelines, although it could potentially present opportunities for acquisition financing, capital expenditure financings (particularly reshoring opportunities), and capital solutions strategies.

Despite these headwinds, we continue to see compelling opportunities in the lower-middle market, where more conservative capital structures and favourable pricing should provide some cushion against macroeconomic volatility.

Asia-Pacific: Stay local

While direct tariff impacts remain difficult to quantify at this point, we are paying particular attention to potential second-order risks – including currency mismatches for businesses with US dollar liabilities but local currency revenues.

Countries that have been recent beneficiaries of the "China+1" supply chain theme – including India, Vietnam, Thailand, Malaysia and Indonesia – face an uncertain outlook that will only become clearer as and when final tariff terms are agreed.

If these markets become major targets of US tariffs, it will present challenges in the near term. However, with favourable demographics, rising domestic consumption and the need for infrastructure investment, we believe these markets will continue to offer good potential sources of deal flow, especially if domestic bank risk appetite wanes due to macroeconomic uncertainty.

Away from South Asia and South East Asia, we continue to see opportunities in more developed and domestically focused markets like Australia and New Zealand. Meanwhile, in relatively open economies like Singapore and Hong Kong, the structural changes in trade policy are already starting to throw up origination potential where demand for capital solutions could feature strongly.

From a deal perspective, we continue to see opportunities in businesses focused on regional and domestic markets, as well as in defensive sectors like digital and technology related infrastructure, education and healthcare.

Similarly to Europe, APAC may be a beneficiary of investor diversification beyond the US. The region's long-term growth story – driven by favourable demographics and rising consumer demand  – remains compelling, despite short-term challenges.

Looking ahead

As the global economy continues to navigate this period of heightened uncertainty, private debt investors face a delicate balancing act between risk and opportunity. The market is bifurcating – between domestic and international exposures, between upper and lower middle markets, and between cyclical and defensive sectors. These distinctions, which stretch beyond geographic borders, could become increasingly critical to portfolio resilience and returns.

Yet amidst the challenges, compelling opportunities remain – particularly for managers with a local footprint, the flexibility to adjust their strategies to changing environments and the ability to identify attractive niches. Lower-middle market businesses with a domestic or regional focus, companies in essential service sectors, and borrowers with strong pricing power could prove more resilient to the challenges ahead.

The coming months will bring further clarity on how these dynamics will play out across regions. But in a world of economic fragmentation, adaptability and diversification may prove the most valuable tools of all.

 

References

1.The Center for American Progress, ‘What Will Trump’s Tariffs Do for U.S. Consumers, Workers, and Businesses?’ April 1, 2025.
2.Fitch Ratings, ‘US Tariff Implications for APAC Corporates,’ April 10, 2025
3.Corporate Finance Institute, Lower Middle Market, as of May 2025.
4.CEPR, ‘Enhancing the resilience and security of EU supply chains,’ November 12, 2024.

 

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 May 2025 and may change without notice.

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