5 things you need to know about European debt

The asset class is at an important junction in its history, both in terms of its growth trajectory and the external pressures it faces. Here are the top themes.

1. More investors are looking to Europe…

The private debt investor universe has expanded in recent years as investors have formalised their allocations. Increasingly, it is treated as an asset class in its own right and not merely as an odd hybrid of fixed income and alternatives. The community is also expanding in terms of geography. While European investors – being close to the source – have traditionally accounted for a large share of commitments in the region, some US investors are also keen to bolster their exposure.

A recent qualitative survey held at the PDI New York Forum revealed that 25 percent of investors attending the event plan to increase their allocation. However, there are still a few hurdles to jump before many US investors decide to fully commit (see p. 38). Asian investors, though they account for a relatively small piece of the limited partners pie, could yet a have a bigger role to play. Symon Drake-Brockman, a managing partner at Pemberton AM, notes on p. 8 that Asian investors, attracted by currency hedging and a relatively immature market, are increasingly drawn to the region. With titans like Japan’s Government Pension Investment Fund and Singapore’s GIC among them, even a small increase in Asian allocations would mean a lot more capital to play with.

2. …but it is getting harder to stand out

The ability to be flexible and offer diversity has long been a virtue in the private debt industry and was a major theme of this report last year. Little has changed in that regard. If anything, the case for differentiation is stronger as the European market matures. There are two factors behind this. Firstly, more mangers have entered the market, so standing out from your competitors is harder. Secondly, more and more money is gravitating towards the biggest players every year.

Limited partners, especially the inexperienced ones coming into the market, put a lot of value in track record and brand name. So, unless general partners can count themselves among the market leaders, they need to work to set themselves apart. On p. 26, Andrew Ritchie notes managers are increasingly differentiating on cost, speed and flexibility. At the same time, investors do not like volatility, so strong risk and credit management is also a key characteristic.

3. Special situations are gaining traction

Senior debt still remains a dominant strategy in European private debt, and PDI’s data on fundraising and funds in market bear that out. That said, distressed, special situations and subordinated debt strategies are growing in importance. Private debt funds are looking to raise approximately $24. 4 billion across these strategies. There is LP appetite for it too. Private debt investors are increasingly sophisticated and have previous experience in private equity. As such, they are more willing to look at distressed debt, special situations, and other investments that might be further down the capital stack. There is also the matter of where we are in the cycle. Pemberton’s Drake-Brockman points out distressed players have already started to market quite heavily in the US in anticipation of a slowdown. For Europe, that may be a couple more years down the line, especially if interest rates are slow to rise. Nevertheless, investors are thinking about putting money towards distressed in anticipation of future opportunities. However, few can confidently predict the macroeconomic environment, especially in such a politically volatile time.

4. Politics looms larger…

The ‘B-word’ has dominated European discourse to such an extent over the past two years that one even tires of saying the word. Indeed, last year’s European report avoided the topic where possible to demonstrate that the UK’s exit from the EU was not the be-all-and-end-all for European private debt – and it isn’t. That said, with a very possible “no-deal” a mere four months away, it has become the elephant in the room that must be addressed. The consensus seems to be that the event will have negatives and positives for managers depending on how they exploit the opportunity. In our roundtable, Christopher Bone, Partners Group’s head of European debt notes: “We are looking to see where macro risk as led to mispricing. Of course, you do have to avoid getting caught in the middle of the storm in March.”After March, other political confrontations – namely tension between the EU and Italy’s administration (see p. 30), plus external threats from ongoing trades disputes – may have an even bigger impact on Europe.

5. …and so does technology

In the fullness of time, technology may prove to be a bigger disruptor than politics.
LPs are more sophisticated, but they are also more discriminating. This is true
in terms of the type of information they expect and how they access it. Partners
Group’s Bone notes that investors want to see things like pricing and leverage in real time
on their mobile devices. “Technology risk is a black swan and [investors] are
very keen to know how technology is impacting portfolio companies.”
It is in this area that smaller European managers may be at a disadvantage. But,
as many have already pointed out, having the best system to extract data does not
always guarantee a manager will be the best user of that data.