There are bargains to be had in private debt

With the holiday season fast approaching, it’s the time of year when discerning consumers are readying themselves to try to drive a few hard bargains. If you’re an LP, your festive mood will no doubt be lightened by the “discounts available” sign hanging from the door of your nearest private debt shop.

A story we ran this week highlighted just how fee-conscious private debt firms have become. In the case of Urbanite Capital, this extends to charging no management or performance fees at all on its second fund – instead, the firm will pay itself any surplus over and above an agreed fixed quarterly return.

This may an extreme example, but what is clear from the recently published Financing the Economy 2018 survey by industry body AIMA and law firm Dechert is that fees have been tumbling since private debt first emerged from being a mere subset of private equity. Back in the pre-crisis days, and in the immediate period thereafter, many private debt firms attempted to cling to private equity’s “2 and 20” fee and carried interest model.

No one can blame them for trying, but those days are long gone. The survey found the average management fee charged by private debt managers today is 1.29 percent and average carried interest is 15 percent. These figures can vary greatly depending on the type of strategy but what is almost universal, it seems, is a willingness to consider lowering fees even further. No fewer than 80 percent of managers said they would think about lowering their current fee rates for the right investor. Over the last two years, 25 percent of debt managers have lowered fees and only 9 percent increased them.

One of the more notable features of private debt fee charging is its focus on drawn capital only – an approach characteristic of four in five managers. The survey described this as a “key selling point” of the private credit industry and is a contrast with other asset classes. The recent Fees and Expenses Survey 2018 carried out by sister title pfm found that only 30 percent of private markets managers (mostly private equity GPs) were holding off from charging fees until capital was called.

The survey did draw attention to a potential drawback of charging fees only on drawn capital, namely the temptation to make investments simply to pay the bills rather than putting money to work only in those deals where managers have the greatest conviction. But all it means is that the onus is on LPs to take a detailed look at their managers’ loan origination and risk analysis teams. It might demand a lot of time and effort, but that’s one price investors will likely be prepared to pay.

Write to the author at andy.t@peimedia.com