This article is sponsored by Alter Domus
What fundraising trends are you seeing in European private debt?
Spencer Wells: Europe’s appetite for investing in private debt is probably at its highest to date, with an expanded variety of investors coming in with particular interest in the real estate private debt space. Investors are especially attracted to the risk-return profile of those asset classes and the speed with which those returns can be delivered. Real estate assets are highly sought after in the UK and throughout Europe at the moment, with the UK in particular enjoying high demand for investment in development projects such as logistics and student accommodation.
Both banks and private lenders have continued to fulfil borrower needs, owing either to increased demand or easier access to funding sources. We’re also seeing ever-more sophisticated real estate and infrastructure debt lenders coming into the space. The industry is maturing with both private debt managers and investors boasting teams of specialists familiar with the assets, resulting in a higher frequency of deals coming through.
Patrick McCullagh: Over the last few months we have seen greater activity from CEE-focused managers and debt funds. The rise in the number of portfolio investments made by special situations funds shows a large number of private debt managers are no longer dependent upon a sponsor and can demonstrate their ability to source their own pipelines. Investors still see the market as very strong, so the challenge for managers has shifted away from finding investors and more towards finding good debt to fund or acquire.
How are investor attitudes and demands changing over time?
PM: We certainly see an increase in the level of expertise many investors possess, so it’s now evident that both investors and managers have a much better understanding of the type of information they need in order to analyse and manage the investments which are being made. Reporting, particularly at a portfolio level, has a much deeper level of detail and granularity, and investors are pushing for still more of ways of collecting, viewing and analysing that information.
SW: The onus is on administrators to be ahead of the curve in providing managers and investors with what they need, according to the profile of the assets they’re investing in and the type of asset form. US investors may have different needs to European LPs, for instance, and can find themselves subject to Alternative Investment Fund Managers Directive regulation, perhaps for the first time, so they need people who are able to guide them through the relevant processes and procedures.
What can European managers do to attract US investors?
SW: The key thing when it comes to crossing the Atlantic is making it easy for those investors to come into the fund. European private debt is a nice diversification strategy for US investors, and they are aware of all the opportunities that exist and the decent returns on offer. Despite these major attractions, the managers definitely need the right infrastructure and advice in place to support them with unfamiliar aspects.
PM: As well as seeing US investors coming into European funds, we also see a good number of US managers setting up parallel funds to attract European investors. They often incorporate special structuring or, for example, strategies such as ‘season and sell’ to avoid a fund being classified as engaged in a US trade or business and therefore exposed to unrelated business taxable income. In the case of ‘season and sell’ we often see two parallel funds formed – one in the US and one offshore – with the US fund originating the loan, holding it for a period of time, and then selling it to the offshore fund. Special transatlantic arrangements like this require managers and administrators to be well aligned with tax and legal advisers who can support investors through complex structuring.
SW: It is also important for managers to make their funds appealing from a financial point of view. When trying to attract US investors who generally operate on a tight total expense ratio in the US, you need good terms and cost controls set up in order to attract them. Having the right fund administration and reporting platform and technology in place is key, and so is having staff with a track record of administering similar funds and portfolios. Debt is an asset class that requires fund administrators with specific expertise in this area.
Where do you see the European private debt markets expanding in the year ahead?
SW: We are seeing more collateralised loan obligation activity returning after a few quieter years. The big providers are setting up new CLOs to support the increased amount of private debt in the market and it makes sense for some of that to be collateralised into bigger portfolios. The rating agencies are also much closer to the market. We see a lot of opportunities in the CLO space; where private debt funds may have 30 loans in a portfolio, CLOs might have more than five times that, and as an administrator, we have the ability to service them.
PM: We’re continuing to see new debt managers enter the market too, although the barriers to entry may be getting a bit higher owing to the demands of regulatory and investor reporting. Investors now have more choice about which debt strategies they invest in and are often keen to see a proven track record of loans being created and well managed. Equally, the challenging reporting requirements continue to have a barrier-to-entry effect amongst administrators as well. Administering and reporting on complex real estate and private debt structures requires substantial investment in teams and technology, both of which we’ve seen many administrators shy away from. In fact, only a small fraction of specialist administrators have invested in real value-added middle-office teams and platforms to perform this work. The reality is, the complexity of administering debt assets requires strong, technology-enabled middle office teams.
This is something we’ve invested heavily in at Alter Domus because we realise that the asset class requires more than just debt-focused tools. It requires teams who understand the nuances of the asset class to be able to leverage that technology in ways that ultimately deliver on managers’ and investors’ expectations. Our debt operations expertise is a combination of teams consisting of CFAs, MBAs and professionals with deep experience evaluating loan agreements. Many have learned about the debt market having gained hands-on experience in the field, and then place that expertise alongside our technology tools to provide a seamless service delivery to our clients. It’s that combination of experienced teams and dedicated technology that really helps new debt managers find their footing.
Do you see a growing sophistication in performance measurement in private debt?
SW: Yes. You’ve now got specialist private debt teams behind the administrators just as you have behind the managers, because the volume and complexity of the work requires specialists who can aggregate and present the data for investors to be able to adequately monitor portfolio performance. While overall the market performs well, there will still be occasional non-performing assets and it is vital for the manager to be able to show investors what has happened, why, what the work-out strategy is and how that will affect their investment. The increased scale and complexity of debt activity also means that a lack of expertise by a manager or administrator is more easily uncovered and can cause fundamental issues.
PM: Due to the typically shorter fund lifecycles for private debt funds compared with private equity funds, (eg, four to six years instead of eight to 12) we also see many of our debt fund manager clients launching second and third funds more quickly than in other asset classes, with people quickly getting up to three or four funds over a four- or five-year period. That means the market renews quickly and delivers more strategy fine-tuning and diversification, which needs understanding and support from specialist partners, whether they be law firms or administrators for example. It’s certainly an exciting sector to work in and one where continued investment in human expertise, technology and operational scale are vital for keeping pace with the growing sophistication and needs of debt fund managers, investors and borrowers.