With so many investors looking to increase private credit allocations over the next 12 months, there is a corresponding demand to diversify fund manager relationships. Nearly one in six private debt investors hope to increase the number of managers they work with over the coming year, with a further 30 percent hoping to keep the number of relationships the same.
We see this demand for a more diverse range of relationships steadily increasing over the past few years, with 44 percent looking to work with more managers in 2020 and 59 percent today. LPs are reticent about investing with first-time managers, thereby limiting their ability to expand their rosters.
Of investors, 50 percent in private debt say they never invest with first-time managers, and only 5 percent say they are more likely to invest in a first-time manager this year than they were last; 14 percent are less likely than they were a year ago to back a new entrant.
The hurdles that emerging managers have to jump have always been high, with most LPs reluctant to entertain conversations with any new managers that cannot demonstrate a proven track record, seed capital, a niche strategy and, ideally, some attachment to a larger private markets platform.
And as if that were not difficult enough, the pandemic has made it even harder for first-time managers to build relationships with prospective investors.
Jess Larsen, CEO and founder of specialist placement agent Briarcliffe Credit Partners, told Private Debt Investor in November 2021: “Pre-covid, over the last 10 years, on average the top 50 private credit GPs raised about 70 percent of all assets on an annual basis. If you weren’t in the top 50, you were fighting over that remaining 30 percent. Then covid hit, LPs weren’t able to meet new managers and establish new relationships, so the concentration of capital among the top 50 went up from 70 percent to 90 percent.”
The hunger for a more diverse range of opportunities among LPs means it is possible for managers to break through. Klaus Petersen launched Apera Asset Management in 2019 after leaving BlueBay Asset Management, where he was head of German direct lending. He was able to raise €750 million for Apera Capital Private Debt Fund I, which provides senior secured loans to lower mid-market companies in northwestern Europe, in one of the largest first-time fundraises of recent years.
He says one of the biggest challenges for new managers is infrastructure: “You can be very experienced, but unless you have an infrastructure comparable to existing players, how can you expect to convince people to give you significant amounts of money to manage on their behalf?”
Differentiate to succeed
But the real key to success for any manager is differentiation, and that is what is driving investor appetite to work with a wider pool of funds. Petersen argues the bigger private debt players are so focused on the top end of the direct lending market that they are leaving an opportunity for new entrants.
“We were differentiated because as funds have grown massively and started doing much larger deals, they are leaving behind a market segment that is the biggest by numbers, because it doesn’t make sense to do €60 million tickets with a €10 billion fund,” he says. “That market segment is underserved, with banks also rotating out of the space. The big guys are focused elsewhere and that just creates a massive opportunity.”
The question now is the extent to which the concentration of capital in the hands of bigger funds will continue as covid restrictions ease.
Some are already reporting a thaw. US law firm Seward & Kissel published a survey that showed four out of five investors allocating to managers founded less than two years ago.
Partner Kevin Neubauer said: “In 2020, managers who had existing relationships were much more successful at raising capital than emerging managers. A lot of emerging managers pushed ahead and did their best, but maybe their fundraising results were not as good as they had expected.
“At the start of 2021, there was a recognition from institutional investors that if they did not get comfortable with remote meetings they were going to miss out on good opportunities with emerging managers. We have seen an uptick and there is certainly still institutional investor appetite for new managers.”
Investors are cognisant of the fact that new managers bring innovation and creativity, albeit with heightened risk, and their desire to work with more players may foster more appetite for first-time funds going forward.