It’s often said you should never rush to conclusions. Was the decline in global private debt fundraising a sensible pause for breath by investors that had committed unprecedented sums to the asset class the previous year? Or was it more a case of investors taking fright because of concerns about economic and political volatility – as well as increasingly questionable deal structures?
It may take a while before answers to these questions become apparent, but one thing that can be seen clearly from the fundraising data we compile is that Europe bucked the trend. Almost 30 percent of private debt capital raised in 2018 was for funds with a sole focus on the continent – the first increase in funding for the region, relative to the rest of the world, since 2014.
Delegates at our PDI Germany Forum this summer were upbeat about the continent’s appeal: 55 percent said they planned to increase European exposure over the next 12-18 months compared with just 30 percent who projected higher investment in the US.
Sources have told us that one factor relevant to the region’s growing popularity is the increasing willingness of European managers to offer leveraged options at the fund level. Leveraged private debt funds have long been a part of the landscape in the US, where investors have become entirely comfortable with the role of leverage in enhancing returns. In Europe, until recently, this has not been the case.
Part of the reason behind the cultural shift in Europe towards embracing fund leverage may be the growing presence there of US-based managers. Ares Management, for example, has been going gangbusters on the fundraising front. This included closing its fourth European direct lending vehicle last year on €6.5 billion, a figure that rose to €10 billion when leverage was factored in. Not bad for a fund with an initial hard-cap of €4.5 billion.
To lever or not to lever?
Of course, not everyone has the pulling power of the big brand names. As one market source pointed out to us: “There are still plenty of direct lending funds offering unleveraged only. Ares and others are able to offer levered and unlevered options and ask investors which one they want. In the end, it boils down to your view on the manager. How good will they be at choosing the right credits and making sure the right protections are in place?”
There can also be concerns over how the leverage might be used – just for deals, or areas such as manager compensation or hedging? Another focus is how the leverage is put together, which is normally by way of a bank facility with appropriate security. If it’s not structured correctly, it could fall foul of regulations, such as the EU’s Alternative Investment Fund Managers Directive.
But what does appear to be changing is the perception that relatively low-risk strategies, such as direct lending, should of necessity be unleveraged because of leverage’s association with high risk. The boundaries of risk appetite are being tested in Europe in the way they already have been in the US – and it’s a development US LPs appear happy to support.