What do limited partners want from private debt? And how much are they prepared to pay for it? These are pressing questions at a time when a report from US research and investment due diligence firm Cliffwater reveals that fees charged by fund managers can vary considerably, even when those managers are targeting the same part of the market.
In a universe that also includes the likes of distressed debt and speciality finance, direct lending is arguably private credit’s plain vanilla flavour. Uniformity is what you might expect, including when it comes to fee charging. What Cliffwater discovered was rather different. It found that a wide range of management fees were being charged, and that “only a fraction” of this variety could be explained by whether fees were charged on net or gross assets. The fee range was 0.75 percent, which Cliffwater described as “a very meaningful difference for any asset class”.
The fact that 2020 was a subdued fundraising year for private debt is not much of a surprise given the onset of the pandemic and the subsequent reliance on remote due diligence. However, it would not be a good idea for fund managers to complacently assume that capital raising will become much more straightforward once the effects of the health crisis begin to subside.
According to a placement agent we recently spoke with, covid-19 has created a state of flux in which investors are re-examining the pre-pandemic rules of engagement with private debt managers to make sure they are still appropriate. GPs may be in for a rude awakening if they rely on what was normal a year ago still being normal today. “LPs don’t want to hear from GPs bluntly asking them for primary fund tickets,” said the placement agent. “That’s naïve. LPs are trying to work the situation out.”
The same source said seed investments were seen as useful in terms of de-risking a portfolio prior to the pandemic. At the height of the first wave of the coronavirus, such an approach was frowned upon as investors did not want exposure to covid-affected businesses. Today, investments made during that period are seen as much more desirable. It underlines the point that LP views are changing fast in turbulent times and the key for managers is to engage with investors more closely than ever before.
How investors commit in future may be through a separately managed account, a secondaries investment or some sort of hybrid approach – all three are predicted to find favour. It may not be a standard commingled fund. What the pandemic has brought home to LPs is that some sectors and types of businesses have fared well while others have struggled. There is still a lot to play out in terms of winners and losers, but one outcome that is crystal clear is the sharp focus LPs will now have on tailored solutions that fit their specific needs – regardless of the format in which the solution is delivered.
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