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What are you currently observing in terms of capital flows into European private debt?
We still see a dominance of local for local, so European money going into European opportunities. That really accentuated over 2020 and into 2021, but we have started to see glimmers of it defrosting, with US investors starting to consider investing in Europe and certainly European investors looking to the US. It has been quite tough for a European manager to raise money in the US due to a lack of travel and in-person meetings. But the opportunity set for Europe remains really interesting so it should be just a matter of time.
Anyone launching now and looking to raise money globally needs to factor in a longer timeline. While Europe is an active fundraising market it is less mature in private debt relative to the US; firms can raise meaningful amounts here but are missing out on those deeper pools of capital. A longer time horizon allows for onsites and trips to the US to eventually return.
Where do you see expanding areas of opportunity?
The beauty of the European opportunity set is that the region is highly fragmented. Beyond the vanilla private debt opportunities in direct lending, we are seeing an expansion in the toolkit of many European private debt platforms.
We have definitely seen newer strategies like fund finance, venture debt and specialty finance gaining ground. Venture debt is an established part of the US framework of private debt strategies but very nascent here with only a handful of GPs. Similarly, consumer lending and specialty finance strategies are interesting because there are not many players here and we are talking about highly granular pools of underlying loans that have proven to be fairly resilient because of the diverse nature of the exposure.
In the face of downward pressure on returns in direct lending and questions around deployment pace, investors are really keen on strategies that offer a ‘direct lending alternative’, with a strong cash yield profile, and relatively mitigated downside risk through the structure or through covenants.
What challenges do managers fundraising for niche strategies currently face?
In Europe, the investor base for private debt is still growing and maturing. While investors are moving up the learning curve the bulk of the capital still remains focused on senior opportunities, vanilla private debt, probably more towards direct lending allocations and continuing with existing GP relationships. However, those that were early into the space or are de-risking from equity allocations are looking for diversification and have really embraced niche, specialist strategies.
The key for anyone looking to offer something differentiated is to really home in on repeatable returns, as well as show that despite running a niche strategy, they still have the framework necessary to serve institutional capital. If they can do that, and really demonstrate expertise in their field, they’ll find an audience. We are certainly excited by the opportunities we see in the market, but it is not easy.
How are the lines blurring between public and private debt markets, and how might that trend evolve?
We saw through 2020, when there were huge swings in the market, that those with an ability to be a bit more tactical were able to deliver really interesting returns to their investors. They have been rewarded with the ability to remain flexible, so we are starting to see a few more managers embedding the ability to cross between public and private where they see the opportunity, and that has resonated with investors.
There’s still a large group of investors that have quite defined segregation between public and private allocations, with different teams making those decisions, so if a private debt fund has too much public market exposure, they can end up falling between two stools. But increasingly, with credit opportunity funds and special situation funds, we continue to see flexibility from investors for managers to explore things outside pure private debt.
The flipside of that is we did see some hedge funds moving towards less liquid opportunities and setting up side vehicles last year. In that context, there’s probably more of a mismatch between liquidity for investors and the investments they were making. It is easier to be flexible and play into opportunities with a seven-to-10-year lock-up.
Finally, what are the latest developments around sustainability in private debt?
We are seeing a lot of integration of ESG into private debt, with talk about whether private debt strategies can be Article 8 or Article 9 under the Sustainable Finance Disclosure Regulation.
What’s really interesting, however, is we are starting to see an expansion in the sustainability sector, where historically it has all been about equity strategies. There is now growing interest from investors as well as growing opportunities for third-party capital to get into financing strategies in the sustainability sector.
We are talking about things like managers offering access to renewables debt financing, which has historically been dominated by banks and usually associated with more developed opportunities. Now, you can find some managers raising funds focused on early stage construction financing for things like solar platforms.
This is really an expansion of infrastructure debt, which was historically very focused on senior infrastructure lending to underlying assets and was embraced by long-term pension funds and insurers. That’s developed to much more of a strategy that can be embraced by private debt allocations, and resonates because it’s yielding, there’s a hard asset underpinning, it’s inflation-linked and there is duration.
As such, there’s a growing ability to be a debt provider and drive a sustainable agenda. We are suggesting that is not just going to sit with infrastructure allocators but increasingly with private debt allocators looking to diversify from just corporate cashflow lending.
With the growing interest in ‘non-correlated’ strategies, what examples are you seeing in the market?
Investors are looking for something differentiated and now, given the mini cycles we have been experiencing, non-correlated strategies are gaining more traction. But the challenges remain the same, because it is often hard to scale into these opportunities and they are typically serviced by smaller managers. We have seen a few groups pull together multiple strategies for this non-correlated theme, but those are rare. As the European private debt market matures, we expect the ‘supply’ side of the opportunity set is likely to expand, making some niche strategies more scalable over time.