Friday Letter: Future proofing in 2016

It’s been a great year for private debt, but challenges on the horizon mean the next 12 months could be much more interesting.

Growing market share, strong fundraising, increased investor appetite and understanding, as well as evolving depth and sophistication on the manager side, have all contributed to one of the best years for private debt as a developing asset class.

And looking ahead, 2016 promises to be exciting, too. This month, PDI published our first survey of investor attitudes to private debt alongside a forward look at allocation intentions over the next 12 months. The results showed overwhelmingly that investor appetite for private debt is on the rise.

On the investment side, the stats are also strong. In Europe, Deloitte’s corporate debt advisory team publishes a quarterly review of deals done by alternative lenders. The latest edition, covering the second quarter of 2015, showed a 67 percent year-on-year rise in deals signed. The tracker also reveals that in Europe private credit providers are taking market share from banks, with 85 percent of the transactions recorded by Deloitte sitting in traditional bank loan territory.

And growth is not restricted to Europe. As PDI highlighted here last week, managers are increasingly looking to Asia-Pacific for new opportunities.

But for all that 2015 was a great year, 2016 will be a different beast.

The Fed raised interest rates this week. And while the move was anticipated and greeted by markets with something akin to relief, the impact will be profound and long-term as one of the world’s largest economies moves towards a more ‘normal’ interest rate following almost 10 years with rates at rock bottom.

More significantly for private debt as an asset class, managers in the US are looking towards a turn in the credit cycle. How long-established and newer managers come through a period of rising defaults will be significant for the whole asset class.

The full force of rising defaults is unlikely to be felt in 2016, the anticipation period as well as preparation for it has already begun.

And it’s not just the US that ought to be wary. Most private debt managers in Europe and Asia-Pacific are new players. They may have teams built around individuals with decades of experience but, institutionally, they are young and untested. And if the 2008 crisis taught investors anything, it is that strong institutions are essential.

It is this stage of the cycle that typically brings some players down; it doesn’t take many months of over-enthusiastic refinancing to create years of workout pain.

So even as debt managers congratulate themselves on a good year, they ought to look towards 2016 with enthusiasm tempered by caution.