“A digestion point,” is how one market source described to us the current state of affairs in private debt fundraising. It’s one way of explaining the fall in total capital raised by the asset class globally from $253 billion in 2017 to $176 billion in 2018 and then $147 billion last year, according to Private Debt Investor data.
What lies behind the digestion theory is the belief that so much money was ploughed into private debt funds three years ago – as many investors latched onto the opportunity for the first time – that areas of the market (notably direct lending) became saturated. Consequently, it seems natural for investors to dab the brakes and wait for supply and demand to move back into equilibrium.
But not all parts of the market have joined the downward slide. One segment that has bucked this trend is distressed debt (which, by our definition, includes special situations). There is a view that many LPs have become somewhat bogged down by re-ups, as direct lending funds particularly have returned to market quicker than expected. This has hindered their plans to both diversify and juice up returns.
This is now changing, with capital being deployed into distressed funds at an increasing rate. The strategy accounted for 36 percent of total money raised last year (making it the most popular). Five of the top ten funds that closed in 2019 were distressed debt funds, including Lone Star’s $8.2 billion Fund XI and Blackstone’s $4.5 billion Energy Select Opportunities Fund II.
This shows that investors either have short memories or – more charitably – have found a better way to access distressed debt. In the last downturn, capital flooded into the space only to find the opportunity set was so slim – with banks failing to sell their non-performing loans with the gusto that was anticipated – that much of the capital ended up being diverted into the high yield market.
Many investors also got burnt by fees on committed capital during the period when the distressed opportunity failed to materialise. Perhaps with this in mind, many of today’s funds are raised on a contingency basis that sees much more proactive and considered stewardship of the capital (through investment in liquid products, for example) at times when the distressed opportunity is not optimal.
The majority view appears to be that both diversification into opportunistic strategies as well as more LPs moving into the private debt asset class for the first time will help to sustain positive fundraising momentum in 2020 – in the words of one source, “putting the wind in the sails”. PDI sees no reason to disagree with this assessment. The steady slide since 2017 points more credibly towards LPs taking stock rather than fleeing for the hills.
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