As we take our annual look at the key trends shaping the future of private debt, it seems apt to begin with some cautionary words from our senior editor Andy Thomson, who noted the references made to the ‘golden age of private debt’ at our PDI Forum in New York in September.
So what, he wonders, could possibly go wrong? Surely fundraising capital will flow freely again before much longer? Investors are much more cautious, he says, and have highlighted a number of concerns that they feel should mitigate against complacency.
While it may indeed be a ‘golden age’ for current vintages, there was, as he notes, a view that recent past vintages may struggle unless considerable underwriting discipline has been applied. “What happens when the music stops?” is the rhetorical question he poses.
Graeme Kerr outlines five key takeaways from our Future of Private Debt report, heavily underscored with a note of caution that we really shouldn’t get too carried away with bullish predictions amid unprecedented uncertainty for the asset class.
1 Private debt is better placed than other asset classes
Three years ago, Private Debt Investor launched a cross-asset class Fund Leaders Survey comprising more than 100 senior buyout, growth, private debt, venture capital, real estate and infrastructure executives.
The difficult fundraising climate took its toll on this year’s poll, which found that a smaller proportion – only 56 percent – say their current fund is larger than the predecessor, down from 75 percent in 2022 and 74 percent in 2021. Instead, 30 percent say they are targeting the same amount for their next fund as their last, which was the case for just 1 percent of fundraises last year.
“NAV financing is poised to become an integral part of the private equity financing ecosystem”
Pemberton Asset Management
But market participants say the landscape may be more positive for private debt than other asset classes. “Unlike in private equity where there has definitely been a pronounced slowdown in the need to raise capital and the size of funds, in credit the fundraising numbers are a bit higher,” says Jeffrey Griffiths, co-head of global private credit at placement agent Campbell Lutyens.
“We see more like two-thirds of managers fundraising right now and most groups are looking for larger fund sizes.”
And returns are strong: “This is the best environment we have seen since 2009-10,” say Gregory Racz, president and co-founder, and Daniel Leger, managing director of MGG Investment Group.
“With interest rates much higher and capital scarce because of the pressure on banks, we can get paid more, and it is easier to negotiate the tight covenants and other investor protections that are standard in our loan agreements. We are finding we can get better origination fees and higher floors, so the packaging overall is more favourable to the lenders.”
That point is backed up by Mark Posniak, European lending development director at Arrow Global Group. “Specialist lenders have historically done well in recessionary periods, filling the gap left by the banks as they get to grips with their legacy positions,” he says. “The non-bank lenders can really come into their own if they have efficient capital to deploy, as they can create products to deliver solutions without having to push the boundaries in terms of leverage, borrower solvency and asset quality.”
2 All eyes are on AI
The same survey also suggested a growing role for AI in shaping business and investment processes over the next decade: 63 percent of fund leaders agreed or strongly agreed with the statement that artificial intelligence will be the most significant technology to shape business and industries over the next decade, with due diligence and data analysis seen as the areas of greatest impact.
Keith Miller, global head of private debt at Apex, says this is reflected in a growing number of conversations about opportunities for AI around the review of underlying assets. “That credit review process has always been incredibly manual but the big win for the asset class is the ability to review the underlying assets from a portfolio and risk monitoring perspective and conduct predictive modelling across assets to deliver scenario analysis.”
3 Retail is making inroads
Tokenisation, which can convert private debt assets into tradeable instruments, is opening the door for fund managers to reach out to retail investors. Trailblazers including Hamilton Lane and KKR are already embracing tokenisation as a means to broaden their investor bases and lower minimum subscriptions.
Robin Doumar, founder and managing partner at Park Square Capital, believes retail channels are an “interesting opportunity”.
“We want to be thoughtful and to make sure, from a distribution standpoint, that we’re tapping into that channel in the appropriate way. But while I do agree that it’s important, I think the emphasis might be a little overstated,” he says. “Personally, I think private credit investing is a more natural fit at the most sophisticated end of the individual investor market.”
4 Bigger is better
One notable trend over the past few years has been the increasing deal size – something fund managers fully expect to continue to grow.
Blackstone started its private credit business in 2005 when the deals to mainly small businesses were done privately for more complicated credits. Blackstone’s Brad Marshall says that by 2024, multi-billion-dollar private financing will have multiplied to the point that the firm could lead a $12 billion private financing if an issuer was looking for it.
“Specialist lenders have historically done well in recessionary periods”
Arrow Global Group
“We increasingly see that investing in larger companies has a lot of intuitive advantages,” says Marshall, global head of private credit strategies and chairman and co-CEO of both Blackstone Private Credit Fund and Blackstone Secured Lending Fund. “Bigger companies tend to grow because their products or services are high quality, they may attract a strong management team, a compelling PE sponsor, and they are likely a bit more diverse in terms of their business mix, which de-risks the investment.”
Craig Packer, co-president of Blue Owl Capital, also notes demand for bigger deal sizes. “We recently surveyed 100 private equity firms asking what they would like to see from direct lenders, and it was interesting but not surprising to hear back that they like direct lending, they are happy with the product and they want to use it more,” he says.
“It was very clear that they embrace private credit and want to use it for more solutions, so they would like to see direct lenders broaden out the kind of solutions we offer, particularly in terms of size, where they want to work with larger players that can write and hold bigger cheques.”
5 NAV lending is set to grow
A decade ago, the sub lines market was in its early stages and there was much hesitancy about its adoption as a fund management tool. Now it is used by more than 90 percent of private equity funds, and many predict that NAV financing will go the same way.
In an environment of longer hold periods, NAV facilities offer both a route to liquidity to effectively provide a bridge to LPs waiting for assets to sell and a source of capital to keep driving value creation at the tail end of a fund’s life.
“NAV financing is currently estimated to be around $100 billion in volume. We certainly see this as becoming larger than the sub line business, which is now worth over $500 billion globally – and that is just for buyouts,” says Thomas Doyle, partner and head of NAV financing at Pemberton Asset Management.
NAV financing is “an all-weather solution”. Pemberton expects adoption to keep accelerating as it becomes clearly designated as a private debt product with private debt structures, covenants and instruments. “NAV financing is relevant across market conditions in both up- and down-market cycles. We therefore believe that NAV financing is poised to become an integral part of the private equity financing ecosystem.”
Matthew Taylor, head of alternative debt at LGIM RA, agrees that the NAV financing space, although relatively small compared with subscription lending, has growth potential. “There are a small number of institutional investors today alongside banks, and activity levels for both can be expected to mushroom in the coming years. That is a market we are watching closely,” he says.