Loan Note: Key themes in fund structuring; Oaktree says rate pressure yet to feed through

They said it

“Q3 2023 provided further confirmation of the ‘higher for longer’ interest rate environment that we had been expecting, alongside a key consequence for corporate borrowers: a higher cost of capital”

Taken from BlackRock’s latest Global Credit Weekly

First look

What’s front of mind in fund structuring

A survey from law firm Dechert and the Alternative Credit Council identified four key themes in European private credit fund structuring, indicating greater complexity as the asset class increasingly reaches out to new types of investor. The themes are as follows:

Customisation: The majority of capital allocated to private credit strategies continues to be through commingled funds, but 95 percent of managers now offer managed accounts for single investors – with half doing so for tickets of over $100 million and the other half doing so for smaller tickets. More than two-thirds of respondents to the survey said they expected demand for co-investment to increase.

Liquidity: An increasing number of evergreen and hybrid vehicles – combining aspects of closed-end and open-end funds – are now offering investors partial liquidity. More than half of respondents to the survey (51 percent) said they offer investors some form of right to redemption. Managers are increasingly employing a range of liquidity risk management tools to align the liquidity profile of the fund with any right of redemption.

Retail capital: The hunt for retail capital is intensifying. Of the surveyed manager, 41 percent said they currently have retail clients and 66 percent said they are either currently considering – or will consider – retail clients for upcoming fund offerings. Those considering retail for future fundraises said they would primarily focus on high-net-worth individuals and semi-professional retail investors. The survey noted that there remain operational challenges relating to marketing and distribution, but that new vehicles such as the European Long-Term Investment Fund and UK Long Term Asset Fund would help.

Domicile familiarity: Familiarity was cited as a major factor in the popularity of Luxembourg and the Cayman Islands as domiciles, with 59 percent of managers saying they had a fund based in these jurisdictions. The US, Ireland and the UK were the next most favoured domiciles. Other factors driving domicile decisions include marketing restrictions, tax neutrality and regulatory certainty.

Oaktree: Don’t assume we’re through the worst

There may be few signs of it so far, but a new Oaktree Insights report says distress could become apparent, even if the US avoids recession.

Oaktree acknowledges that “many companies appear to be weathering the sea change in interest rates surprisingly well”. But in its view, the “storm clouds are gathering” and there should be no room for complacency.

The problem with elevated interest rates is the pressure it is putting on companies to service their floating rate debt. Signs of this are already being seen in the increased pace of defaults and distressed exchanges over the last nine months, and Oaktree says it expects distressed opportunities to expand further – regardless of whether recession hits or not.

Oaktree expects to see this distress in both leveraged loans and private debt, which are both largely characterised by floating rates. The firm points out that, according to its estimates, around two-thirds of the US loan market was unhedged against interest rate risk at the end of 2021. Since then, the three-month SOFR reference rate has increased more than 5 percent.

Backing Oaktree’s view that current performance should not be viewed complacently, Oaktree points out that loans’ reference rates aren’t immediately reflected in companies’ interest expenses – and firms that failed to hedge are only just now starting to contend with much higher borrowing costs.

A call to LPs

Our LP Perspectives 2024 Survey is now live, and we would greatly appreciate your participation as we seek to understand investor sentiment in the private markets today. Here’s the survey link.

Some pointers on this year’s survey:

LP Perspectives is PEI Group’s annual study of institutional investors’ approach to private market asset classes over the coming year. The survey gathers insight on investors’ asset allocations, propensity to invest, performance predictions and views on the wider market.

The results will be published across all our titles.

Respondents will receive the results of the asset class of their choice as a thank you for completing the survey. PEI Group will also donate $5 to UNICEF for each completed response.

The survey takes no longer than 10 minutes to complete, and all submissions will remain anonymous.

The deadline for submissions is Friday 6 October.

Essentials