Loan Note: Private debt luring dollars from private equity; investors accept a new era has dawned

Flexstone highlights a shift from private equity to private debt. Plus: why the higher-rate environment is no short-term blip; and Ares makes progress on its latest direct lending fund. Here’s today’s brief for our valued subscribers only.

They said it

“Despite the rapid growth of private credit assets under management, which may on the surface suggest irrational exuberance, private/direct lending has not added meaningful leverage overall”

Khalid Khan, head of portfolio management at Aeon Investments, defending the asset class against the prospect of tougher regulation.

First look

Riding a wave: private debt attracting private equity capital (Source: Getty)

Feeling flexible

Private markets investors are said to be leaning into private debt at the expense of private equity in this high-interest rate environment, according to reporting from our colleagues on Private Equity International.

That’s certainly the experience of Flexstone Partners, a Paris-headquartered investment firm owned by Natixis Investment Managers. “Our clients have told us that they are reducing allocation to private equity and increasing private debt – that is a very definite trend, and it makes a lot of sense,” managing partner Eric Deram told affiliate title Private Equity International’s Side Letter. “They’re not changing the overall allocation to private assets, but they’re balancing a little bit within private assets.”

Flexstone has approximately $10.1 billion of assets under management, about two-thirds of which are SMAs and the remainder being funds of funds, secondaries funds and co-investment vehicles. The manager’s clients are 70 percent Europe-based institutions and 20 percent Asia-based institutions, while US-based clients are mostly from the private wealth channel.

Flexstone’s clients aren’t alone in eyeing private debt. More than 60 percent of surveyed asset managers, hedge funds and wealth managers plan to increase their allocations to private credit, according to October research from Coalition Greenwich and Percent. A report on the survey supports estimates that the private credit market could more than double in assets under management from $1.3 trillion, the value it assigns to the end of 2022, to $2.7 trillion by 2026.

Just last week, Side Letter noted that the ¥103 trillion ($691.4 billion; €632.7 billion) Japan Post Bank is leaning into debt amid a slowdown in private equity distributions. This strategic shift will include the likes of infrastructure debt and mezzanine investments. It is designed to brace JPB’s portfolio “in case the economy should experience weakness”.

That investors are backing credit when rates are high isn’t exactly unexpected. This dynamic could, however, represent yet another unwelcome headwind for PE fundraisers struggling to capture LP dollars.

Higher rates here to stay

Investors are being forced to re-evaluate their investment strategies as they concede that we have entered a new era of policy and market behaviour – dashing hopes of a quick return to prior conditions – according to Schroders’ Global Investor Study 2023.

The study of 23,000 investors in 33 locations globally found that almost 80 percent believe that – with higher inflation and interest rates – we are witnessing a regime shift for policy and markets. Forty-seven percent agreed with the suggestion and 31 percent strongly agreed.

This is a sharp contrast with the equivalent study last year when respondents overall believed conditions to be temporary with a quick return to a benign, low-rate environment expected.

In light of an acceptance of the new reality, 54 percent said they had already adjusted their investment strategies and a further 34 percent said they hadn’t yet but intended to do so.

Investors were optimistic when it came to returns, with 42 percent thinking returns over the next 12 months would be higher than the previous 12 months and 18 percent predicting they will be significantly higher.

Ares’ $7.4bn second close for direct lending fund

Ares Management, the Los Angeles-based fund manager, has set a $10 billion target for its third senior direct lending offering, according to a person familiar with the matter. On its second close, this month, the fund was at $7.4 billion seven months after launch.

The fund, Ares Senior Direct Lending Fund III, will follow a first-lien senior debt strategy, lending to sponsor-backed mid-market private companies.

Fund III will specifically look for North American (and, more specifically, US) enterprises with EBITDA of more than $10 million and less than $150 million. It will be looking to commit $50 million to $159 million per transaction, and hold its positions for two to three years.

It has received commitments from, among many other institutions, the Arizona Public Safety Personnel Retirement System and the Teachers’ Retirement System of Louisiana ($200 million each) according to PDI data.

Ares Management has total assets under management of close to $395 billion. It declined to comment on the second close.

Essentials

Amundi, Indosuez link up with digital platform

AirFund, a Paris-based digital platform created in 2021 to facilitate the link between management companies and distributors of private markets funds with retail investors, has announced a financing round of €6 million.

The new round is jointly led by Amundi and Indosuez Wealth Management, which become minority cornerstone shareholders and will participate in the company’s governance and strategic committee.

The transaction will help market private asset funds managed by Amundi and Indosuez and facilitate subscription and repurchase transactions in the funds.

AirFund and Amundi Alternative & Real Assets will join forces to expand their offerings. On the one hand, funds managed by Amundi will be accessible via AirFund, enabling the company to reach new customers and serve existing Amundi customers through new digital channels.

On the other hand, Amundi’s expertise will help AirFund to offer tailor-made real asset fund of funds and feeder fund vehicles, meeting demand from AirFund’s clients, whether asset management companies or distributors.

By partnering with AirFund, Indosuez Wealth Management will digitalise the distribution of its private markets funds to its large private investors, the Crédit Agricole Group’s network banks and its external distribution partners. The partnership is in line with Indosuez’s development strategy to take the growth of its private markets business beyond €10 billion in assets under management by 2025.

Large debut CLO for Sona

Sona Asset Management, the London- and New York-based alternative asset manager, has priced its first-ever collateralised loan obligation.

Sona Fios CLO I, priced at almost €424 million, was – according to the firm – the largest European CLO from a debut 2.0 CLO platform. Investors comprised a mixture of institutional investors and asset managers.

The strategy seeks to drive returns and protect downside by active portfolio management, constructing and maintaining an investment portfolio with a focus on relative value and capital preservation.

In early 2023, Sona hired Jacob Walton from Rothschild & Co to join Ludovic Walter as co-portfolio manager of the Fios CLO strategy.

Founded in 2016 by chief investment officer John Aylward – previously a senior executive at Highbridge Capital Management – Sona has a long/short credit hedge fund and a capital solutions private credit strategy.

Most rated Italian companies stable

Rated Italian companies should be able to withstand current economic weakness and preserve their credit quality, according to an S&P Ratings report (login required).

“Four-fifths of rated Italian companies have a stable outlook, indicating credit resilience in 2024 ahead of current economic weakness,” said S&P Global Ratings credit analyst Renato Panichi. “Negative outlooks, at a moderate 11 percent of total ratings, are unchanged compared with 2022, and slightly better than the European average,” he added.

Italian companies’ revenues should increase by a moderate 5 percent in 2024, in line with the European average and similar to 2023. Falling volumes due to the current weak economic environment should partly offset the continued pass-through of cost inflation.

EBITDA has recovered to pre-pandemic levels, boosted by higher inflation since 2022, as in European peer countries. Energy costs moderated significantly since the peak reached in Q3 2022 due to lower demand from corporates and households, thus easing concerns on companies’ competitiveness. However, current geopolitical tensions could amplify volatility ahead of next winter.

LP watch

Institution: Kansas City Public School Retirement System
Headquarters: Kansas City, US
AUM: $749.6 million
Allocation to private debt: 5%

Kansas City Public School Retirement System (KCPSRS) announced updates in its maiden private credit programme in its 6 November board meeting.

The Missouri-based pension fund announced asset allocation targets for its private debt portfolio. The policy target for private credit is 5 percent, with a range of 4-10 percent.

The organisation’s investment consultant, Segal Marco Advisors, presented updates in their private credit manager search in the meeting. The IC shortlisted the following vehicles for consideration:

The fund managers were assessed against criteria such as institutional client bases, operational processes, investment team seniority, due diligence and terms and conditions.

Ultimately, Segal Marco Advisors recommended the hire of Churchill Middle Market Senior Loan Fund V. According to the consultant’s analysis, Fund V offers lower management fees and carried interest over the other candidates. Additionally, Churchill Asset Management will retroactively aggregate the assets of investors advised by Segal Marco Advisors, leading to a size discount.

Managed by Churchill Asset Management, the 2023 vintage fund has raised $729 million against a target of $3.5 million, according to Private Debt Investor data. The direct lending fund has a regional focus in North America.

Kansas City Public School Retirement System will make its first private debt commitment in early 2024, as confirmed by the public pension.


Today’s letter was prepared by Andy Thomson, with John Bakie, Christopher Faille and Robin Blumenthal contributing