LPs cautious about first-time funds

Investor appetite for emerging managers appears to be declining.

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In a tight fundraising environment, fund manager relationships in private debt are stickier than ever. According to Private Debt Investor’s LP Perspectives 2024 Study, more than half of LPs intend to keep the same number of manager relationships through this year, up from 39 percent a year ago, and only 45 percent are looking to increase their relationship roster – the lowest percentage since 2020.

The appetite to support first-time managers is also small, with 42 percent saying they do not support first-timers and 20 percent saying they are less likely to invest in them now than they were a year ago. Just one in 10 LPs say they are more likely to back a first-time manager in 2024 than they were in 2023.

Of course, not all emerging managers are the same, and Jess Larsen, founder and CEO of private credit placement agency Briarcliffe Credit Partners, says there is more appetite for some than others. “We are seeing LPs very positively inclined to look at first-time credit managers that are attached to PE platforms.

“It makes a lot of sense and is an interesting development. If a PE firm has been around a long time, maybe with a speciality in a certain sector, opening up private debt to those companies is something LPs are very open to.”

There is also more inclination towards first-time managers in certain strategies. “If you’re an emerging manager in plain vanilla direct lending, you are having a very, very tough time right now,” says Larsen. “That market is all about scale and efficiency and is dominated by a small number of players with little incentive for an LP to try something new.

“On the other hand, if an LP really likes asset-based lending or the NAV lending space, they need to look at new names because there are only a handful out there and the demand is bigger. Really, it is about emerging strategies rather than emerging managers, with more dedicated vehicles coming out in areas like sports lending and mortgage servicing rights, while asset-based lending is a big growth area.”

“If you’re an emerging manager in plain vanilla direct lending, you are having a very,  very tough time
right now”

Jess Larsen,
Briarcliffe Credit Partners

For Emma Bewley, head of private debt and uncorrelated strategies at Partners Capital, emerging managers consistently hold some appeal. She says emerging managers and first-time funds have always been part of their programme. The attraction is the lack of legacy issues within portfolios, but Bewley says a tough capital raising environment is a constraint for less proven managers and strategies.

“The challenge when it comes to emerging managers can be getting a good sense of their sourcing capability,” says Bewley. “Mid-market direct lending is a highly competitive part of the market; there are established incumbents with strong sponsor relationships. By contrast, lending into specialist sectors like software, healthcare and life sciences offers an opportunity for specialist lenders with differentiated underwriting or sourcing approaches. In a capital-constrained environment, assets tend to flow to larger managers, but we do see opportunities for emerging managers in specific niches.”

As LPs look to diversify their private credit strategies and allocate more to the asset class, the number of investors that say they never invest in first-time managers does show signs of dropping – it stood at around half of LPs in 2021 and 2022, but dropped to 32 percent in 2023 before rising moderately to 42 percent this year. And there is little evidence of LPs actively scaling back their lists of relationships, with only 4 percent saying they will decrease the number of firms they work with this year.

The challenge for investors is to find a differentiated offering in new managers. Fabian Chrobog, founder and CIO at NorthWall Capital, says: “LPs are focused on identifying best-in-class managers that have a real reason to exist, ie managers that occupy a part of the market where their capital is not a commodity product. In our diligence processes, we are often asked why borrowers chose to work with us over others, and why we encounter less competition. Especially in Europe where the market favours embedded, local players, LPs favour GPs that have a long track record of successful operation.”

The other hurdle for newer players is convincing LPs that they are a safe pair of hands and have the scale to operate in an increasingly crowded and competitive environment. Bewley says you are underwriting emerging managers’ ability to run a business as much as their ability to run a fund, so you must be comfortable that they are well funded, with a good operational setup and a thorough understanding of the compliance environment. “You need to understand the economics of their business; for example, how costs are covered in the early years and the longer term hiring and retention strategy,” she says.