The main thing is: be different

A protracted cycle and fierce competition mean investors in private debt need to try and escape the crowds.

Investors know what they like, and many of them are sticking with it.

The most favoured strategy in private debt over recent years has been direct lending. Despite competition building to challenging levels and dubious deal terms creeping down from the leveraged-loan and high-yield segments into private debt’s mid-market, faith in the strategy has never wavered.

But while direct lending has been the constant companion, distressed is now turning heads. This was demonstrated by our H1 2019 fundraising figures, which showed the strategy accounting for around $35 billion of fundraising globally in the six-month period. This strategy too has LPs hungering for a slice of the action.

Subordinated/mezzanine debt and CLOs also have their fans. And the only category bumping along the bottom in the fundraising charts is the one we describe as “other” – a catch-all for unconventional private debt strategies, including those that typically fall under the “speciality finance” banner.

This is surprising and will surely need to change. Yet the insubstantial fundraising is in no way reflected in the views being expressed by investors. As Cambridge Associates’ Tod Trabocco relates in an interview for our upcoming October issue: “[LPs] see the competition in direct lending and they’re looking for something interesting to do where they can lock up capital for a decent return. And they realise that speciality [finance] offers a lot.”

It certainly offers a lot of different strategies. Trabocco names the likes of rediscount lending, music and movie royalties, healthcare royalties, trade finance, life settlements and non-performing real estate loans as sub-sectors that fall within Cambridge’s definition.

Alternative definitions to Cambridge’s are rife, but this only underlines the diversification benefits awaiting those investors brave enough to take the plunge into private debt’s less populated waters. Trabocco points out that return profiles range from LIBOR plus two percent to gross 15 percent. Aircraft leasing alone offering a range of strategies with returns all the way from 5 percent to the mid-teens.

The reticence thus far in terms of making commitments is understandable, given that different underwriting skills are required for pools of assets as opposed to corporate credit. Some specialist strategies, such as music royalties, are underpinned by very different dynamics from those that LPs have become accustomed to assessing. Making the necessary adjustments is not easy.

Even taking that into account, investors would be well served by broadening their horizons in an asset class with a clear concentration risk in terms of both strategy and geography (private debt has more of a US/UK bias than other alternative asset classes).

This week saw New York-based Marathon Asset Management embark on a $750 million fundraising for a vehicle targeting a range of speciality finance strategies, with Minnesota State Board of Investments stumping up $100 million. We’ll be expecting to bring our readers similar examples as LPs seek refuge from the crowds.

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