Nascent private debt market positive for asset managers

Fund managers with expertise in private debt can generate performance fees ranging from 10 to 20 percent, Moody's reports.

Although still in its infancy, the European private debt industry has the potential to significantly grow the level of assets under management and become a permanent feature of the region’s markets, Moody’s has said.

In a report called ‘Growth of Private Debt Funds in Europe is positive for Asset Managers’, the rating agency said that it expects private debt funds to grow amid strong supply and demand dynamics.

Limited access to bank loans, especially for SMEs, is expected to drive greater demand for alternative lending in Europe. In the US, where corporates are far less reliant on bank funding, borrowers have better access to more competitive debt financing, while private debt funds generally offer borrowers more flexible terms than bank financing. This along with an increase in capital in the sector provided by institutional investors, searching for yield in a low interest rate environment, is expected to spur the growth.

“We believe that both supply of and demand for private debt funds will increase in the coming years, particularly as borrowers become more familiar with non-bank external financing sources,” the report stated.

Citing Private Debt Investor data, Moody’s said  there are more than 60 new private debt funds in Europe raising capital exceeding $33 billion as of May 2014.

And for those asset managers with the expertise to manage private debt, the rewards are significantly higher than those received when managing fixed income funds, Moody’s said.

“Despite pressure from investors to lower fees, the aggregate amount of fees generated by private debt funds are significantly higher than fees of traditional debt funds.

“The AUM earn high fees, with management fees alone on direct lending as much as three to five times higher than those on traditional fixed,income funds. In addition, most private debt funds allow asset management companies to take a percentage of the fund’s return in the form of performance fees,” the agency said.

According to Moody’s research, higher fee margins on private debt will boost their revenue base. An increase in supply and demand for alternative finance, and a long lock-up period in terms of investment from institutional investors, typically for the life of the fund, means management fee revenues from private debt funds can also be relatively stable. “During this period, investors can receive some of their investment in the form of distributions but are typically restricted from receiving the remaining principal,” it said.

Private debt funds also allow asset managers the opportunity to take a portion of returns in the form of a performance fee.

Management fees for private debt funds range between 1.00 percent and 1.50 percent, higher than those from traditional fixed income fund which range from 0.20 percent to 0.50 percent. In terms of performance fees, private debt funds can make between 10 percent and 20 percent, while there are none on offer in fixed income.