Operating on the margins

A new generation of debt strategies are emerging and they are expected to make their presence felt in 2017.

If 2016 was the year that private debt reached a new level of maturity, then 2017 is likely to be the time more specialist strategies receive attention. At least that is the prediction of one director at a London-based placement agent who argues that investors are increasingly interested in what he describes as the second generation of private debt funds – embracing strategies including project finance, asset-based lending and sector focuses.

There is plenty of evidence that we may be seeing more niche strategies gain acceptance. Last week, IPF Partners, a Geneva-headquartered debt fund, began marketing its healthcare-focused senior debt strategy with the aim of raising €200 million – almost double the size of its predecessor vehicle.

The firm focuses on investments in high-growth healthcare companies. These are young firms ranging from manufacturers of innovative medical equipment to developers of mobile software technology to help with the management of diabetes. Due to the fact these companies are not yet profitable, banks will not touch them.

Banking disintermediation is central to this development, just as it has been to the development of corporate lending in the decade since the global financial crisis. Indeed, ratings agency Standard & Poor’s published a report recently noting that EMEA project finance opportunities are growing as banks continue to exit the space, citing regulatory constraints. As a result, they expect capital markets will fill the gap.

“The finalisation of the Basel III regulation … requires banks to meet stricter leverage ratios, and emphasises standard capital models rather than banks’ own models. This could mean a major increase in capital requirements for long-term project financing,” the report said.

Towards the end of last year, the Association of Asset Based Finance reported a flurry of activity in the ABL sector in the fourth quarter, with £4.3 billion ($5.4 billion; €5.1 million) in debt financing made available to UK small and medium-sized enterprises – a 22 percent increase compared with the same period in the previous year.

Furthermore, the growth of fintech has been well documented, and the popularity of the sector is now dragging traditional banking institutions into the market. Royal Bank of Scotland this week launched its own online platform to provide loans of up to £150,000 to UK SMEs. Last year, Santander started a partnership with marketplace lender Kabbage to tap into this growing market.

Assembling all of these strategies under a single label is unsatisfactory. The strategy managed by IPF has very little in common with something like trade finance apart from relative newness. And for the time being established European corporate lenders needn’t worry about competition for capital, as fund sizes are still at the smaller end.

That said, all investment products are measured by their returns. And if IPF can continue to hit returns of 15-20 percent for its senior debt strategy, then it will attract more commitments. Scaling the strategy will take a while, but 2017 may be the year they, and other firms operating on the margins of the private debt market, take a significant step up.