How has your investor base changed over the years? Are you seeing new types of investors entering Europe?
If you look at the European market, I think we have seen an ongoing movement of allocations into private debt. Most of the large institutional pension funds and insurance groups have formalised allocations towards private debt and have started to execute investments into the asset class. It has been a growing trend over the last five years.
Asian investors have become more interested in Europe versus the US, mainly because of the hedging costs that come with changing dollars back into the local currency. There is also a feeling that the US is much later in the credit cycle and therefore Europe still looks to be several years behind the US. So, between the currency hedging and economic environment in Europe, a lot of Asian investors have started to move allocations into Europe.
Do you expect demand for senior debt in Europe to remain strong?
I think senior debt is still by far the most active part of the market. You are seeing investors coming out of potential high-yield and bank loans and moving into senior secured mid-market loans. Obviously, some of the well-known distressed players have started to market quite heavily to investors around the world, particularly focused on a potential slowdown in the US.
As it now looks like we are in the later stages of the credit cycle,investors are thinking about putting money into distress funds to take advantage of opportunities that may come up over the next couple of years. A lot of the investors I speak to are more focused on this in the US market where the rise in interest rates is going to put a lot more pressure on debt servicing in mid-market companies. The interest cost has risen quite a bit and therefore some of those companies may struggle because they were relatively
highly geared. I think in Europe the risk on debt servicing cost is still very benign, with limited opportunities on the distressed side because rates are so low that debt servicing for mid-market companies is still modest. It looks like rates will be slow to rise in Europe over the next several years.
Do you think the amount of dry powder in the market is causing managers to diversify their strategy into niche areas?
Although a lot of people talk about dry powder, the amount of dry powder on the debt side is modest compared to the amount of dry powder on the private equity side. There is still a lot of M&A activity going on in Europe. We have seen an increase of M&A in markets that have been historically quiet, such as Germany, where there has been an uptick in private equity deals and therefore a big pick up in the volume of private debt deals. You can pretty much see that across the whole of Europe.
The issue is that the private debt market is becoming more mature. If you look at the volume of traffic, there are probably 10 or 12 firms in Europe that are doing two-thirds of the deals. The deal volume is getting more concentrated into the hands of a small number of larger players which includes ourselves. I think that’s pretty similar to the banking market where there used to be 40 leveraged finance banks across Europe, and the top 10 did two- thirds of the volume. That is an inevitable occurrence in markets as they develop.
To me, the critically important part is to a have a truly pan-European platform where you can be drawing transactions out of all of the key markets without being reliant on any one market. If you have got the footprint, you can be doing less competitive deals in other markets when individual markets become slightly overheated.
What role do non-sponsored deals have in a diverse European-strategy given where we are in the cycle?
If you look at the information coming through some of the advisory firms, non- sponsored deals are around 20 percent of the market at the moment. About 30 percent of our deals are non-sponsored, and I think there’s a growing acceptance and familiarity with private debt funds among private companies. There is a certain attraction for those private companies to get longer-term financing because the banks prefer to do more five-year-amortising-type structures.
Because of the maturity of the industry, private debt funds are becoming better known in each of the domestic markets. Many of the advisors talking to private companies are becoming much more familiar with private debt funds and starting to recommend funds over the historical relationships with the national banks. There is a gradual, ongoing evolution of increased opportunities in the non-sponsored part of the market, just at a much slower pace to private equity.
“I think in Europe the risk on debt servicing cost is still very benign, with limited opportunities on the distressed side because rates are so low that debt servicing for mid-market companies is still modest”
How much of your portfolio is composed of UK private debt and what impact do you think Brexit will have on this?
I think it is hard to predict the final economic impact of Brexit because it heavily relies on what the deal is with Europe. There are myriad of views on what the free trade agreement will be and what access there will be to European markets. The UK market is 20-25 percent of the core European market GDP and our fund reflects that. We are around 25 percent invested in the UK and 75 percent invested in continental Europe. We think that fairly reflects the GDP importance of the different regions and it means that, although the UK in volume is 40-50 percent of the market, we can be very selective of the UK by keeping the portfolio at around 25 percent. We look at companies that we feel are very recession-proof, where the implication of a no-deal Brexit will have a modest impact on the overall outcome of the business. I think investors, particularly European investors, are nervous about the UK and what the implications could be. We have been very focused on being modestly exposed to the UK market – and by having our offices in Paris, Frankfurt, Milan and Madrid, and opening two new offices this year – this has given us tremendous access to deals across Europe. This means we are not reliant on UK dealflow to be able to deploy capital.
Which other jurisdictions in Europe do you expect to be more focused on?
I think the part of Europe that has been less active in private debt up until now has been the Nordics. The Nordic banking system has been very robust post-2008 and the banks have been very competitive on the pricing of deals. In the last 12 months or so we have started to see more opportunities for private debt funds, where they can come in and provide term financing and the banks want to do shorter amortising. The region has been the slowest to adopt but it is now showing signs of more activity. In Spain, where the Spanish banks have been very competitive, we are also now starting to see more opportunities and more M&A activity.
As Europe continues to grow, the percentage of private equity deals being done in Europe will grow substantially and therefore the UK’s percentage of the total market will continue to decline. That is not just because of economic issues, but it is more that we are seeing demographics coming into countries like Germany where family-owned businesses are selling to private equity firms where historically they would have been passed down to the next generation. Owners of these companies do not necessarily want their children to take over and so are looking to partner with private equity firms.