Predicting the next decade: The future of private debt

The private credit asset class continues to go from strength to strength, despite a lengthy and ongoing period of significant macroeconomic uncertainty. Having first proved its mettle as an alternative to bank finance when those lenders started retreating from mid-market corporate loans in the wake of the global financial crisis, it has won over private equity sponsors, endured covid in rude health and has now emerged as a true alternative to the liquid markets, capable of financing the biggest corporate loans.

But what does the next decade hold for the asset class, as investors increase allocations but seek to diversify away from mid-market direct lending? Looking into their crystal balls, here some of the industry’s leading thinkers outline the six themes that will characterise the next 10 years of private credit.

1Beyond sponsor-backed lending

If the first decade of private debt has been about backing private equity firms with LBO financing, expect the future to hold increasing penetration of broader lending to non-sponsored borrowers.

Anthony Fobel, founder and CEO of Arcmont, says the future growth area on the deal side will be the increasing number of sponsorless deals. “The European market has very much been a sponsor-focused market but, as in the US, increasingly the benefits of private debt will become evident for corporates that are not sponsor-backed,” he says.

Mark Hickey, partner and co-founder of Pemberton Asset Management, says there are a lot of opportunities in almost all segments of corporate credit for institutional capital to play a greater role, as well as in transportation, real estate, infrastructure, structured finance or specialist lending strategies. “All of those segments are still very much dominated by banks but there are parts of them where borrowers don’t have access to as much capital as they would like,” he says.

At Apollo, John Zito, the CIO of credit, says the future will see more investment grade asset-backed financings – he sees the evolution of private credit moving increasingly into the asset-backed space. “We have built our own origination platforms in areas like aviation, trade finance, fleet finance, commercial real estate and residential real estate. We have more than 3,000 originators across those platforms who just originate asset-backed loans, which are predominantly investment grade,” he says.

“We expect private credit to continue to expand into the investment grade space, in both corporate and asset-backed lending, as LPs look to diversify from traditional mid-market sponsor-backed lending. If you look at that addressable market it is worth trillions of dollars and there has been very little penetration by institutional capital so far.”

Zito believes that more credit managers are moving into hard assets and collateral as investors look for fixed income replacement in private credit. “Anyone that can privately originate those investment grade products is going to see growth,” he says.

“We have built our own origination platforms in areas like aviation, trade finance, fleet finance, commercial real estate and residential real estate”

John Zito
Apollo

2A focus on delivering liquidity

As the asset class continues to scale and mature, both GPs and LPs will seek out more liquidity solutions. The growth of NAV lending and private credit secondaries will be a theme. “The market is going to broaden in terms of where private credit goes,” says Andrew Bellis, global head of private debt at Partners Group. “We see private credit secondaries being a big part of that, offering solutions to LPs and GPs as we see a much longer tail of older funds. If the market is really going to grow you need that whole ecosystem there that you see on the PE side.”

A growing number of sponsors will also tap third-party debt and equity capital, with more contemplating collateralised fund obligations, or CFOs. In December, Tikehau Capital raised its debut $300 million CFO backed by cashflows from commitments to its direct lending and private debt secondaries strategies.

Other managers are looking to offer LPs liquidity through evergreen structures or with new strategies designed to break away from the traditional closed ended lock-up. Pemberton recently announced it has now raised $1 billion for its Working Capital Finance strategy, targeting short-term financing needs for major corporates. Pemberton’s Hickey says: “Most private credit funds lock up capital for five to seven years, but our working capital finance strategy is an open-ended structure that we believe was one of the first short-dated private debt strategies.”

The Pemberton strategy funds short-term, self-liquidating assets for large companies, in the form of receivables and payables. “That is a space we expect to see a lot more private capital coming into. People are really interested in that short-term private credit option,” Hickey says.

3Closer partnerships with banks

Despite credit funds growing up on the back of winning lending opportunities away from bank competitors, their increased penetration of the corporate lending market, the ever-increasing regulatory burden on banks and pressure on bank balance sheets mean the future looks like one of partnership rather than rivalry.

Cécile Mayer-Levi, head of private debt at Tikehau Capital, says: “A big trend moving through the next decade will be a greater combination of bank financing with private debt funds in the same groups of lenders. That is being driven by bank consolidation and their lack of buy-and-hold appetite in light of Basel III and Basel IV, and private credit’s ability to step in to support them as partners in delivering finance solutions to their clients.”

4The new breed of investor

As the asset class scales, the big fund managers are eyeing opportunities to tap new investor classes, expanding their efforts to secure capital from individuals.

Fobel at Arcmont say that for capital raising, the new frontier in Europe is going to be on the wealth management and retail side, reflecting the trend in the US. “There is no reason why European high-net-worth or retail investors shouldn’t have an allocation of their own portfolios to private debt in the same way as they might to private equity, bonds or equities, reflecting what we see amongst institutions,” he says.

“The technology is now being built in Europe to provide highly regulated structures that enable professional, knowledgeable private investors with sufficient net worth to come into the asset class, and we will see a lot more of that.”

Meanwhile, in the US, managers are working hard to bring more insurance capital into private credit strategies in a way that works with their regulatory capital requirements. Rated-note feeder funds are one of the new and innovative ways in which fund managers have sought to accommodate insurers, who already make up a substantial part of private debt’s capital base but still have deep pockets. In PDI’s latest Global Investor ranking, published in November 2022, the top four allocators to the asset class were all insurance companies – MetLife, TIAA, Manulife Financial and Allianz Real Estate.

“The size and scale of private debt funds now means we are really a proper, reliable and flexible alternative”

Anthony Fobel
Arcmont

5Data, data everywhere

Fund managers will need to deliver more and more information to investors, regulators and other stakeholders in the next decade, not only in the rapidly growing ESG space but also to meet greater disclosure requirements and transparency demands.

Mayer-Levi at Tikehau says that LPs are asking us for more and more data and the market is becoming “very KPI-oriented” as those investors look to make better comparisons. “At some stage there will be more indexes and more benchmarks to bring much greater transparency to the market,” she says. “LPs are under pressure, with fewer people in their own teams and a need to move fast, so they want to be able to compare managers so some increased clarity will come with a maturing of the market.”

6The big will get bigger

As both investor and borrower appetite for private credit continues to soar, we can expect the small group of the world’s biggest managers to keep on getting larger – raising more capital from LPs and meeting ever-greater financing requirements.

Fobel expects to see private debt increasingly taking market share away from the liquid markets, due to a combination of both the flexibility that private debt firms can offer and also the reliability fund managers have demonstrated by remaining in the market when the public markets close.

“We are now really at the start of private debt increasingly becoming the go-to source of capital for private equity-backed deals, because even when the liquid markets re-open, the size and scale of private debt funds now means we are really a proper, reliable and flexible alternative,” he says.