Q – Globally, which regions do you think offer the greatest opportunity for growth in the private debt industry?

As far as private debt funds are concerned, we are currently advising on fundraising solely for European GPs in the current cycle. It’s currently a more compelling market in Europe than in the US, for example: the banks have retreated further, it’s not as commoditized, spreads are wider, it generally generates higher returns, and GPs tend to have interesting stories.

Q – Has that been born out in terms of LP interest?

Certainly. There’s been strong interest in European private debt not only from European LPs as you would expect, but having realised Europe is “not falling off the map”, from North American and Asian LPs as well. A disproportionate amount of their European allocations have gone to European private debt funds, which they consider the most compelling asset class in Europe, so it’s proving a fertile ground for managers.

Q – Are investors gravitating towards a particular end of the [debt] capital structure?

There’s interest across the spectrum, from senior debt to mezzanine and growth debt. It all depends on the type of return profile LPs are looking for. Senior debt, yielding sub-10 percent returns, will attract investors who have developed an alternative debt strategy carved out an existing high yield or public debt allocation. Such allocations are usually managed from the fixed income desks of institutional LPs. 

For uitranche, mezzanine and growth debt and special situations, we see a lot of interest from investors with PE allocations looking for risk- return profiles that complement their PE portfolios and that match or exceed what they’d get from PE funds on a risk-adjusted basis. In those cases, it’s the private equity or alternatives portfolio managers that we’ll usually engage with.

Q – Managed accounts seem to be a growing feature of the market. Do you see that trend continuing?

Absolutely. For managers, the Holy Grail is a traditional fund structure with ‘standard’ PE fees of 2 and 20, for example. However, within the private debt industry structures tend to be far more bespoke than you get with private equity.

Large pension funds and insurers, and increasingly, sovereign wealth funds, are certainly keen on customized managed accounts. There’s a definite trend towards tailor-made vehicles. Ultimately, while GPs may jave to comromize on fees a bit they’re a good thing for the industry as it grows assets under management and therefore overall investment capital.

Q – Has there been much variation in the terms for private debt funds?

There’s growing pressure, from a terms perspective, on strategies which are viewed as requiring less direct, day-to-day management. Can you justify a 1.75 or 2 percent management fee and 17 or 20 percent carry for a fund where the portfolio, once established, requires very little daily engagement? Investors are certainly asking the question. By contrast, smaller, more entrepreneurial managers who are able to dig out really interesting opportunities and deliver strong returns should be able to command higher fees along more typical PE lines.

Q – Do you see allocations to private debt continuing to rise?

Yes. Investors will continue to grow allocations to private debt as they recognise the risk-adjusted returns are very attractive. LPs are like oil tankers – they take a while to turn. But that turn is well underway. Decisions to commit to private debt made last year will mean allocations are now formally available this year. However, the risk to the private debt asset class is that some alternatives managers will see allocations rising and decide to branch out in to private debt with little relevant track record. When it comes to manager selection though, LPs can generally assess when managers are going down that route. That’s why it’s very important for managers to be sure that they are matching their track records to their current strategy. And despite the increasing popularity of the asset class, managers shouldn’t underestimate the length of time and amount of effort it takes to raise a fund in this market. ?

David Waxman is the founder and managing director of Azla Advisors, which offers fundraising placement advisory services to GPs, as well as secondary market advisory services to LPs. Azla is based in New York and London.