Capital keeps flowing, despite the concerns

Investors have conflicting feelings about private equity and private debt, according to a new survey.

Tucked away in the latest edition of Coller Capital’s investor questionnaire on alternative asset classes are two sets of figures that hint at cognitive dissonance in the way limited partners think about private equity and private debt.

In isolation, each figure is an interesting informational nugget regarding how institutional investors are thinking about the market. But they may be misleading when it comes to assessing how fundraising for private equity and private credit – two assets classes with intertwined fates – may fare in 2018.

London-based Coller found that an overwhelming proportion (89 percent) of respondents to their Global Private Equity Barometer said “too many weak” private equity general partners are landing investor commitments. Given that it seems every financial firm under the sun wants to launch a private credit practice, a similar argument could be made for private debt.

In addition, North American and European LPs – 51 percent and 63 percent, respectively – said a debt glut has led to “poor buyout deals” and higher leverage on the better deals. Perhaps documents from the Alaska Retirement Management Board’s December meeting explain it well: debt is “readily available” and a “growing cadre of non-bank lenders” are making supply even more ample.

For some time, there seems to have been disagreement between investors and managers on private credit – managers have fretted about the deterioration of loan terms and documentation, while investors have been bullish on the asset class. At industry events and in conversations, managers have expressed alarm, while many LPs have increased their allocations.

Two other numbers in the Coller survey show this may be poised to continue. Six times as many European LPs will increase their allocation to the asset class than will decrease it (44 percent to 7 percent). For their part, five times as many North American LPs plan to increase their exposure to private credit than decrease it (32 percent to 6 percent).

In addition, almost half of European LPs and a quarter of North American LPs plan to increase their private equity allocation. Only 2 percent and 5 percent, respectively, of respondents plan to pare back such commitments.

While many factors related to portfolio management come into play, there seems to be a conflict inherent in upping allocations to asset classes where “weak” managers are successfully raising funds and a debt over-supply is leading to a race to the bottom on deal terms.

Assume a not-so-implausible scenario: an alternative lender with ample dry powder provides a covenant-lite loan to back the buyout of a business that in less exuberant economic times might not get funded. If repeated regularly, that may just be a recipe to sour investor appetite.

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