Return to search

Some demons are imagined

LPs anxious about systemic risk and dry powder accumulation may have less to worry about than they think.

$1 trillion sounds like a big number. It made headlines after a recent study by law firm Dechert and the Alternative Credit Council revealed the global private credit industry was on course to reach a cool trillion in assets under management by 2020.

The industry has seen a 14-fold increase in AUM since 2000, reaching $600 billion by the end of last year. It sounds like a number to make investors sweat. After all, as the industry swells in size, will this not encourage regulators to take a second look? We may have moved beyond the point where private debt was inextricably linked with the “shadow banking” label – but isn’t $1 trillion enough to arouse regulatory suspicion that private debt may be creeping into ‘systemic risk’ territory?

Not so, according to Jiri Krol, deputy chief executive of the ACC, when reflecting on the survey results. He insists $1 trillion is not systemic and regulators should not be worried. Context, after all, is everything – the Financial Times recently noted that China was now home to the world’s largest total banking assets at $33 trillion at the end of 2016, followed by the eurozone at $31 trillion.

Another oft-cited cause for investor concern is the weight of capital being raised – and the implications this may have for competition and pricing. It was clear from our recent Q3 fundraising numbers that the flow of capital into the asset class is showing no sign of easing, with 2017 on course to be a record year. LPs may be wondering if this is creating a potentially troublesome build-up of dry powder – capital reflective of the scale of investor interest, but not necessarily of the opportunity to put it to work.

But a look at the survey data also provides reassurance on this score. Dry powder as a percentage of the overall private credit industry stood at around 35 percent at the end of last year, which is around the average percentage since the data was first collected in 2000. The dry powder peak, at more than 50 percent of the total, was way back in 2003 and the overall trend (subject to annual variance) has been downwards ever since.

In number terms, US private credit managers’ dry powder stood at less than $150 billion last year, while in Europe the total reached just over $60 billion. By contrast, Bloomberg in August counted $963 billion of dry powder in the private equity asset class – only slightly less than the projected total size of the private debt asset class in three years’ time.

Stuart Fiertz, president of fund manager Cheyne Capital and chairman of the ACC, suggested that the moderate amount of dry powder in private debt may be explained by managers typically not charging fees on uncommitted capital – providing an incentive both for realistic fundraising targets and rapid deployment of raised capital.

There are reasons to be concerned about the future of the private debt asset class. Weaker deal structuring could pose major problems, testing in particular those managers – and there are many of them in private debt – who have yet to steer their firms through a severe downturn. But the Dechert/ACC study indicates that some fears may be misplaced and the real-life trend can sometimes be your friend.