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Talking point: Valuations are next under the microscope

Private debt has been coming under closer scrutiny. The methodology used to value investments is likely to be the next preoccupation for investors.

We previously examined the progress made by firms in relation to sustainability-linked loans, a topic later covered in depth by our February 2022 cover story. What we found, in our initial research, was that plenty of progress has been made but much more remains to be done.

This acts as a reminder of private debt’s relative immaturity as an asset class. Because it has come so far so fast in terms of investor allocations – as confirmed each passing year by our Global Investor 30 and PDI 100 rankings – it is easy to forget that private debt is a relative newcomer when measured against other alternative asset classes such as private equity and real estate.

Systemic risks

In a press release, the European Leveraged Finance Association and Houlihan Lokey remind us that the European private debt market has grown from €8 billion in 2012 to €120 billion in less than a decade. With rapid growth has come increased regulatory scrutiny: most recently, the EU has pondered whether private debt poses systemic risk.

But it’s not just regulators keeping an eye on private debt firms, it’s also investors. The credibility of sustainability-linked loans is a hot topic they have been closely engaged with. The next issue, and what prompted the ELFA/Houlihan Lokey press release, is how managers value their investments. You could argue that this should always have been front of mind, but while valuation has been the subject of countless private equity discussions, it seems to have been below-the-radar in private debt.

“It’s easy to forget that private debt is a relative newcomer”

This looks set to change, not least because of the market volatility triggered by the covid outbreak in 2020. With dislocation funds springing up left, right and centre to take advantage of discounted loans, it was a challenge to anyone who had previously assumed the value of loans would necessarily remain more steady and more predictable than ‘racier’ types of investment.

And there are many differing approaches to private debt valuations, especially between managers based in North America and in Europe. There are also signs that managers may be moving to a more blended approach. As with much of the other work it does, the ELFA will no doubt be striving to bring best practice and consistent standards to this area as private debt continues its march to maturity.