Too much investor caution may backfire

Private debt fundraising is tough going, and it’s being made even tougher by European LPs wary of committing to new funds on a virtual basis.

Private debt fundraising may not have fallen off a cliff amid the trials and tribulations of 2020, but it has still faced something of a struggle. The $110 billion raised in the first three quarters of this year compares with the $150 billion raised over the equivalent period in 2019.

Other comparable asset classes have suffered their own dips without seeing quite such a large fall as private debt. There is a view that the likes of private equity and real estate have been around longer and that investors already have a pretty good idea about how they perform through cycles. For private debt, still relatively nascent and having enjoyed a benign economic backdrop for many years, this is arguably the first big test. Investors will be inclined to sit on their hands for a while, waiting to see whether performance through this period justifies continuing support.

Although this approach sounds sensible, it risks denying capital to those in need of it. Private debt has increasingly displaced banks in both the sponsored and non-sponsored markets as private equity firms and corporates alike have come to appreciate its flexibility and the speed with which it can be delivered. Investor caution may ultimately lead to the widening of a financing gap that private debt has been doing much to close since the global financial crisis.

This caution has only been exacerbated by one of this year’s big trends: virtual due diligence. A survey this week from placement agent Capstone Partners found that although more than three-quarters of North American investors were comfortable underwriting new funds without in-person meetings, the same was true for only 20 percent of their European counterparts.

In attempting to explain this reluctance, market sources point to the natural conservatism of European LPs as well as the greater regulatory burden they tend to be under. North American investors – as indicated by their greater comfort with subordinated debt and leveraged funds, for example – are more likely to be returns-oriented and have a more pragmatic approach to risk.

One of the concerns expressed is that investors, cagey about committing capital to new relationships, might be tempted to settle for what is being termed the ‘lazy re-up’. This implies a willingness to assume that committing to a new fund with an existing manager will be much like committing to a previous one – but without necessarily doing the spadework to confirm the truth of that assumption. At what point does caution blur into carelessness?

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