Why LPs are getting narrow-minded

‘Going niche’ with debt fund products may help the loan origination process, but is investor demand there for more focused offerings?

Aside from pricing, there are a few other words which get bandied about when debt managers discuss why a borrower would go to them rather than the competition. ‘Flexibility’ seems to be one common buzzword. Perhaps we can soon add ‘niche focus’.

An increasing number of managers seem to be launching smaller, narrowly focused funds. In the last year, 27 funds globally have held a final close on $100 million or less (according to PDI data), with a number having very focused strategies. Competition appears to be more subdued compared with the larger, more generalist private debt offerings.

One fund manager who runs such a niche product recently told PDI he had participated in numerous deals where he was the only prospective lender. Focusing on a particular geography, sector or size of deal seems to be a credible way of responding to an increasingly competitive landscape.

Given this dynamic, it’s pertinent to ask whether the introduction of more focused offerings is due to a desire to aid loan origination, or whether there is genuine investor demand for differentiated products?

When it comes to attracting investors, managers with a narrower focus may be able to make the case that they’re offering something different from larger, established funds. With many institutions yet to meaningfully embrace private debt, however, it could be questioned whether the industry is at a level where specialisation is either required or desired.

While private debt is still in its relative infancy as an asset class, both placement agents and managers themselves have told PDI investors are indeed demanding access to a variety of strategies, including those more narrowly focused.

A simple rationale for this is a desire to manage currency exposure within a sleeve of private debt investments. Adding exposure to dollar-, euro- and sterling-denominated debt can help an institutional investor diversify the impact currency movements may have on a portfolio. The more focused a strategy is on a region or country, the easier it might be to tailor exposure.

Moreover, different return streams may be expected from funds taking a specialised approach. In recent conversations, PDI has heard about the benefits of strategies focusing on royalty streams and trade finance, for example, as diversifiers in relation to more general private credit investments.

It should be noted that narrowly focused funds tend to be smaller in size than those with a broader mandate. Funds capitalised at sub-$100 million are unquestionably on the tiny side, and the loans they can write will be for smaller deals only. This means they can’t be everybody’s cup of tea. With investors generally not wanting to represent a high percentage of a fund’s total capital, it’s possible the diversification benefits of niche strategies won’t be optimised until larger offerings are raised.