Performance test looms for $900 billion private debt market

Private debt investors face upheaval, fund managers have warned, after a decade-long boom propelled assets in the sector to around $900 billion.

The market boomed in the wake of the financial crisis as banks, under regulatory pressure, stopped lending to small businesses unable to obtain funding in government debt markets. But credit managers warn that lower lending standards before the pandemic will mean reckoning within the next two years.

“It’s too early to say how managers will fare in terms of performance and we’ll see who played a dangerous game,” said Frédéric Nadal, managing director of MV Credit, who has two decades of experience in the field. private business loans in Europe. .

“Investors took it on faith,” Nadal said. “The real test is yet to come,” he added, saying it’s “difficult to tell” which managers made the right bets in a more opaque market than their public counterparts.

Since 2008, smaller, bespoke transactions in the private debt market, organized by specialist managers and private equity firms, have increasingly attracted established investors, including pension funds and investment companies. ‘insurance. Private debt offers higher fixed rate returns than public transactions because investors put their money in debt for a long time that is not as easily marketable. This so-called “illiquidity premium” for private debt has gained traction in a world of low interest rates.

Fund managers say there was a loosening of lending standards in the years before the pandemic, which helped propel the private credit market at $887 billion in June 2020 compared to $575 billion at the end of 2016. The number of funds raised from 2017 to the end of 2019 has increased sharply and they have raised almost $300 billion of so-called dry powder ready to be deployed during this period, according to Preqin.

“It was a borrower-friendly market before the pandemic and these are deals that managers end up holding for a long time,” said Candy Shaw, deputy CIO at Sun Life Capital Management, a longtime private markets investor per through direct and long-term loans. future infrastructure projects. SLC has been less active since 2019 as loan terms eased.

“Over the next two years you’ll probably see some managers who were less disciplined realize losses and that will lead to more consolidation in the industry,” Ms Shaw said.

Losses are expected for loans made in recent years to retail, leisure and hospitality businesses that have been hit hard by pandemic-related shutdowns and restrictions. Britain’s high street, for example, has come under intense pressure, with several direct loan funds expect to incur losses on their loans.

Others in the industry expect a hype of new managers over the next two years, as many of them did not experience past default cycles in 2001-2002 and 2008. They also note that There is also a much greater dispersion in terms of performance by private managers. than among those who manage corporate bond funds.

Bar chart of private debt net IRRs by vintage showing that performance varies widely across private credit managers

The “performance dispersion around private lending” underscores the importance of selecting “private credit managers with strong balance sheets,” said Robert Morgan, managing director of 50 South Capital, an alternative platform owned by Northern Trust Asset Management. He said established companies with strong balance sheets typically have access to better private deals compared to “new entrants” to the industry.

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