Wednesday, October 4, 2023

Performance test looms in $ 900 billion private debt market

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Private debt investors are facing a jolt, fund managers have warned, after a decade-long boom propelled the sector’s assets to around $ 900 billion.

The market flourished in the wake of the financial crisis as banks, under regulatory pressure, gave up lending to small businesses unable to finance themselves in the public debt markets. But credit managers warn that lower lending standards ahead of the pandemic will mean a calculation in 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, CEO of MV Credit, who has two decades of experience in credit. private to companies in Europe.

“The investors took things on faith,” Mr. Nadal said. “The real test is yet to come,” he added, saying that it is “difficult to say” which managers made the right bets in a market more opaque than his public counterparts.

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

Fund managers say there was a relaxation of lending standards in the years leading up to the pandemic, which helped propel the private credit market to 887 billion dollars by June 2020 against 575 billion dollars at the end of 2016. The number of fundraisers from 2017 to the end of 2019 has increased sharply and they have amassed nearly 300 billion dollars of so-called dry powder ready to be deployed during this period, according to Prequin.

“It was a borrower-friendly market before the pandemic and these are transactions managers end up holding for a long time,” said Candy Shaw, deputy chief information officer of Sun Life Capital Management, a long-time investor. date in private markets through direct loans and term infrastructure projects. SLC has been less active since 2019, as loan conditions have become more flexible.

“Over the next couple of years you will likely see less disciplined managers taking losses and this will lead to more consolidation in the industry,” said Ms. Shaw.

Losses are expected for loans made in recent years to retail, entertainment and hospitality businesses that have been hit hard by lockdowns and restrictions linked to the pandemic. The High Street of the United Kingdom, for example, has been under intense pressure, with several direct loan fund are expected to incur losses on their loans.

Others in the industry expect a hype from 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 the performance of private managers. than those seen in corporate bond funds.

Bar chart of net IRRs of private debt by year showing that performance varies considerably among private credit managers

The “dispersion of performance around private lending” highlights 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 generally have access to better private deals compared to “new entrants” to the industry.

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