NEW YORK: First came the debt specialists and the private equity firms. Then hedge funds and wealth managers saw an opening. Now everyone from sovereign wealth funds to venture capitalists is spouting Wall Street’s favourite buzzword: private credit.
Higher rates, banks’ lending retreats, and strong fees are bringing a raft of newcomers to the product that has quickly turned from a niche to a must-have.
Amid the proclamations of an industry poised for a multi-trillion-dollar boom, a few voices are whispering that it may all get ugly very soon.
DWS Group, Fidelity International, PGIM and T Rowe Price are among the investing stalwarts that are buying or building private credit franchises. Even SoftBank and Qatar’s sovereign wealth fund are wading in.
But if the last decade was marked by low rates and even lower defaults, the next era will be one of higher upside and more pitfalls.
“Years ago, everyone was expecting consolidation as the market grew, but the opposite has happened,” Faisal Ramzan, a partner at Proskauer Rose, said in an interview.
“We’re seeing more first-time funds trying to raise cash we think will be tough, at least in the current climate.”
The private credit market, which began catering to private equity businesses and grew rapidly as banks pulled back after the global financial crisis, has roughly tripled in size since 2015 to US$1.5 trillion (RM6.9 trillion).
Apollo Global Management, the biggest alternative credit manager, said the industry could grow to replace as much as US$40 trillion (RM183 trillion) of the debt markets.
Like private equity funds, private debt companies raise capital from investors, but instead of using that money to take ownership of companies, they lend to them instead.
The relationship between private equity and private credit persists, with many of the biggest private equity firms having large private credit businesses they use to finance their acquisitions.
Now, while established veterans such as Oaktree Capital Management and BlackRock Inc continue to raise cash for their mammoth strategies, traditional asset managers, including Allianz Global Investors and PGIM, are also making moves on what’s become a sought-after option for investors targeting net returns in the high single digits to as much as the high teens.
The private credit market has increasingly become a catch-all concept that incorporates everything from traditional direct lending to smaller companies, buyout financing, and even real estate and infrastructure debt.
In short, it’s a way for fund managers to capitalise on strategies they say shield them from the volatility of mark to market losses in public markets.
Fees for running these strategies are lucrative, and in some instances, managers can expect to net around 1% to 1.5% on assets under management and a 15% cut of gains provided they hit an 8% hurdle rate, according to people with knowledge of the matter.
Sona Asset Management and Marathon Asset Management are among the hedge funds expanding or moving into the sector.
Sona is planning to raise at least US$500mil (RM2.3bil) for a private credit strategy and will target returns in the mid-to-high teens, its chief investment officer John Aylward said in an interview.
Risk strategies across the array of funds piling in or expanding into the sector differ vastly.
From providing credit to back private equity buyout deals to offering so-called senior secured debt to mid-size companies with relatively low leverage. Others are also offering higher-risk mezzanine financing, which sits between debt and equity, to firms that are struggling.
Almost all of the funds that are expanding their presence in the market are hiring experts to help fundraise.
Marathon chief executive officer (CEO) Bruce Richards said earlier last month that the firm is looking at private asset-based lending and expanding credit facilities to mid-market companies, including those with stressed balance sheets.The investment arm of Deutsche Bank AG, DWS, has increased emphasis on private credit as it continues to invest in its alternative business.
It recently hired industry veteran and former Blackstone executive Paul Kelly to help grow the franchise.
Its CEO Stefan Hoops said in an interview that it’s been tough to raise funds for firms without a strong track record in the sector.
Indeed, fundraising is proving a trickier proposition than in previous rounds.
Assets under management in the industry, which have swelled from US$500mil (RM2.3bil) in 2015 to US$1.5 trillion (RM6.9 trillion), were expected to reach US$2 trillion (RM9.1 trillion) in 2025.
That forecast has since been revised down to US$1.8 trillion (RM8.2 trillion) by Preqin, in a sign of cooling demand.
“Fundraising has been slower and that’s mainly been driven by investors being more cautious, having more questions and wanting to do more due diligence on their fund managers,” Stephan Caron, head of European middle market private debt at BlackRock Alternative Investors, said in an interview.
In the first three months of 2023, the amount raised fell by about 10% to US$31.9bil (RM146bil) raised from 33 funds raised in the same period a year earlier, according to a report by Preqin.
The number of fund closings in the first quarter of this year marked the lowest since at least 2017, the data showed.
For example, almost six months after starting a fund targeting Europe’s wealthy, Blackstone Inc own figures show it’s attracted €240mil (US$258mil or RM1.2bil) to its new private credit fund, dubbed ECRED.
That’s a fraction of the US$12bil (RM55bil) raised for BCRED, an equivalent US fund, at the half-year point of its fundraising about two years ago.
For the new managers trying to access an already saturated market, it’s turning out to be even more difficult, as data from Preqin showed. “Raising capital now is tough for everyone, whether you’re big or small,” said Marc Chowrimootoo, managing director at Hayfin Capital Management.
“What we’ve found recently is that LPs are favouring managers that have an established track record in investing, even in tricky markets.”
The saturation of new entrants hasn’t deterred the rolling flurry of asset managers announcing their new strategies or expansions.
The saturation of new entrants hasn’t deterred the rolling flurry of asset managers announcing their new strategies or expansions.
Allianz Global Investors is stepping up its presence in Asia’s private markets, and SoftBank is looking at deploying as much as US$1bil (RM4.57bil) privately for tech firms.
That’s happened just as the market is set to face another strain.
Most private credit funds arrange loans on a floating-rate basis.
That boosts returns for the funds as rates rise and protects their holdings from interest-rate risk.
But the structure is coming under pressure after central banks around the world embarked on a series of rate hikes to combat spiralling inflation.
Since the start of 2022, the Federal Reserve has raised its benchmark rate 10 times to 5.25% from 0.25%, the Bank of England has hiked its key rate 11 times to 4.5% from 0.25% and the European Central Bank has increased its rate seven times to 3.75% from 0%.
The terms of the majority of private credit investments outstanding today would have been agreed at least 18 months ago, assuming a three-year average life, according to James Keenan, chief investment officer and global head of credit at BlackRock Alternatives.
Higher interest payments will stress borrowers’ balance sheets and are likely to lead to defaults, he said.
“Those investments were made against a very different economic backdrop from today’s,” Keenan wrote in a November report for the asset manager.
“Subsequent developments have the potential to significantly affect the performance of those companies, their debt, and the funds that are invested in them.” — Bloomberg
