The pace of fundraising for private debt strategies is showing signs of slowing, a reversal of last year’s rapid clip, according to PitchBook data.
According to PitchBook, just $28.9 billion was raised for private debt funds in the first quarter of the year, a sharp decrease from the record $72.8 billion seen in the fourth quarter of 2021 Global report on private fund strategies. While the delay in fundraising data means the drop may not be as severe as it appears, the drop signals that current economic conditions may hamper fundraising for such strategies.
A number of macro headwinds – including supply chain disruptions, persistently high inflation, a tight monetary policy environment and falling equity markets – are weighing on managers’ fundraising efforts. However, certain strategies – which could maintain robust performance in volatile markets and rising interest rate environments – will remain popular with allocators looking for opportunities to generate higher returns in a period of uncertainty.
We recently spoke to Jess Larsen, Founder and Managing Director of Briarcliffe Credit Partners, to get the pulse of the current personal credit fundraising market and what limited partners expect of managers.
Larsen founded the company in 2019. It is a placement agent for private loan managers, advising clients ranging from wealth management giants seeking fundraising advice for their private loan offerings to specialist boutique loan managers with billions of dollars in assets under management .
PitchBook: Given the current market turmoil, where are investors looking for yield in the personal lending space?
Larsen: Valuations in the public stock market have fallen, which has led to the so-called “denominator effect”. If you’re a pension plan manager, the sudden fall in public market valuations may cause your portfolio to become overweight private markets. As a result, some limited partners are considering options to manage this situation.
We are seeing increasing capital flowing from the fixed income side into private debt strategies, which is an interesting development. And we are seeing demand for strategies that are uncorrelated to the stock market, including specialty finance, special situations and distressed debt. Examples could be equipment leasing, trade finance, or the financing of tangible assets such as athletes, whiskey casks, and works of art. These differ from the typical direct lending strategy, which is about corporate health. As we anticipate an imminent recession, we will likely see corporate health take a hit. What LPs really want is a private credit portfolio that can weather the storm as we head into a recession.
We’ve seen many investors absorb distressed debt funds during the height of the pandemic in 2020. Why are we now seeing renewed interest in this strategy?
During the height of COVID-19, a significant amount of capital flowed into funds aimed at investing in emergencies and special situations as investors thought the pandemic would trigger a recession. However, when we came out, we didn’t have a recession.
But the macro environment has changed dramatically over the past three months. We now consider the prospect of a recession. If a recession is expected, this would be a benign environment for managers to focus on stressed and distressed investments as companies will face challenges.
However, we have only begun to see a shift in the macro environment. So it will be some time before we actually see a recession and companies start going into default mode. We’ve started to see some cracks, but we’re still some time away from a full-blown recession. Now is a good time to raise capital so you have the capital available when the time comes.
Some GPs have raised trigger funds that are set up to draw tied-up capital from LPs on certain triggering events. These triggers could include unemployment rates, slowing GDP growth, inflation rates, changes in yield spreads and other financial and economic data.
Trigger funds, or contingency funds, have been around for years. They are primarily set up for distressed strategies. To be successful with distressed investing, you usually need a challenging economic environment. The structure of trigger funds allows investors to invest only when the market is ready for such strategies, rather than allocating capital during a bull market where distressed opportunities are hard to find. We’ve seen significant growth in trigger funds over the past five years.
Infrastructure assets are typically viewed as an inflation hedge. What about infrastructure loans? Are we seeing increased demand for infrastructure debt funds now?
One could argue that infrastructure credit is uncorrelated because investments are linked to a physical asset. The challenge we sometimes have with infrastructure debt strategies is that their net returns are typically 5% to 6% to a maximum of 7%. And that doesn’t always meet an investor’s internal hurdle rate of 7% to 8%. While infrastructure debt is a great strategy, it doesn’t always meet these yield requirements.
The market seems to have changed dramatically in the last few months. Last year we had a dealmaking frenzy, while now suddenly everyone is talking about stagflation or recession prospects and deal activity has slowed in a variety of sectors. Have LPs adjusted their return expectations for private debt strategies?
About 18 months ago, the typical return target we heard from US LPs was a 14% net return for these uncorrelated private debt strategies. Now we hear 12% as a target return more often. That’s probably one argument that people are setting a less aggressive rate of return expectation.
Is now generally a more challenging time for personal loan financing?
In the near term it will be a tougher environment for fundraising in the private market in general as LPs deal with the macro environment, the denominator effect and write-downs – particularly in venture capital.
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