Pitchbook characterise the first half of 2023 as a period of robust private debt fundraising activity which saw continued interest in a diverse range of private debt strategies. In particular, the Report highlights the following.
The extent of H1 2023 activity in this space, and the fact that the second half of the year is typically the stronger of the two – a trend that is likely to be played out this year given the stockpile of dry powder currently held1 – suggests that 2023 will be the fourth year in a row with new institutional commitments above $200bn; this notwithstanding a slowdown in retail fundraising in the US and a potential return of syndicated bank loans.
We see this widening of the markets readily evidenced by, among other things, the rise of club deals, with direct lenders once focused on standalone financings capping out in the €200m ballpark now clubbing together to finance loans typically the purview of the syndicated markets, and a new wave of mid-cap funds as established players have moved to large cap deals with the increasing retrenchment of bank lenders historically dominant in the space. Those new players are also open to sharing deals so as to participate in a more diverse portfolio and build their track record faster.
Pitchbook further note that in the US markets two of the top ten funds closed in H1 2023 were closed by emerging managers – being those managers with three or fewer funds – and that generally emerging managers accounted for 12.8% of the market in H1 2023 compared to 7.5% in 2022. This growth suggests that notwithstanding a general backdrop of a flight to scale2, allocators are prepared to select managers on the basis of their specialised or differentiated approaches (for example those relatively few Article 9 credit funds3), and not simply on the basis of their size and track record. Indeed, in the volatility of the current high interest rate and high inflation macroeconomic environment it may be considered advantageous to be absent of an existing, potentially stressed, portfolio (and some new entrants to the market are certainly marketing themselves as absent of portfolio distraction). This appetite for differentiation also rings true in Europe where, notwithstanding that forecasts suggest that there will be tougher conditions for emerging managers in H2 2023, specialised or differentiated approaches are heralded as the key to attracting commitments and some new mid-market managers have managed to withstand the headwinds and raise first funds.
The Report notes that in H1 2023, for the first time since 2013, private debt strategies consistently outperformed most other private market strategies (save for real assets and real estate) and the S&P 500 – where stock and fixed income investors saw losses of 18.1% - having benefited from floating-rate structures and diligent underwriting amid a rising interest rate environment. PitchBook’s final estimate of fund performance is that private debt funds returned 4.2% in H1 2023. On the other hand, increased performance has driven new entrants and increased competition amongst established GPs, which in turn has led to pressure on fundraising and fees in the estimated $1.5tn private credit sector.
Despite a fall in the volumes of US retail fundraising with H1 2023 seeing an estimated $16.6bn being committed, a quantum someway below the 2022 quarterly average of $12.0bn, the number of product launches has increased significantly as sponsors try to emulate the success of Blackstone’s Private Credit Fund. While some lenders look to closed ended funds, other sponsors are launching alternative (evergreen) retail vehicles, such as interval funds and business-development companies, the latter path recently trodden by T Rowe Price and Oak Hill Advisors who have together launched the T Rowe OHA Select Private Credit Fund. While sponsors have tapped into the vast potential of the US retail market, entering the UK/European retail landscape presents its own set of challenges. Not only is the latter smaller in size, but it's also grappling with regulatory reforms like MiFID II, aimed at enhancing transparency and reshaping distribution channels. As a consequence, some innovations that gain traction in the US might initially find their footing in the UK/European institutional segment. Two notable and innovative institutional products are the evergreen European direct-lending funds launched recently by KKR and Carlyle. Neither of these funds will charge carried interest or any form of performance fees. It will be interesting to see whether this is the beginning of a broader trend of managers prioritising asset accumulation over performance-based rewards4.
Whilst certain strategies are clearly preferred options in certain sectors - with for example direct lending continuing to be the preferred financing option for large leveraged buyouts, especially in the middle market, as banks remain cautious and selective in the syndicated loan market – the increasingly dynamic landscape highlighted by the Report is exemplified by the strategies of the top private debt funds closed in H1 2023, which funds cover the breadth of mezzanine, special situations and direct lending. Macfarlanes are seeing this in practice with managers establishing funds with differentiated strategies from their flagship senior loan or direct lending funds, and often very specific strategies (such as healthcare, infrastructure, fund NAV and leverage lending, impact investing, etc.). This opens up a wider spectrum of deployment opportunities, whilst also playing to the different appetites of the LP investor base to which they market. Finally, it remains to be seen the role of continuation funds, which only continues to grow in the context of private equity, will play in this asset class – private debt, by its nature, often has shorter durations than private equity investments. However, given the evolving nature of the private credit market and its increased complexity and diversification, there's potential for such liquidity solutions to be explored in private credit, especially for longer-duration or more illiquid credit strategies5.
