Alt Investments

Direct Lending Market Prospers, Matures As Thirsty Investors Hunt Yield

Tom Burroughes, Group Editor, 20 May 2021

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The research firm has chronicled the changes taking place in the private market investing arena, which has boomed because investors are eager for yields, even if that cranks up their risks.

Investors, including those in the wealth industry, are pumping billions more dollars into direct lending at a time of low yields from conventional investing, although some returns will be squeezed as capital floods in, a research firm says. After the wreckage caused by lockdowns and the pandemic, direct lenders will pivot from bargain-hunting strategies to more "forward-looking" ploys, Preqin said.

One big theme for HNW clients’ investments over recent years has been a switch toward private market debt and away from more traditional lending by banks and through bond issuance. After the 2008 financial crash, tighter capital rules, regulations such as Dodd-Frank and deleveraging by investment banks crimped of traditional credit sources. Result: enter the world of private credit. This took the form of fund-based lending, and sometimes direct lending via entities such as family offices and partners of wealthy investors and institutions. 

Since the end of 2009, private credit assets under management have risen from $264 billion to almost $1 trillion as of last September, according to Preqin Pro, part of Preqin, which tracks alternative asset classes. 

Among private credit funds focused on North America, funds of vintage 2020 – a year when the COVID-19 pandemic rocked markets – closed with $148 billion in capital. Through the first five months of 2021, funds of this year’s vintage have closed with only $26 billion, the firm said. It noted that another $64 billion of targeted capital is being raised. The sum, $90 billion, is already higher than 2016 or any year prior, and on track to top the average $103 billion secured by fund vintages 2017 to 2019, Preqin said. 

In a commentary, Preqin author Charlie McGrath said a well-understood driver of this change has been the US Federal Reserve. Very low interest rates, along with buoyant equity markets have warmed investors to shouldering more risk. Low conventional market yields have driven investors up the risk curve in search of returns. 

“The surge in private credit assets suggests many are willing to trade liquidity for returns, even if it means stepping further out on the risk spectrum than they would normally,” he said. 

Direct route to goal
The report noted that figures show a shift in focus from 2020’s bargain hunting to more forward-looking direct lending funds in 2021. Distressed lending funds raised a total $35 billion last year across 19 vehicles, well ahead of the next-largest asset gatherer, senior direct lending ($24 billion). 

“The emphasis on distressed debt was clear as the COVID-19 pandemic stressed nearly every aspect of North American and global economies, leaving many otherwise healthy businesses in need of liquidity. How these funds perform is yet to be seen as government stimulus provided cheap and, in many cases, forgivable loans to help businesses stay afloat,” McGrath said. 

“The 2021 vintage, however, is showing signs of a return to normalcy. This time, private credit lenders have put far more money into direct lending strategies. Broad direct lending funds have raised or are targeting $23 billion so far this year, followed by $21 billion for senior debt direct lending. Distressed debt funds trailed with $13 billion in capital,” he said. 

McGrath ended on a sanguine note: “Like private equity, returns will dip as more participants enter the market, but private debt will still be seen as a higher-yielding alternative to its public market counterpart. Liquid or not, public credit is no longer the rock it once was and, like equity, private markets are calling.”

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