CFOs Forum: Private equity diversifying into credit

Entrants into private debt are hunting for yield in a competitive landscape that is technically complex.

More private equity firms have added credit funds to their arsenal, and they are learning some tough lessons on the new battlefield, according to panellists at sister publication Private Debt Investor‘s CFOs & COOs Forum.

The opportunity to play in a different part of the capital structure offered optionality to the market entrants, but sobering layers of complexity and competition could make adding debt an expensive proposition.

Firms including BC Partners and Capital Dynamics have added credit to their offerings in the last 18 months.

The importance of downside protection in credit investing was described as one of the draws to adding a debt platform for some alternative asset managers.

“The launch of the [private debt] business was a diversification move of course, but it was also because fundamental underwriting was taking downside lenses,” one panellist explained.

“So much conversation [around our private equity deals] has been on downside protection that credit was a natural place for us to evolve,” another attendee noted.

Crossover managers echoed the hope of catering to their strengths within the debt markets – leveraging their industry expertise and relationship.

“The biggest advantage for us is [to be] sector-focused,” one senior executive said. “Maybe we like the name in private equity, and we didn’t get the deal, but still think it’s great from a credit perspective.”

One person liked the idea of private equity relationships being a “source of good dealflow”,  which motivated the firm to enter the debt markets.

One thing that could help ease the transition into credit markets is bringing in an experienced team.

“It’s a different skillset and different [set of] experiences that is very important [and] that [a new] team brings with them,” one conference-goer said. “Certainly, there were complementary relationships that we had with that new team, and it turned into a powerful origination platform for us.”

It’s also helpful to for new entrants to spend time talking to their LPs early on about their opportunity set and how they planned to deal with conflicts of interest.

“One big hurdle was to get existing LPs to come through on the debt fund [for funding],” one panellist said.

Another said, “My experience is that LPs don’t want you to change. If you’re $2 billion in size, they don’t want you to be $2.5 billion. If you do private equity, then they don’t you to do credit.”

When asked to reflect on something they wish they knew before entering the private credit markets, one panellist said: “It’s a big market with a lot of competition. We should have started down this road sooner, to build credit relationships sooner.”