“Every day it seems a fund or two announces a debt business,” says one European LP. “It’s a real trend in the market.”
Numerous private equity firms have moved into private debt over the last 18 months, some of which we detail on the opposite page.
There is logic to support such moves and it isn’t necessarily a worry for LPs (“as long as they keep it separate from their equity businesses”, says the same investor). Equity shops can expand their limited partner bases, increase their fee-paying assets under management and diversify their product offering. But peril may also lie in wait.
Data from our sister title Private Debt Investor show there are currently 139 first-time funds in market targeting a combined $42.8 billion for private debt, with 30 initial credit vehicles seeking more than $7 billion launched this year alone. In 2017, seven first-time funds have closed, locking down nearly $4 billion. This is on track to surpass the $5.5 billion raised last year by debut managers.
Any slowdown in first-time fund launches in the near future appears unlikely.
“There are still a lot of first-time credit fund managers jumping into the space that still believe there are opportunities out there, despite the fact that many experienced credit lenders believe we are in the later stages of the game,” says Stuart Wood, a managing director at fund administrator Cortland.
In total, 528 funds were in market in the first half of the year, according to PDI data. But first-timers keep popping up and, as the credit cycle lengthens, there’s a chance managers could be imagining an opportunity that proves to be illusory at worst or fleeting at best.
“In this market, you have to prove [yourself]. It’s not ‘if you build it they will come’,” says one market source.
He adds first-time managers must build an internal track record through a vehicle backed by an anchor investor or by the firm itself, as BC Partners did with its ‘friends-and-family’ $200 million opportunistic fund.
Mid-market lenders have become a dime a dozen, and it is becoming more difficult for firms to differentiate themselves. Specialised vehicles, such as those targeting a specific industry, can fare better on the fundraising trail.
There’s still appetite for debut funds, as the Illinois Municipal Retirement Fund proved in September when it made a $25 million commitment to The Sterling Group’s first mezzanine vehicle. But there is also a sense that moving a prospective investor to the ‘yes‘ column has got harder.
That so many vehicles are vying for a finite amount of dollars – even if that pool is growing – comes as funds may be struggling to find the deals that can produce the hoped-for results.
“We’ve seen funds that have gone through their fundraise and set their hurdle rate, but now they are sitting on a lot of dry powder. Many fund managers are not finding the deals out there that are going to meet their target yield requirements,” Wood says.
Fundraising competition is fierce and deal terms are loosening while each day more private credit practices are launched. It’s a potentially troubling mix.