Lockdowns and stock market volatility put private debt fundraising on hold earlier this year, but activity has shown signs of recovery in H2 2020. Industry experts joined a recent webinar hosted by Real Deals and Preqin to discuss how private debt fundraising has evolved through the Covid dislocation period.

ON THE PANEL:

Antoine Josserand, Head of Business Development, Pemberton

David Lowery, Head of Research Insights, Preqin

Paul Shea, Co-founder and Managing Partner, Beechbrook Capital

Reji Vettaseri, Lead Portfolio Manager, Alternative Funds, DECALIA

Ramesh Yesodharan, Head of Credit Strategy, The Sumitomo Mitsui Trust Bank

Prior to lockdowns and travel restrictions, the growth of the private debt market was on an upward curve. The disruption to capital markets in the spring, however, shifted the dynamics.

Investors took pause to assess their positions. M&A markets locked up and private debt managers shifted focus from new deals to triaging portfolios. Now, as borrowers, managers and investors adjust to the new normal and fundraising resumes, how are LPs allocating to private debt strategies and what capabilities are they looking for in managers?

In a recent Real Deals webinar, held in association with alternative assets data specialist Preqin, a panel of experts discussed how private debt has evolved since the onset of the pandemic and what this means for the asset class’s long-term prospects.

A bump in the road

Preqin’s head of research insights David Lowery pointed out that prior to the pandemic, private debt assets had followed a strong growth trajectory over the last decade and were on track to top US$1 trn in 2020.

Covid-19, however, sparked a sharp reduction in private debt fundraising over the first half of 2020. Despite this drop off, the aggregate capital raised so far in 2020 was still greater than the amount raised in 2011.

There are reasons for optimism that private debt can navigate the current period of disruption and continue expanding on the other side of lockdowns. Lowery said that both the number of funds in the market, and the amount of capital targeted, was at record levels.

“There does seem to be increasing focus on private debt. This is unsurprising given the returns and stability private debt offers,” Lowery said. “The bounce back in activity has been remarkable. There is a need for funding on a global basis and the private debt market does remain very well-placed to take advantage of that.”

From traditional to alternative lenders

Beechbrook Capital managing partner Paul Shea said that despite Covid disruption, private debt was still wellpositioned, given the secular trend of lending shifting from banks to alternative lenders. This trend still had a long way to run, pointing to further room for growth in private debt AUM. One silver lining from the current downturn was that it provided an opportunity for private debt to demonstrate its value and longevity.

“Private debt is a long-term asset class and there is a systemic shift from lending by traditional lenders, such as banks, to private debt funds and other institutions. We are only part way through that shift as new managers come in and new strategies become available,” Shea said. “This is a blip, as there always are in business cycles, but it is one where the managers can demonstrate communication, portfolio management, downside protection and stable yields.”

An opportunity to lean in

The downturn following the accelerating spread of the coronavirus has seen credit supply tighten and taken some of the heat and competition observed at the top of cycle out of the market. This has created an attractive inflexion point for leaning into private debt, which has also been less exposed to valuation gaps than other private capital strategies, most notably PE.

“We think it is a very attractive time to invest,” Reji Vettaseri, lead portfolio manager for alternative funds as DECALIA, said. “If you look at the deals we are seeing now, and compare the underwriting previously, they feel materially different and better than six months ago. The other important point is around the volume of deals in private debt relative to private equity. It takes a long time for bid-ask spreads to change to a point where private equity can play, but in debt, the refinancings and some of the special situations tend to come in earlier, so it is a little easier to lean into private debt today than into other private market opportunities.”

Repayments: a key predictor of fundraising activity

Pemberton’s head of business development Alain Josserand said that after the initial lockdown period, when LPs paused to assess portfolios, most investors resumed allocations in line with long-term plans.

The one caveat, however, was the slowdown in distributions from existing managers.“When LPs build their allocation plans, they assume a certain repayment by their existing managers, so that they can factor in the right amount of money to reinvest and direct to new investments,” Josserand said. “In this market, refinancing will be lower than expected, so some LPs may have less capital to reallocate. That will manifest with LPs making larger allocations to fewer funds, or making smaller allocations to the same number of funds.”

Resource and workout infrastructure importance

For LPs making allocations to new private debt funds, the ability of managers to evidence investment in infrastructure and workout capability has become far more important.

LPs are skewing towards managers that have the scale and resources to shepherd portfolios through periods of distress and can continue assessing new opportunities simultaneously.

“Post-Covid we could see differences between managers in terms of their ability to quickly analyse the implications for each of their portfolio companies, communicate quickly and transparently with LPs and start to plans for some more challenging exposures,” Ramesh Yesodharan, head of credit strategy at Sumitomo Mitsui Trust Bank, said.

“Even before Covid, we were in a late cycle environment where workout infrastructure and credit pickiness were important features we looked at. Now, this has become an even more important aspect to understand and diligence.”