Private credit assets swell along with portfolio complexity

If the pandemic brought investors and managers anything in spades in 2020, it was the proliferation of private credit opportunities.

Much of that interest has spilled over into 2021 too with fund raising activity from Marathon Asset Management, Kennedy Lewis, Blackstone, Sixth Street Partners, and Bardin Hill in the first two months of the year.

In 2020, Alternatives Watch via our Manager Scorecard found that of the roughly $80 billion was raised within private credit offerings, and that growth trend is expected to continue, according to experts.

For those firms looking to either set-up a new fund or strategy in 2021, there are a key set of questions they need to ask potential administrators. Socium Fund Services, which specializes in working with debt offerings, suggests managers ask specifically about an administrator’s experience with debt products.

Managers should know what experience administrators have in handling the unique features of debt offerings, such as conversion features, debt with unfunded commitments, amortizing loans, the proper accounting of origination fees and original issue discounts (OID) along with expertise in the valuation methods of private credit, according to Socium CEO Michael Von Bevern.

According to Socium, rates on private debt instruments are now averaging 10-15%.  This has attracted investors as private credit yields approach those of traditional private equity.

According to Alternatives Watch’s Manager Scorecard, private equity still accounts for most fundraising activity within alternatives with a total of $190 billion in investment commitments in 2020. We tracked a total of 47 funds that were launched in the private debt space last year, the funds closed at anywhere from $15 billion to $60 million.

These trends mean that the complexity and specialization required behind the scenes may be taken for granted by investors looking to invest in a wide variety of debt structures as quickly as possible in order to combat stubbornly low interest rates. Specifically, the opportunity that arose out of the pandemic meant that billions in distressed debt funds were raised in a matter of weeks last spring.

“For fund administrators, private credit is higher up the complexity scale and often takes a detailed review of the offering documents to ensure the fund, the instruments and the allocations are all setup correctly,” said Von Bevern. “Most private equity systems struggle to handle interest bearing instruments, so selecting an administrator that prioritizes technology that addresses the particular needs of private credit structures/portfolios is equally important as their understanding and interpretation of the fund documents.”

Socium expects the private credit boom to continue as the low-rate environment has also boosted the use of increased leverage for private debt funds as debt capital is significantly cheaper than equity. Von Bevern expects investor interest will likely continue in all arenas of lending, including asset-based loans, cash flow loans, secured, partially secured and unsecured, as well as senior subordinated.

So far this year Alternatives Watch has tracked a number of prominent public pension funds eyeing up additional private credit activity, includes Texas Employees’ Retirement System, New Mexico State Investment Council, Iowa PERS, Los Angeles County Employees’ Retirement Association and the Ohio School Employees Retirement System.

The debt strategies, while complex, do have some similarities in how they are being offered however, according to Von Bevern. These funds typically have longer lock-up periods due to illiquidity. Open-end funds generally have hard lock-ups of up to five years to match the duration of the underlying loans.

“Additionally, we are seeing more closed-end debt funds that have fewer liquidity issues, but often struggle with the increased frequency of capital calls,” Von Bevern observed.

He added that when it comes to fees, private credit tends to be in line with industry norms for open-end funds with the addition of hurdle rates in the 7-9% range.