Why Capital Is Flowing Into the Top 30
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Analysis TALKING POINTS The pandemic has accelerated many themes already evident in private credit, with growing allocations to the asset class and more capital gravitating to the largest managers, say Jeffrey Griffiths and Richard von Gusovius, co-heads of global private credit at Campbell Lutyens Why capital is flowing into the top 30 What themes have you senior end of the capital structure, in- SPONSOR witnessed over the past creasingly preferring senior-only strat- Q CAMPBELL LUTYENS year in terms of LP appetite for egies, and developing a more prudent private debt funds globally? attitude towards unitranche strategies. Jeffrey Griffiths: We have seen con- removed themselves from the private Then there are others looking at strat- tinued flows of capital into private debt credit markets and gone elsewhere. egies seeking higher return targets in despite the pandemic environment, Private credit remains core for a lot special sits, credit opportunities and with no significant pullback. There has of institutional investors and is a place dislocation themes. So, we have seen a been some slowdown in fundraising ac- where they are looking to grow their bifurcation into super-senior and dis- tivity, in line with all alternatives, which exposures. tressed, with many investors also show- is partly due to the weaker environment ing, due to travel limitations, a prefer- for transactions creating less need for Richard von Gusovius: Many of the ence for backing GPs that they already managers to raise new capital. But in- long-term trends we were seeing in know well. vestors have not pulled away from their the market have been accelerated by plans to grow their allocations. covid, including the amplification of The total capital On the margin, some investors have the bar-belling of the investor appetite Q commitments of the top become more cautious and delayed or along the risk/return spectrum. Many 30 private debt managers have slowed activities, but very few have investors have gravitated towards the increased from $230 billion last February 2021 • Perspectives 33 Analysis grow relationships with new groups, We expect the US market to move “North American there is a natural tendency towards ex- more in the direction of European and isting relationships. We have seen the Asian investors with a preference for investors are more larger managers are well-placed to take downside protection, but that’s likely advantage of a market like this, and as to be a gradual process. risk-taking and are new investors are coming into private credit, they are also tending to make Europe and North America therefore going further their first deployments with the more Q continue to be the focus well-established groups. However, as for investor appetite, with Asia- down the capital funds get larger and larger, we can see Pacific and the Middle East and structure” their performance deteriorate. So it is North Africa some way behind. often best for investors not to just focus Is the impact of covid likely to on the big managers but also to get to change these dynamics at all in JEFFREY GRIFFITHS know others that are at an earlier stage 2021? in their development, with the newer RvG: We continue to see North Amer- teams more aligned with investors for ican investors focused on investing in success. North American assets and European year to more than $300 billion investors looking to deploy in Eu- today. What has driven that Subordinated/mezzanine rope, and I don’t think covid is going significant flow of capital into Q debt remains the most to change that. Globally, all investors these top 30 funds? popular strategy for private wanted to talk about dislocation and RvG: There are a number of factors debt investors, followed by distressed strategies for three or four that play into the hands of the larger distressed. Have you seen months, but now they have made their managers at the moment. First, as pri- much shift in strategy by bets and we will see how that plays vate debt continues to grow its share of private debt investors through out. The cost of capital among pen- LPs’ allocations, the larger players are 2020? sion funds and insurance companies well positioned to take a disproportion- JG: In part this is driven by the data in Europe is lower, whereas American ate share of new allocations – as LPs do set. What we see in North America is investors need to seek higher returns, not see the benefit of additional GP that investors doing private credit tend so there are many reasons why that is a diversification in direct lending, where to be investing from private equity long-term trend. differentiation is marginal. Differently or alternatives allocations, where the We find it increasingly difficult to put, it often doesn’t make sense to add a objective is a higher-risk, higher-re- find offerings that will appeal to all seventh or eighth direct lender to your turn strategy. That puts private debt investors globally, with appetite now portfolio because they are all doing alongside private equity and other eq- really varying regionally. Asian inves- much the same thing. So you give more uity allocations. That in turn tends to tors, and particularly those coming to your existing relationships, as long as induce them to seek returns similar to out of Japan and Korea, are more in they do a good job. private equity, which would push them the yield-seeking camp with European At the same time, there is a benefit towards subordinated, mezzanine and investors. There are some shifts un- from limiting the number of relation- distressed strategies over senior debt or derway when you look at the Middle ships as it will allow you to drive bet- unitranche. North American investors East, however, where there seems to ter economic terms that way, including are more risk-taking and are therefore be a move going on as investors con- access to special co-investment rights going further down the capital struc- sider more yield-orientated perform- and so on. Finally, when some of the ture. ing credit strategies. One of the most very large institutional investors start In Europe, investors are generally innovative groups in that region is to move 1-2 percent of their AUM into coming from a fixed-income back- Mubadala, which has recently teamed private debt, that is a lot of money to ground, where they are faced with very up with Apollo and Barings to create deploy and that also favours the large low yields that they are trying to solve direct lending partnerships, and we see platforms. through private debt. So, they are not them setting the tone for a strategic looking for double-digit returns, but play throughout that region. JG: Many of the larger managers have more like 7-8 percent. been asking investors to re-up and are That is likely to change, as the US How do you expect pushing bigger fundraisings. In a time markets are not immune to yield com- Q allocations to evolve in of pandemic when we can’t travel and pression, and in fact we have seen that. 2021 and what do you expect 34 Private Debt Investor • February 2021 Analysis to see investors focusing on? JG: The economic environment will result in some increased default rates and loss rates, which is actually a healthy development for the private credit market. Private credit managed through commingled GP-LP struc- tures has not been in existence for long – senior direct lending only really start- ed in its current form around 2010 – so we are going to get to see how funds perform in a more difficult economic climate. That will be helpful, because it will prove that many managers will have done a good job at protecting capital and creating resilience in their North America continues to dominate when it comes to fund returns, and that is something Q capital commitments by regional HQ of the top 30. Why that investors have been waiting to see. is this, and do you expect it to change in the year ahead? As the market is tested and comes out well, we expect allocations to increase JG: The top 30 is really dominated by North American institutions, and still further. in the last five years we have seen a real geographic retrenchment where The average pension fund is cur- North American investors have favoured investing in North America, and rently only allocating about 2-3 per- the same with Europe. That was a bit different a decade ago, but there is a cent of total assets to private credit, new preference to focus on home markets, partly because European total and that is very low when you consider returns have come down as interest rates have fallen and the economic how natural it is as a market for most growth environment in Europe has been lower than the US. That was of these investors, which are looking the case pre-covid, when the US market was attractive from a returns for mid-to-high single-digit returns. A perspective. But now the interest rates have harmonised, that may change. more natural allocation would be 5-10 percent. RvG: North American firms have long dominated private markets and I don’t expect that to change. Houses like KKR, Carlyle and Blackstone RvG: Allocations will continue to in- recognised alternatives as an industry and have driven proliferation of crease into the asset class and, when it strategies, seeing themselves as asset managers rather than investors. They comes to strategy, the larger manag- have achieved a real scale advantage that allows them to absorb very large ers will look to continue to build new allocations, being a first point of call for new LP entrants, and move much offerings.