Private debt comprised of direct lending, mezzanine, distressed debt and special situations funds – together with private equity are expected to be the main drivers behind the alternative industry's spectacular growth. Preqin added that private debt AUM is forecast to climb by 11.4% annually from $887 billion in June 2020 to circa $1.46 trillion by the end of 2025. The Preqin data also found that 47% of institutional investors intended to commit more capital to private debt, while 40% confirmed they would maintain existing investment levels. As a result of this, private debt is now the third-largest private capital asset class behind private equity and real estate.
Just as the asset class outperformed its peers in the aftermath of the 2008 financial crisis, private debt is in an excellent position to take advantage of some of the countercyclical opportunities on offer as a result of the COVID-19 crisis. Consequentially, there is likely to be a significant accumulation by private debt firms of distressed assets with strong long-term fundamentals. Other alternative and asset managers have taken note of the recent success of private debt, with hedge funds being one example. Although hedge funds outperformed the markets last year and provided investors with solid downside protection, a number of managers are increasingly conscious that they will need to diversify their businesses if they are to weather future crises. In response, many hedge funds are now launching private debt products as they look to widen the scope of their investment returns. As the number of hybrid firms swells, managers need to think carefully about how they run their operations.
How to manage data effectively
To manage operations effectively, private debt firms need to have access to consistent and easy to consume data. This can be achieved by using integrated or centralized systems instead of relying on a multitude of different platforms. With information readily available in a single place, it will be easier for private debt firms to oversee investments together with vital risk management metrics such as credit modeling, liquidity projections and loss given default scenarios.
In addition to centralizing data, managers need to find effective ways of automating their data collection processes, not least because it can help them control costs. Manual processing is no longer acceptable for many institutional investors as it can increase the risk of errors or misreporting, both of which could have devastating consequences.
As a result, private debt firms need to invest in their technology infrastructure to enhance their client reporting. For instance, more managers are beginning to utilize private debt dashboards to visualize borrowers' data and produce detailed analysis – information that is subsequently shared with investors. Elsewhere, other managers adopt real or near-real time reporting tools and make investment and risk data available to clients via their smart devices.
Although the private debt market is in healthy shape, fundraising is extremely competitive. Preqin found that 200 private debt managers raised $118 billion in 2020, although 39% of those inflows were secured by the top 10 funds, an increase from 31% in 2019. If managers want to obtain mandates, then they need to show that their client reporting processes are fit for purpose. At the same time, key decision-makers at institutional investors are getting increasingly younger and tech savvy, making it essential for managers to leverage best-in-class systems.
Investors cannot be taken for granted
Private debt is in a solid position, and it is an asset class poised to deliver strong returns over the next 12 to 18 months. Inevitably, this is leading to a spike in investor inflows, which in turn is prompting more managers from across the asset class spectrum – especially hedge funds - to launch private debt funds. Despite this bullishness around private debt, fundraising is not as straightforward as many experts would have you believe. Investors are very selective when awarding mandates meaning managers need to demonstrate that they can deliver more than just returns. With clients now demanding regular, timely reporting that can be accessed easily through smart devices, private debt firms will need to improve their data management and data visualization processes if they are to rise to the challenge.
Article originally appeared in AIMA Journal Edition 125.