Unlocking Private Debt's potential in 2025

After almost 20 years of growth, the private debt market has certainly matured and evolved. In our latest thought leadership by Altum Groups Chief Commercial Officer Stephen McKenna we take a look at the current state of play and how the industry might develop in the short and medium term. The US market has always been ahead of Europe and therefore the thoughts gathered from the recent LP GP Connect Private Debt New York conference from industry leaders at is a good indication of what is set to come in Europe too.

Unlocking Europe’s Private Debt potential

In the US it is estimated that up to 80% of all corporate lending is provided by non-bank lenders. Europe is considerably behind these levels of penetration and corporate borrowers probably remain less aware of the funding options available to them. This provides optimism for future growth in Europe. Investors have also become much more aware of the benefits of the asset class and now see private debt as an allocation in its own right after many years of being lumped into the private equity bucket.

The various strands of private debt have also increased dramatically. Direct lending is the pioneer and still the headline act but additional strategies such as asset backed, opportunistic, non-performing, CLOs, Venture debt, NAV financing and many more provide a plethora of options that are now available today.

What is likely to be the goals for investors into private debt?

A strong risk adjusted return profile is the cornerstone of the private debt investing rationale. Downside protection while providing a stable income generation. During a period when private equity exits have stalled the income generated by private debt has been even more valuable to investors.

Given the floating rate nature of private debt, the higher interest environment of recent years has meant that the return provided by debt has moved much closer to that offered by its bigger brother, private equity. Combined with the income generation and being higher in the capital stack one can see the appeal. Should interest rates fall as expected then some of that return will be reduced but the risk profile of the borrowers will also improve and interest floors will mitigate and danger of returning to a very low interest environment.

Diversification and enhanced return profiles

Diversification has always been a factor when considering adding debt to a portfolio and products such as CLOs provide supercharged diversification. Products such as NPLs and special situations can provide even higher return profiles and potentially an equity kicker for increased upside.

Challenges with manager selection

Given all the options, selecting the right manager for the right product becomes even more difficult. This was a trending topic  of discussion at the recent LP GP Connect conference and there were a couple of interesting suggestions put forward.

• What experience and capacity does the manager have for working through a default?
• Do they have the bandwidth to work with multiple borrowers who might need assistance and have they done that before?

This might mean a movement to larger managers which has definitely been a trend in recent years but research suggests that newer or emerging managers tend to generate better returns so again it depends on your aims as an investor. Unanimously it was agreed that  connection with and availability to the management team is as important as the track record for managers when investors were discussing their selection criteria.

Resilience of non-sponsored businesses

One interesting area of the selection criteria that was surprising for me was the importance placed on the managers ability to lend in the non-sponsored space. Given direct lending has been dominated by sponsor backed borrowers I found this surprising. Having a private equity backer acting as a buffer in the capital stack always felt like a reassuring presence, however, there was an argument that private equity is more likely to have worked through efficiencies in the business and stripped out some of their ability to withstand a downturn in income. Therefore, suggesting that non-sponsored businesses could be more resilient and given the sponsor would not have negotiated the terms the loan could also be more favourable for the lender.

There were still areas of concern or factors to consider at least such as the increase in lender-on-lender violence which has attracted a lot of media attention despite being isolated to a relatively small number of examples. There was also reference to the ‘denominator effect’ which isn’t something I have heard mentioned for a while. A few years ago, this dominated conversations but despite a lower profile remains a consideration especially with increasingly volatile public markets.

How Altum Group can help you

Despite these considerations the long- term outlook for private debt remains incredibly positive. Debt is a core product for Altum Group and our expert teams are available and happy to discuss any questions you might have.