Asset AllocationJuly 30, 2014

Private Debt: the Up-and-Coming Alternative Player

Investors are increasingly re-allocating capital from traditional fixed income and alternatives to private debt, Preqin has said.

Reported by Featured Author

Private debt has emerged as a new alternative investment—with the potential for immediate returns and low correlations—that is appealing to investors on the hunt for yield in the years since the financial crisis, according to Preqin.

Prompted by increasingly stringent regulations that closely monitor traditional banks’ lending practices, debt fund managers have stepped into newly created opportunities, where previously they had been committed to traditional fixed income and alternatives.

“The post-crisis appetite of investors for private debt exposure has developed aggressively as traditional fixed interest vehicles struggle to offer the attractive yield or risk profiles as before the credit crisis of 2008,” the report said.

“The asset class has developed an identity separated from private equity and hedge fund classifications, which will aid would-be fundraisers in the future,” Preqin said.

The fundraising outlook for private debt managers is optimistic, Preqin claimed, as capital has been flowing out of corporate and sovereign debt and into the private sector.

According to the report, two thirds of more than 240 institutional investors surveyed said they had already invested in private debt or were considering investing. Among these asset owners, the current average allocation was 5.6%.

Investors also said they planned to allocate to private debt by moving capital from traditional fixed income (24%), private equity (20%), and broader alternative buckets (19%). Their target returns ranged from 8% to 14%, with North American investors anticipating more aggressive returns—between 9% and 15%—than their European counterparts.

“The observed proportion of private debt investors with a specified private debt allocation is likely to grow as presumably more institutions install personnel to oversee debt portfolios,” Preqin said.

The majority—78%—of surveyed investors said direct lending debt was the most attractive strategy, followed by mezzanines at 61% and distressed debt at 59%. The least desirable fund type was junior debt, with only 38% of investors expressing interest.

Preqin found investment preference concentrated in North America (74%) and Europe (59%), largely due to asset owners’ inclinations to “remain within the confines of the countries with the most transparent legal systems, highest investment activity, and available market intelligence.”

“These facilities are necessary to establish stable interest terms, uphold deal framework, and see through complex compliance mandates between lenders and borrowers,” the report said.

However, challenges still exist for this burgeoning new asset class, according to Preqin, as private debt managers need to successfully structure and position funds within portfolios—a task largely done by altering allocations to alternatives and traditional fixed income.

“The asset class has developed an identity separated from private equity and hedge fund classifications, which will aid would-be fundraisers in the future,” the report said.