Private credit is an increasing area of focus for fund buyers looking for alternative sources of yield and diversification. In fact, private credit may become the fastest-growing strategy in European alternative investments over the next 12–18 months, one study predicted, as leading fund groups come to the market with new offerings in this space.
A recent survey of 110 UK and European fund managers conducted by Gen II Fund Services revealed 64% plan to launch private credit funds in the next 12 to 18 months. This was the highest rate of any alternative asset class.
Wave of fund activity
This tidal wave of new fund activity aligns with expectations of growing investor demand. The report found 38% of fund managers anticipate that investors will increase their allocations to private credit over the next year.
Investors are attracted to the asset class by its high yields, steady income and diversification benefits, as well as the potential for low volatility as, not being publicly traded, it is not marked to market daily. The emergence of private credit has helped bridge the gap left by banks which have pulled back from financing in the middle market sector, according to Morgan Stanley.
Several fund groups have recently come to market with private credit strategies, including AXA IM, Amundi and Aegon.
Asset managers snap up private credit specialists
Private credit (or private debt) includes sub-types such as mezzanine debt (a debt/equity hybrid), distressed debt (lending to companies in financial difficulties), venture debt (for startups), asset-backed lending (loans secured against property or equipment), and real estate debt (lending for commercial or residential property deals).
As more capital flows into private credit, fund managers are targeting a broader mix of strategies, with planned launches spanning some of these sub-types, including real estate debt (23%), mezzanine (15%), distressed debt (14%) and both venture debt and special situations (13%).
Alex Di Santo, head of private equity, Europe, at Gen II Fund Services said: “Private credit has performed well over the years and we expect to see continued growth in the space from established credit funds as well as newer players. Private credit today is a lot more than direct lending – there are many other compelling credit products that are attractive to investors.”
Recent M&A activity has included private credit-focused firms: Janus Henderson acquired private credit firm Victory Park Capital last year, with CEO Ali Dibadj also noting that “asset-backed lending has emerged as a significant market opportunity within private credit, as clients increasingly look to diversify their private credit exposure beyond only direct lending.”
Meanwhile BlackRock agreed to buy private credit specialist HPS Investment Partners at the end of last year in a deal which would create a $220bn private credit franchise. BlackRock has predicted that the private debt market as a whole will more than double to $4.5tn by 2030.
Despite their expectations for growth in private credit, fund managers surveyed by Gen II Fund Services reported that they remain mindful of broader macroeconomic risks. Political uncertainty was cited by 33% of respondents as the most significant obstacle to growth, while 25% pointed to the risk of recession, reflecting a note of cautious optimism amid ongoing global economic headwinds.
Di Santo continued: “These concerns have not dampened conviction. If anything, managers are positioning themselves to take advantage of potential dislocation. Private credit has proven to be a very resilient asset class in a challenging macroeconomic environment.”
Private debt vs private equity
But why private credit as opposed to private equity? Pete Drewienkiewicz, chief investment officer at Redington, highlights the fact that these are very different asset classes. Private credit comes with a lower level of risk – it sits higher up the capital structure than equity and some other forms of debt, meaning it offers lenders more security that their capital will be repaid.
Private debt is shorter dated than private equity and pays a higher income at present, he added, making it attractive to investors. “Private credit has a lot to offer as a yield enhancement in the wealth arena and given its shorter-dated and cash-flowing nature is less problematic liquidity-wise than PE, where you might be locking up money for 10 years or more.”
Liquidity challenges
James Sullivan, head of partnerships at Tyndall Investment Management, agreed the yields available in the private credit space are attracting investors, but said liquidity remains an issue in this complex area of the market. “Investing in private credit comes with headwinds of illiquidity and complexity; however, these are often compensated for by a more attractive yield than public debt,” he said. “Depending on the strategy, expected returns can typically range from 7-12% – something more akin to equity investing, if gotten right.”
Personally, he is not investing in private credit at Tyndall IM because of the illiquid nature of the asset class.
“Despite this yield appeal, we are not currently exploring private credit as an investment theme because the liquidity mismatch with our mandates makes it incompatible. We do not have a mandate to ‘lock up’ money, even if only for a short period, so liquidity remains front and centre in much of what we do,” he added.
Some of the other challenges of investing in this area include ongoing scrutiny of debt levels, and the quality of borrowers within a constrained credit environment, Gen II’s research suggested. However, it is still predicting an increase in the average internal rate of return (IRR) from 8.1% between 2017 and 2023 to 12% between 2023 and 2029, suggesting private credit will remain firmly on professional investors’ radar.
