PREQIN SPECIAL REPORT: PRIVATE DEBT FUND MANAGER OUTLOOK H2 2017 alternative assets. intelligent data.
PREQIN SPECIAL REPORT: PRIVATE DEBT FUND MANAGER OUTLOOK FOREWORD So far in 2017, private debt fundraising figures are on pace with those of 2016, with funds closed so far this year having secured just under of the aggregate capital raised in 2016. Considering this momentum, and the fact that 300 funds are currently in market seeking an aggregate $146bn in targeted capital, the private debt asset class appears to be set up for another successful year. In June 2017, Preqin surveyed private debt fund managers to understand their outlook for the industry, covering key issues such as deal flow, investor appetite and their plans for the year ahead. Optimism among private debt fund managers remains high, no doubt as a result of increased investor appetite over the past year, as reported by 90% of managers. However, managers are still concerned with deal flow, the influx of new managers into the industry and the pricing of assets. The fundraising environment is expected to remain highly competitive, as more and more investors break out private credit as a separate allocation and look to increase their capital commitments. We hope you find this report useful, and welcome any feedback you may have. For more information, please visit www.preqin.com or contact info@preqin.com. p3 p5 p6 p7 Deal Flow and Competition Fund Manager Views on Investor Appetite Outlook and Future Plans In Focus: ESG Impact and Differentiation Survey Respondents by Headquarters Location 60% 2 16% North America Europe Asia Survey Respondents by Primary Private Debt Investment Strategy Proportion of Respondents 4 40% 3 30% 2 20% 1 0% 4 Direct Lending 36% Mezzanine 8% Distressed Debt Special Situations 8% Other Primary Investment Strategy All rights reserved. The entire contents of Preqin Special Report: Private Debt Fund Manager Outlook, H2 2017 are the Copyright of Preqin Ltd. No part of this publication or any information contained in it may be copied, transmitted by any electronic means, or stored in any electronic or other data storage medium, or printed or published in any document, report or publication, without the express prior written approval of Preqin Ltd. The information presented in Preqin Special Report: Private Debt Fund Manager Outlook, H2 2017 is for information purposes only and does not constitute and should not be construed as a solicitation or other offer, or recommendation to acquire or dispose of any investment or to engage in any other transaction, or as advice of any nature whatsoever. If the reader seeks advice rather than information then he should seek an independent financial advisor and hereby agrees that he will not hold Preqin Ltd. responsible in law or equity for any decisions of whatever nature the reader makes or refrains from making following its use of Preqin Special Report: Private Debt Fund Manager Outlook, H2 2017. While reasonable efforts have been made to obtain information from sources that are believed to be accurate, and to confirm the accuracy of such information wherever possible, Preqin Ltd. does not make any representation or warranty that the information or opinions contained in Preqin Special Report: Private Debt Fund Manager Outlook, H2 2017 are accurate, reliable, up-to-date or complete. Although every reasonable effort has been made to ensure the accuracy of this publication Preqin Ltd. does not accept any responsibility for any errors or omissions within Preqin Special Report: Private Debt Fund Manager Outlook, H2 2017 or for any expense or other loss alleged to have arisen in any way with a reader s use of this publication. 2
DOWNLOAD DATA PACK: www.preqin.com/pdfmoh217 DEAL FLOW AND COMPETITION Between the abundance of fresh capital raised among private lending funds and near-record-high dry powder levels in recent years, managers are highly motivated to put available capital to work in the private debt market. The largest proportion (48%) of fund managers surveyed for this report believe that private debt deal pricing has not changed from 12 months earlier, while 38% feel pricing is now lower. Only 1 of fund managers stated that deal pricing is higher as of H2 2017. FUND MANAGER VIEWS ON PRICING FOR PORTFOLIO COMPANIES COMPARED TO 12 MONTHS AGO 1 48% 38% Pricing Higher Pricing Lower Fig. 1: Fund Manager Views on the Difficulty of Finding Attractive Investment Opportunities Compared to 12 Months Ago 39% 18% 43% More Difficult Same Easier Fig. 2: Amount of Investment Opportunities under Review by Fund Managers Compared to 12 Months Ago Reviewing More Opportunities High levels of deployable capital and a growing number of sophisticated industry participants are likely contributing to the increased difficulty in identifying attractive investment opportunities, as reported by 43% of respondents (Fig. 1). As a result, 61% of managers are reviewing a greater number of potential investments in H2 2017 than a year earlier, and only are reviewing fewer opportunities (Fig. 2). Although 39% of respondents experienced no change in the level of difficulty in finding attractive investment opportunities, 18% of survey respondents have found it easier. The different environments managers are experiencing are likely a reflection of the diversity among surveyed managers investment strategies, sponsor relationships and dealsourcing methods. 3 Although senior lending has stood out across the private debt and alternatives market in general in recent years, there now exists growing optimism around mezzanine and subordinated debt moving into H2 2017: of managers believe these strategies present the best opportunities for the next 12-24 months (Fig. 3). Direct lending and senior debt strategies are favoured by 59% of 61% Reviewing Fewer Opportunities managers, followed by unitranche (32%) and special situations (1). Distressed debt and NPL strategies are thought to present the best opportunities by the smallest proportion (9%) of fund managers, a departure from 2016 when distressed debt funds secured the most capital among all private debt strategies. At this point in H2 2017, it appears that 3
PREQIN SPECIAL REPORT: PRIVATE DEBT FUND MANAGER OUTLOOK managers are more focused on lending higher up the capital structure via performing loan arrangements rather than non-performing, a possible indication of managers views on credit cycle timing. The amount and types of covenants included in private debt transactions can depend on several conditions between the borrower, lender, sponsor and other external market factors. The large majority (77%) of managers are maintaining the same amount of covenants as 12 months ago, while 18% are including more than in mid-2016 (Fig. 5). Only of managers are participating in deals with lighter covenant structures. FUND MANAGER VIEWS ON THE CHANGE IN DIRECT LENDING TERMS COMPARED TO 12 MONTHS AGO More Borrower 47% Friendly 53% The consensus among direct lenders surveyed is that financing terms have not changed in their favour over the past 12 months. In fact, more than half (53%) of lenders are seeing the same borrower-lender favourability balance in direct lending terms as 12 months ago, while 47% have seen a shift in favour of borrowers. The increased investor appetite, available capital and competition for deals among private debt fund managers are certainly all factors working in borrowers favour. Fig. 3: Strategies Fund Managers View as Presenting the Best Opportunities in the Next 12-24 Months Direct Lending/Senior Debt Mezzanine/Subordinated Debt Special Situations Distressed Debt/NPL 38% Unitranche 9% 1 32% 59% 0% 20% 30% 40% 60% 70% Fig. 4: Fund Manager Views on the Level of Competition for Transactions Compared to 12 Months Ago 62% More Competition Less Competition Fig. 5: Fund Manager Views on the Number of Covenants within Deals Compared to 12 Months Ago 18% More Covenants Fewer Covenants 77% 4
DOWNLOAD DATA PACK: www.preqin.com/pdfmoh217 FUND MANAGER VIEWS ON INVESTOR APPETITE Ninety percent of managers surveyed have noticed an increase in investor appetite for private debt over the past 12 months (Fig. 6). Furthermore, no managers reported a decrease in investor appetite, and only saw no change. The largest proportions of managers saw increased demand from family offices (78%), fund of funds managers (71%) and wealth managers (63%, Fig. 7). More than half of managers also reported increased demand from asset managers, insurance companies and public and private sector pension funds. A few managers (6% or less) reported less appetite from both foundations and endowment plans; however, 59% and 42% noted increased appetite from those investors respectively. According to managers surveyed, investor appetite for private debt has particularly accelerated in North America, with 71% of managers experiencing increased demand from investors based in the region, followed by those located in Europe (47%) and Asia (4, Fig. 8). As investor demand for private debt grows, competition among fund managers for investor capital is intensifying. Over half (62%) of managers believe there is now more competition among peers than 12 months ago, while only feel there is now less (Fig. 9). Fig. 6: Fund Manager Views on How Institutional Investor Appetite for Private Debt Has Changed over the Past 12 Months Fig. 7: Fund Manager Views on How Institutional Investor Appetite for Private Debt Has Changed over the Past 12 Months by Investor Type 58% 32% Significantly Increased Slightly Increased Slightly Decreased Significantly Decreased Family Office Fund of Funds Manager Wealth Manager Foundation Asset Manager Insurance Company Public Pension Fund Private Sector Pension Fund Bank Endowment Plan Sovereign Wealth Fund Superannuation Scheme Government Agency 6% 6% 17% 2 37% 3 41% 4 4 53% 53% 71% 7 7 78% 71% 63% 59% 59% 56% 56% 47% 42% 29% 2 2 0% 20% 40% 60% 80% 100% Decreased Increased Fig. 8: Fund Manager Views on How Institutional Investor Appetite for Private Debt Has Changed over the Past 12 Months by Investor Location 100% 90% 80% 70% 60% 40% 30% 20% 0% 71% 29% North America 47% 4 53% 56% Europe Asia 21% 27% 27% 20% 79% 73% 73% 80% Latin America Australasia MENA Sub-Saharan Africa Increased Decreased Investor Location Fig. 9: Fund Manager Views on the Level of Competition for Institutional Investor Capital Compared to 12 Months Ago 33% 1 48% Significantly Increased Slightly Increased Slightly Decreased Significantly Decreased 5
PREQIN SPECIAL REPORT: PRIVATE DEBT FUND MANAGER OUTLOOK OUTLOOK AND FUTURE PLANS According to fund managers surveyed, deal flow, the influx of new managers and deal pricing are the key issues affecting the private debt industry. The majority of fund managers do not foresee many challenges for the industry over the next 12 months, with deal flow the only response identified by as much as half of GPs (Fig. 10). It is therefore unsurprising that no fund manager surveyed expects to deploy less capital in the next year than they did in the previous 12 months, with 3 planning to deploy significantly more capital and 39% slightly more (Fig. 11). While the majority (62%) of fund managers in the process of launching funds will not alter their targeted returns based on current valuations, the remaining 38% plan to lower their targeted returns. Over the next 12 months, private debt managers in general plan to offer more alternative investment structures to their investors. The majority (56%) of respondents plan to offer more coinvestments to investors in their funds, with 47% looking to provide more separate account opportunities (Fig. 12). Along with private BDCs, no fund managers plan to decrease the number of alternative structures offered. Fig. 10: Fund Manager Views on the Biggest Challenges Facing the Private Debt Industry in the Next 12 Months Deal Flow Amount of New Managers Deal Pricing Fundraising Performance Fee Pressure Ongoing Volatility in Global Markets Due Diligence Fulfilling Investor Demands Portfolio Management Regulation Perception of Industry by Public Governance Other More than a third (38%) of managers surveyed had a private debt fund in market as at Q2 2017. Nineteen percent of respondents expect to launch funds in either the second half of 2017 or the first half of 2018 respectively, with another of fund managers planning to launch a new private debt fund in H2 2018. As the pool of fund managers in the private credit space continues to grow, standing out with a unique skillset and marketing aptitude will be of great importance to secure investors going forward. 21% 17% 17% 13% 13% 29% 46% 42% 38% 0% 20% 30% 40% 60% TIMEFRAME WITH WHICH FUND MANAGERS INTEND TO LAUNCH THEIR NEXT PRIVATE DEBT FUND H1 2018 19% ALREADY IN MARKET 38% H2 2017 19% H2 2018 Fig. 11: Amount of Capital Fund Managers Expect to Deploy in the Next 12 Months Compared to the Past 12 Months 26% 39% 3 Significantly More Capital Slightly More Capital Same Amount of Capital Slightly Less Capital Significantly Less Capital Fig. 12: Fund Managers Plans to Offer Alternative Structures to Investors in the Next 12 Months Compared to the Past 12 Months 100% 90% 80% 70% 60% 40% 30% 20% 0% 56% 4 Co-Investments 47% 53% Separate Accounts 100% Private BDCs Offer More Offer Same Amount Offer Fewer 6
DOWNLOAD DATA PACK: www.preqin.com/pdfmoh217 IN FOCUS: ESG IMPACT AND DIFFERENTIATION Evolving market conditions and investor preferences mean that fund managers are looking to differentiate themselves from their competitors in the race to secure capital. One increasingly prominent due diligence consideration among investors is the environmental, social and corporate governance (ESG) policies and implications of a portfolio company. In June 2017, 61% of GPs surveyed consider ESG factors during the deal-making process (Fig. 13) and 60% have decided not to invest in a portfolio company as a result (Fig. 14). In comparison, 39% do not consider such factors including 8% that do not currently consider ESG factors, but may in the future and have never eliminated a potential investment due to ESG objections. Governance factors are considered by the largest proportion (71%) of private debt managers, followed by social (62%) and environmental (57%) policies. All managers surveyed that consider governance factors also take the balance of the management structure into account. Fig. 13: Fund Managers that Consider ESG Factors as Part of the Deal-Making Process 31% 8% Over half of fund managers identified both child labour and health and safety as the most important social issues, while sustainability of resources is the most commonly considered environmental factor among fund managers, followed by climate change. 61% Consider ESG Factors May Consider ESG Factors in Future Do Not Consider ESG Factors The most important factor in differentiating themselves from other fund managers, according to surveyed GPs, is their deal sourcing capabilities (62%, Fig. 15). A consideration of ESG factors is one of many aspects of the deal sourcing process that fund managers can therefore use to stand out among investors. Fig. 14: Frequency with Which Fund Managers Have Decided Not to Invest in a Portfolio Company Due to ESG Factors Fig. 15: Fund Manager Views on How to Differentiate Themselves from Their Peers Deal Sourcing 62% 39% 17% Frequently Occasionally Network Offering Alternative Structures to Commingled Fund 1 Rarely Increased Outsourcing of Services 39% Never Increased Transparency Lower Fees 0% 20% 40% 60% 80% 7
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