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Before founding Fundviews Capital, I helped wealth managers to create customised portfolios of alternative investment products, which included private credit funds. The team I was part of reviewed more than 600 of them, with strategies ranging from specific exposures such as life settlements and aircraft leasing, to more general, industry-agnostic, private debt / direct lending funds.
I’ve always been interested in the industry, and it’s been good to watch it grow in the past few years. It’s probably no surprise that regulators have started to make noises about the space (and in some cases, take action – the EU amended its AIFMD regime recently to mandate leverage limits for loan origination funds, for example), and plenty of nay-sayers have emerged, warning about what they say are the risks in debt financings. But that’s to be expected of a mature asset class, which private debt now certainly is.
Something I’m particularly curious about in the private debt world is how prevalent continuation funds will end up being. You see a lot of news in the trade media about this trend in the private equity world, which makes sense, as GPs with funds at the end of life look to hold onto good companies – that are still recovering from the geopolitical and Covid-19 displacements of recent years – instead of being forced sellers.
And, now that many of the wave of private debt funds that launched in the middle of the last decade are maturing, it seems that this trend could really start to take off in the debt market as well.
A few reasons exist as to why. The obvious ones include wanting to hold onto any upside offered by converting debt to equity, a longer time to exit for PE-backed portcos (which might simply require an extension of the debt facility) or to be a good partner to a company that might need a little more runway – the logic being that the portco would be more likely to work with the same lender in future should they look to access the private debt market again.
But one less obvious one involves the impact of the recent focus on MOIC vs. IRR. If a private debt fund performs very well on an IRR basis, but only called a small portion of capital in odd frequencies it can lead to worse overall performance (since the investor has to keep liquid a larger portion of their portfolio in case of a sudden capital call); continuation funds allow the managers more time to call capital, and therefore increase the MOIC to investors that choose to roll into the 2nd vehicle.
Just how common these funds will end up being depends on investor appetite, of course. Which in turn depends on the underlying companies – any distressed loans, for example, that a GP wants to roll over are harder to value than ‘healthy’ ones. Another potential challenge on the valuation side is that the LPs coming into the fund will need to be confident that they are not on the ‘bad’ side of the trade; the valuation must be accurate and fair to both the exiting LPs and those either rolling over from the existing fund or coming in new.
Lastly, given the more limited upside of debt investments, when compared to the (theoretically) unlimited upside of private equity might mean that many LPs sit on the sidelines until this part of the credit market figures out more standardised structures (depending on the underlying loans and portfolio companies).
So, while I’d expect to see more activity in continuation funds in the private debt space in the coming 12-24 months (and beyond), I think growth will be measured, which isn’t the case for the PE space, which has seen huge growth since mid-late 2020. Still, as a private credit market enthusiast, it’s another indicator of a maturing market, one that’s providing opportunities for an ever-wider range of potential LPs.
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Gregory Poapst is a Managing Partner at Fundviews Capital. Connect with him on LinkedIn here.
Fundviews Capital is a full-service end-to-end Fund Management Platform. Our platform provides a complete end-to-end solution for asset managers or wealth managers to structure, launch, operate and grow their professional investment funds. You can launch a fund in a matter of weeks, not months, and with minimal capital outlay – not only reducing the risk of launching a fund but also maximizing your chance of success. Once launched, you will find that a dedicated team of professionals is just a phone call or email away at all times, handling all aspects of the back and middle office for your fund.