Back in January, JPMorgan’s Nikolaos Panigirtzoglou noted that persistent underperformance from hedge funds over long stretches hasn’t managed to derail the growth of private assets as a group.
“Despite disappointing growth by the hedge fund universe, the total universe of private asset classes including private equity, private debt, institutional real estate and hedge funds, grew by 44% over the past five years, to an estimated $18 trillion at the end of last year, surpassing the 29% growth of publicly-traded equities and bonds over the same period”, he wrote.
I’ve spilled quite a bit of digital ink in (or I guess “on” may be more accurate) these pages documenting the “exciting” world of private debt where, according to Preqin, AUM has more than doubled since 2012 to $812 billion.
All manner of market participants have been lured into this potentially lurid world, including pension funds which, in some cases, have dedicated a sizable percentage of assets under management to private-credit strategies.
Note that the “dry powder” portion of the total $812 billion in AUM sat at $269 billion as of June 2019 — that was just off 2018’s record, and suggested there was plenty more capital waiting to be sent on safari in direct lending, distressed debt, mezz, venture debt and special situations (among other adventurous locales).
The potential problem is the same as it ever was. I’ll just recap using the same language from the linked December post on pensions. Peculiarities and myriad idiosyncratic factors aside, the dynamics in private debt are similar to what you’d expect in a burgeoning, high-growth market. Money coming in equals demand, and where there’s voracious demand, there will be a rush to create supply, which in turn raises the risk that underwriting standards will deteriorate.
At the end of the day, it’s just investors looking to lean into the illiquidity premium in order to capture more attractive yield.
Well, as you might image, the market ran into some trouble in the first quarter amid the coronavirus crisis. In fact, according to the latest update from Preqin, capital raised for private debt strategies plunged 41% YoY for the period.
“This marks the lowest fundraising quarter for the asset class since Q3 2016”, the quarterly report reads. Preqin notes that while there’s some cyclicality at play (Q1 usually sees lower fundraising) both the number of funds closed and the total capital raised “are considerably below the average for Q1 in recent years”.
Obviously, that’s not a coincidence.
“Borrowers will need to be able to detail the impact of the recent market disruption on their businesses”, Mark Birkett, managing director at Livingstone Partners (an M&A and debt advisory firm) wrote, in a note late last month, adding that terms will be tighter going forward. Lenders, he said, may be feeling like they had underpriced risk. (Imagine that.)
And yet, the pipeline is full. “While fundraising may be faltering, the number of private debt funds in market continues to grow”, Preqin goes on to detail, noting that as of April, 457 private debt funds are in the market looking for upwards of $200 billion.
Both figures are records. “[The] fundraising market… is now more crowded than ever before”, Preqin says.
One issue going forward is that, thanks to the pandemic, people aren’t particularly enamored with the idea of being in a closed room with a bunch of other people, let alone strangers. In some cities around the world, such gatherings are literally forbidden.
“Over the last two weeks, at least half a dozen lenders to mid-size businesses actively fundraising in North America and Europe have canceled appointments or travel plans to meet with prospective investors”, Bloomberg wrote last month. “Some managers are opting for video calls with investors in the wake of scrapped travel plans”.
That might work for established players, but investors may be wary of putting money to work in a relatively opaque market based on a Skype meeting with a private credit fund manager they’ve never met in person. Throw in extremely adverse conditions in credit markets where liquidity dried up last month even for US Treasurys, and you’ve got the makings of a downturn.
To be sure, some reluctance is showing up in investors’ allocation plans. For example, Preqin notes that “of the mandates issued for private debt funds in Q1 2020, the majority (73%) are for commitments to a single fund”. That’s up pretty sharply from 62%. The proportion of investors aiming to commit to between four and nine funds dropped to 10% in Q1, representing a veritable collapse from 22% in the same period last year.
Still, more than a quarter of investors plan on committing at least $100 million to private debt in the next 12 months, which is actually up from Q1 2019. For those wondering, the latest figures show direct lending still dominates the market.
Where things go from here is an open question. The US government is now in the “business” of handing out what amount to grants to small businesses and providing low-cost loans to mid-sized enterprises.
Banks, meanwhile, now have the ability to fund loans via a series of Fed liquidity facilities tied to (indeed, named after) the government’s hodgepodge of bailout programs designed to help businesses weather the COVID-19 storm. And then there are pressing questions about how it’s possible for lenders and investors to do due diligence with social distancing protocols in place, not to mention considerations about borrowers who face financial armageddon depending on the evolution of the virus and its effect on the macro backdrop.
Coming full circle, I suppose it’s only fitting that I close with a quote from the very same January note from JPMorgan cited here at the outset.
“While warehousing more illiquidity risk is not a problem for long-term investors in normal times, the lesson from 2008 is that it can become a big problem during crises”, the bank’s Panigirtzoglou warned.
[As an aside, there’s an interesting interplay going on right now between private equity and lawmakers when it comes to the myriad government bailout programs rolled out over the past month. Vanity Fair has a good piece on that here.]
H-Man, private equity is raising money to try and find a live body at the morgue. Good luck on that endeavor.
Pretty gd funny.