Debt Funds - Early innings of a megatrend in private credit?
For years private equity has been seen as the go to place in the alternative investment market. However, the first rising interest rate cycle in 15 years has stimulated a fundamental change in debt vs. equity funding considerations...and debt funds are feeling pretty good about life.
With debt at the top of the capital stack and hence well protected, investors or limited partners are increasingly seeking to deploy capital in private credit or debt funds, given the attractive risk adjusted returns.
With the ability to achieve returns of c. 10%p.a. on a debt fund, versus the increased risk of chasing returns of 20%-25% p.a. on an equity fund, many investors are opting for the former.
“We believe we are still in the early innings of a megatrend in private credit -particularly in today’s elevated base rate environment - and given the senior-secured structure of many of our products - we believe it is currently the best risk-adjusted environment for this asset class in decades.”
Dwight Scott
Global Head of Blackstone Credit, Sept ‘23
Debt Market Maturation
Rising interest rates have reduced debt demand across a number of market segments e.g. leveraged buy-outs and real estate. In contrast, venture debt funds are experiencing a buoyant period.
Debt Returns
For investors, risk adjusted returns in venture debt can be compelling at c. 15% p.a. with a relatively high equity cushion of c. 80%-90%.
For borrowers, the cost of venture debt has stayed relatively constant versus other forms of debt which have increased in line with central bank interest rate movements, leading many companies to choose venture debt as an alternative to equity in order to avoid crystallising valuation / dilution.
Recent Irish Debt Deals
Pricing and terms differ on a case-by-case basis, with a lenders flexibility impacted by whether it‘s own fund is levered to bolster returns, or whether its investors are all in the same instrument and thus receiving the same return.
Outlook
With regulatory pressure on banks making lending to higher-risk companies less attractive, borrowers will be increasingly turning to debt funds as part of the solution to meet their capital requirements.
In Pegasus, we expect more innovative and tailored funding offerings to emerge as fund managers come up with new approaches to meet this demand
AUTHORS
David Lawrence
Conor McDonald
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