The Rise of Private Debt: A New Era for Capital Markets and Portfolios
In a recent webinar, Naji Nehme, CEO and CIO at Petiole Asset Management AG, and Shahab Rashid, Managing Partner and Co-Head of Private Credit at L Catterton, discussed the rise of private debt. The full webinar can be viewed below. The text that follows is a summary of the main points by subject area.
The current state of the market
Private debt currently accounts for US$1.5 trillion of assets, not including the high-yield and leveraged loan sectors, which account for a further US$1.5 trillion. The market has doubled in size over the past five years. Given the size of the asset class, it clearly can no longer be ignored by institutional investors.
L Catterton’s background
Like many other players in this sector, L Catterton’s origins lie in private equity. The firm has been in existence for around 35 years and is focused on the consumer. Managing around US$34 billion in assets under management (AUM), L Catterton provides capital to companies from the early growth stage to the large buyout phase, and operates in the US, Europe, Asia and Latin America.
Uniquely, L Catterton has a partnership with LVMH, the world leader in high-quality products, and Groupe Arnault, the family holding company of Bernard Arnault. The partnership combined L Catterton’s existing North American and Latin American private equity operations with LVMH and Groupe Arnault’s existing European and Asian private equity and real-estate operations, resulting in the largest diversified, consumer-dedicated private equity firm in the world.
L Catterton has invested in around 100 companies, covering a wide range of economic sectors, and has been able to deliver consistent results over a long period of time. It looks at around 800 deals in the US alone every year, many of which are attractive from a credit perspective. It has unique insights into these businesses due to its history, market knowledge and consumer insights. An experienced team has built a highly diversified credit portfolio.
Why private credit is growing rapidly
The common theme across private debt strategies is that the debt is originated, provided and underwritten outside of the traditional banking system. It is undertaken instead by managers like L Catterton—usually on a bilateral basis, between the borrower and the lender.
There are significant benefits for borrowers, including customization and the speed of execution. Private debt also provides firms with the ability to raise funds in the current environment, where there is much dislocation in public markets and it is difficult to raise finance. The consolidation that took place in the banking industry following the global financial crisis, and the increase in regulation, are among the factors behind the rapid growth of the sector. Asset managers such as L Catterton filled the void left by the disappearance of many smaller banks.
Direct lending accounts for roughly 40% to 50% of total AUM and is traditionally associated with senior secured debt. It is the safest and largest part of the capital structure, and it is also the biggest portion of the private debt universe.
Yields have increased significantly and are typically priced over base rates. Today, yields are in the mid- to high teens, almost double the levels seen just a few years ago, so it is a very attractive time to be investing in the sector. There are also junior debt strategies involving mezzanine and secondary debt, and even some preferred equity. The appeal of these instruments—in terms of the risk/return ratio—varies over time.
Distressed debt is another strategy and tends to be at the top of the spectrum from a risk/return perspective. However, the distressed cycle has not happened for many years.
The range of strategies means that private debt can now meet a wide range of investment needs. There are many new products that can address issues ranging from tax implications to liquidity. It is vital, though, that investors check managers have sufficient experience and that they have been through a range of market environments.
The current environment is the most attractive for a decade in terms of building. Risk has declined and returns have risen.
Will the market continue to grow?
The two big drivers of debt today are the need to refinance a huge amount of debt over the next three to five years, plus the need for capital to finance new leverage buyouts based on the dry powder available in private equity funds. Combined, these figures amount to around US$1.7 trillion. That is why we expect the market to double again over the next few years.
Key trends underway
Trends seen in other areas of private markets, including a growing interest in the application of ESG principles, are evident in the private debt space. A secondary market for private debt is also developing and could eventually match or even become larger than the size of the secondary market in private equity. Increasingly, large borrowers are accessing the sector. While once borrowers were looking for sums in the range of US$50 million to US$75 million, now US$500 million-plus is being asked for. Another key development is that retail and High Net Worth investors, as well as family offices, are increasingly accessing what was once the preserve of large institutions. The market is also expanding geographically beyond the US, into Europe and Asia, and it could soon emerge in Latin America. All these regions have their own dynamics, which investors need to be aware of.
Navigating a difficult environment
Investors face a number of challenges currently, including an environment of high interest rates and high inflation, together with two major conflicts in the Ukraine and the Middle East. An increase in default rates is likely, and investors would be wise to adopt a cautious, defensive approach, using their knowledge, insights and experience to pick credits. However, now is also a good time to build a portfolio.
Putting the investor first
On a personal note, Shahab Rashid said that experience had taught him that while it takes a long time to build credibility, reputation can be shattered in an instant. That’s why it is important to always behave in an honest and transparent manner and to constantly put the client’s interest first. Listening to clients and colleagues is also crucial, so that you can create the solutions that address their individual concerns and needs.
In the concluding remarks of the webinar, Shahab Rashid emphasized the importance of being a compassionate and helpful individual, both professionally and personally. He highlighted how small acts of kindness and support can significantly impact others' lives.
Let’s build your bespoke solution
We can create tailor-fit portfolios that suit various investment strategies and risk profiles. Our private market specialists would be delighted to explore with you your investment needs.