Consultants see continued drive towards ‘alternative’ private debt, including regulatory capital and direct lending strategies

Private debt strategies continue to gain investor traction, as institutional allocators look to increasingly esoteric ‘alternative’ fixed- income- style products, according to interviews with global and boutique investment consultancies conducted by Hedgeweek.  

Private debt strategies continue to gain investor traction, as institutional allocators look to increasingly esoteric ‘alternative’ fixed- income- style products, according to interviews with global and boutique investment consultancies conducted by Private Equity Wire.  

Alison Trusty, Associate Partner in Private Debt and Hedge Funds at Aon, said that the general drive towards alternatives in the last few years has particularly benefitted the private debt space, with a range of strategies – including regulatory capital relief, direct lending and distressed credit – proving popular. 

Aon’s investment consultancy advises on a combined AUM of USD4.3 trillion for a client base primarily made up of UK and US pension schemes, both public and private.  

Speaking with Private Equity Wire, Trusty explained that the move, “makes sense for our client base as they don’t need liquidity. In a sense it’s a natural extension of a fixed income portfolio.” She said that private debt strategies offered a way to avoid yield compression in liquidity, while acknowledging that they are not necessarily purely cash flow matching.  

Keith Berlin, Senior Vice President at Fund Evaluation Group (FEG), said his clients are also looking to ‘alternative’ private debt. Berlin projected that demand will shift toward ‘alternative credit’ in the future, as investors look to diversify toward uncorrelated credit strategies such as hard asset lending, real estate related lending, and specialty finance.  

FEG is a Cincinnati-based investment consultancy advising a combined AUM of USD14.9 billion, primarily for non-profits such as endowments and foundations. 

Berlin also estimated that FEG clients institutional investors are increasing their allocation to private debt from 3 to 5 per cent of their portfolio.  

Research from data provider Preqin showed that the total allocation to private debt is predicted to increase 11.4 per cent annually to USD1.46 trillion by the end of 2025, up from USD848 billion at the end of 2020. 

Trusty’s clients are currently looking at a number of strategies within the private debt space, notably regulatory capital relief, also known as significant risk transfer transactions, where managers provide banks with regulatory capital, offering them the opportunity to redeploy their capital and improve their return on equity. 

Regulatory capital strategies gained in popularity after the 2008 crisis as a way for banks to improve their capital ratios without having to sell assets or reduce lending activity.  

Direct lending is also proving to be appealing to investors. Trusty said: “Direct lending is increasingly being seen as providing a steady income, and last year was a good ‘stress test’ for this strategy that held up well.” A survey conducted by Ocorian this year revealed that out of the capital markets professionals surveyed, 87 per cent already had a direct lending strategy, while 57 per cent were looking to expand their current strategy.  

Trusty noted that distressed debt is also attracting new searches and allocations. “Clients saw an opportunity in the distressed debt space prior to the pandemic, but even more so now,” she said. Interest in distressed debt and stressed credit opportunities has been growing since 2008, due to high levels of corporate debt issuance and structurally higher default rates, a trend that has been accelerated by the Covid-19 pandemic. 

Berlin also commented that investors last year rotated into distressed strategies, but that “it was a brief window of several months, as investors have now re-focused on performing credit strategies such as direct lending.” Berlin’s clients are primarily looking at performing private debt products, such as senior, unitranche and mezzanine finance.