Target allocations to private credit are rising as investors remember how the asset class has performed in previous recessions, but – as in private equity – fundraising is being increasingly concentrated among a smaller number of credit fund managers.
- Target allocations to private credit among pension funds in double figures
- Direct lending will remain the standout strategy as interest rates rise
- Average credit fund size approaches $1bn as larger managers dominate
Target allocations to private credit are rising as investors remember how the asset class has performed in previous recessions, but – as in private equity – fundraising is being increasingly concentrated among a smaller number of credit fund managers.
On an earnings call at the end of October, Blackstone’s COO Jon Gray described private credit as a “long-term mega trend” within alternatives, which has been experiencing mega-trend status itself for almost a decade. “I don’t see any of sort of large-scale movement away from this very attractive asset class,” he said.
Pension funds, insurance companies, and endowments have been willing to assume greater credit and illiquidity risk in exchange for higher returns, said Moody’s earlier this year. In a more volatile economy, they are expected to show even more interest in the asset class, rather than less.
“Investors also have long memories, and they remember that the [private credit] vintages raised in the aftermath of the GFC performed incredibly well,” says Jonathan Bray, partner at Clifford Chance, who works with some of the world’s largest credit funds.
Pensions have been the largest allocators to private credit by dollars invested and hold an average allocation of around 3%, but some target allocations are now much higher, in some cases up to 20%. Insurers are also expected to add private credit to their portfolios, though at a more gradual pace, and high-net-worth investors are also allocating a higher percentage of investment capital to private credit.
Fundraising is currently on par with its peak in 2021, according to PitchBook. Managers raised $82bn across 66 funds in the first half of this year.
More growth is expected to come from Europe in the coming years than North America, which is considered to be the more mature private credit market, and larger credit funds will dominate. Almost half of all the capital raised by private credit managers last year was taken in by the ten largest funds, according to Preqin, with the number fundraising dropping from 255 to 202. The average credit fund size grew from $663 million in 2020 to $958 million in 2021.Direct lending – which tends to benefit from rising interest rates by using floating rate instruments and has comparatively lower volatility – continues to be the standout strategy, accounting for more than a third of capital raised in the first half of the year, but special situations funds and real estate debt funds also received plenty of attention.
While it is now rare to see a private credit fund below $1bn in target size – Blackstone’s credit vehicle focused on renewable energy and the energy transition is targeting $7 billion next year – many in the market see the potential for smaller niche strategies within the asset class as banks retreat. Debt funds providing revolving credit facilities could be the next trend here, following distressed or sector-specific vehicles, says one debt fund source.
A scarcity of private credit solutions in the 250-500 bps range could also create an additional opportunity set for direct lenders, according to Deloitte’s Private Debt Deal Tracker.
Almost nine out of 10 private equity GPs have increased or maintained the use of private credit in their buyout financing over the past three years, according to the Dechert Global Private Equity 2022 report. Research by Private Equity Wire during October showed that GPs are working even more closely with direct lending credit funds to fill the gap left by syndicating banks with mispriced loans on their books.
Last year, private credit assets under management exceeded $1 trillion for the first time. Over the next five years that figure is expected to more than double.
Key Takeaway | Larger PE funds will continue to build and consolidate relationships with direct lenders, further boosting their ability to raise larger credit funds
