FOUR TRENDS

DECEMBER 2022 ALTERNATIVE INVESTMENTS

Private debt funds market matures

No longer an interesting niche addition to the Luxembourg alternatives scene, private debt funds are challenging more established asset classes for the limelight. Regulatory trends are working in their favour, and many are structured in a way to help them ride out the current inflationary surge.

Words STEPHEN EVANS

Valeria Merkel Vincent Remy

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Macroeconomic trends Vincent Remy, private debt leader at EY Luxembourg: “2021 witnessed a strong increase of cash deployment compared to 2020. The first two quarters of 2022 followed the same trend. Whilst cash deployment has been quite resilient, new fundraisings have sputtered. Yet the [private debt] asset class will continue to grow due to political support and tighter regulations [such as Basel III], leading to large bank disintermediation and deleveraging.” Valeria Merkel, asset management partner at KPMG Luxembourg: “The consequences of recent geopolitical uncertainties could mean that corporate default rates rise, and this could negatively affect existing private debt investments. On the other hand, this could increase the number of distressed debt opportunities. Also, in a world of rising interest rates, the private debt sector is protected, with rates of return generally floating in step with market benchmarks. This compares favourably to fixed-rate public debt where returns can be fixed for up to 10 years.”

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Investor profile trends Merkel: “Figures about the European market show 17% of private debt assets are held by private pension funds, with foundations and public pensions at about 11% each. Those investors are looking for reliable income streams, and they find this in private, direct lending, which accounted for 58% of this market in 2021.” Remy: “Whilst the US remains the largest private lending market, the EU is a solid second, with a notable refocus on Asia-Pacific, which is regarded as a market with higher growth potential. Most borrowers in the structures we help set up are EU mid-market companies backed by private equity sponsors: thus potentially an option for a European borrower market with 20m+ SMEs. In terms of sectors, managers stay away from retail, preferring to focus on companies in high-end sectors such as healthcare, technology and pharma.”

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Growth trends Merkel: “We see that private debt is overtaking other alternative asset classes. The European private debt market is set to grow by 17.4% compound average annual growth [rate] over the next five years, and despite recent market turbulence, we remain broadly confident in this direction of travel.” Remy: “Private debt is luring hungry investors at a time where private equity may have reached full valuations. The asset class is a good selling point for managers, as it continues to yield higher returns compared to public markets while being a safe haven against their volatility.”

4Structuring trends Merkel: “We see more funds being established but also increasing growth in the average fund size, as well as consolidation and the specialisation of debt managers. These factors reflect maturity and an asset class which is not saturated. Strategies are becoming more complex and diversified, with investors able to structure portfolios as they wish.” Remy: “Luxembourg is the leading jurisdiction in this asset class due to its flexibility to manage all credit strategies. It will be interesting to see how Luxembourg will fare against competitive markets such as Ireland, which has modernised its limited partnerships, or the UK, which has overhauled its holding company regime.”