Global Private Equity Shift to Debt. Will Local Funds Follow?

Bloomberg News reported that Advent International is planning a move into debt investing and is forming a team to raise a dedicated fund. Several weeks earlier, tech-focused buyout specialist, Thoma Bravo confirmed that it’s seeking to raise $750 million for its first fund dedicated to credit investing. And, most recently, San Francisco based PE firm Gryphon Investors raised $100m for its first mezzanine debt fund.

In Australia, we have started to hear from a couple of players that they are going to follow suit and are in the process of raising a dedicated debt fund. Behind this change is a push and pull from both sides of the PE equation.

Investors – Everybody has a boss. For PE it is their limited partners which is made up of super funds, sovereign wealth funds and HNW individuals. Following the GFC, these investors reduced the number of managers they back to a handful of strong relationships. The successful PE funds with these relationships are best positioned to establish new debt funds and service demand from these investors for a high yielding fixed interest asset class.

Opportunities – It has become cliched for people to talk about the banks withdrawing from the mid market but in Australia it is particularly evident. Over the last 3 years, aggregate growth in non-housing term loan portfolios across the Big4 and 2nd tier banks has slowed considerably: down by over 15 percentage points over 2015-16*. This has left a gap for incoming lenders in the A$5m-$20m space to achieve double digit returns that only a limited number of players are currently servicing.

The success of this shift, however, will depend on whether these PE firms have the credit skills to successfully execute their investment strategies. Credit investing is a different mindset to equity investment. In equities you are trying to look for the upside; the angle that will achieve a step change in return. In debt, however, the upside is capped (unless you have warrants in place) and therefore you spend your days looking down and trying to remove as much risk as possible.

Regardless of whether the portfolio ends up performing well, if there is investor appetite for the asset class and the investors are willing to pay a juicy management fee and performance bonuses, you can be sure that PE will be looking to establish a fund to service it – be it equity, debt or everything in between.

Check out the media below from the WSJ and Bloomberg, examining how the Private Equity landscape is expected to change over the coming years.

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