Editor’s Letter – Issue 137

December 2018

Hamlin Lovell
Originally published in the December 2018 issue

Alternative credit goes from strength to strength, according to the fourth edition of Financing the Economy 2018: The Role of Private Credit Managers in Supporting Economic Growth. The paper was produced by the international law firm Dechert in partnership with the Alternative Credit Council (ACC), the private credit affiliate of the Alternative Investment Management Association (AIMA). Assets in alternative credit are on track to meet the forecast of USD 1 trillion by 2020.

Private lending is increasingly providing long-term, multi-year funding and the predominantly institutional investors – pension funds, insurers and sovereign wealth funds – are also effectively locked up or committed for similar periods, thus avoiding the liquidity mismatch and systemic risks that can apply to other types of credit.

Some 25% of investors in private credit are neophytes, and the majority of investors surveyed are planning to increase their allocations. This suggests that the outlook for asset raising is brighter than it is for hedge funds in general, where some investors are frankly lukewarm. But alternative credit is not immune from the fee pressures impacting on much of the investment industry, and managers may need to be flexible on fees and terms to win some big tickets.

Private lending is one area where more assets come from Europe than from North America, which is only thought to make up 38% of committed capital – against 43% from Europe, including the UK. By contrast, for the hedge fund industry as a whole, roughly 70% of capital is believed to emanate from the US. Asia Pacific’s 14% slice of private credit assets is also a higher proportion than its share of hedge fund assets. One obvious explanation here is that many banks in Europe are still deleveraging and have other problems, whereas the US banking system is healthier.

There are concerns that corporate lending multiples for leveraged loans and high yield bonds are reaching extreme levels, but in private credit only around half of managers use any leverage at all, and they tend to use lower amounts.

This is perhaps because many of them have long memories. Some 45% of managers have been around for over ten years, meaning they remember the 2008 crisis. As the credit cycle matures, some managers in 2018 are also favouring more senior parts of the capital structure, and avoiding some cyclical industries.

Beyond this, while borrowers are exerting some pressure on covenants in loan terms, our impression is that the level of covenant protection for private creditors remains far more robust than in some more liquid parts of the credit markets.

The Hedge Fund Journal has interviewed small, medium-sized and large managers, along with associated service providers such as lawyers, pursuing or advising on a wide spectrum of alternative credit strategies. These include: the largest category, private equity-related loans; real estate lending; asset-based lending; direct lending; receivables finance; trade finance; litigation funding, and life settlements.

From all that we have observed, we anticipate that we will continue expanding our coverage of alternative credit managers, service providers and strategies for the foreseeable future.