Private debt funds trends: An historical and evolutive overview

Introduction

As we have already briefly analysed in a previous insight (Private debt funds: exploring a growing market), private debt has become, within a few years (not even 20 years) a valuable source of funding for companies of different sizes and creditworthiness and, at the same time, an investment opportunity for a wide range of investors.

In about two decades, the private debt steadily evolved moving from being a niche investment option to a much deeper, complex and varied asset class, becoming the 3rd one in the world. Private debt represented, and still today represents, an investment opportunity, especially because the solutions that it offers can be tailored on the basis of borrowers’ needs in terms of size, type or timing of transactions and also because it provides real-time interest rate protection, portfolio diversification, flexibility, appealing risk-return profile and steady flows (both for investors and companies that receive their money).

The private debt market has undergone significant evolution since first private debt funds has been set up. Here below we reported the key trends occurred from the birth of private debt funds until today.

Pre-2000s – Private debt’s early years

Private lending as an asset class started to exist in the late 1980s, but it began to gain prominence only in the late 1990s. At the beginning, private debt was mainly utilized by institutional investors and high-net-worth individuals, and first funds were mostly comprised of special situations or mezzanine lending strategies.

Due to their private nature, these funds acted as a hybrid between traditional bank debt and equity financing, providing financing to businesses that were facing challenges accessing traditional bank loans.

Early 2000s – Private debt’s expansion post-2008 Financial Crisis

The 2000s saw a notable expansion of private debt funds.

The Global Financial Crisis in 2008 has caused a shift in the lending landscape as traditional lenders, such as banks, cut back the granting of riskier financing and pulled back from leveraged lending, creating a vacuum in the market.

A reduction in funding for enterprises by banks, occurred together with a significant increase in the number of SMEs, created an opportunity for private debt funds (nonbank lenders) to fill that vacuum by providing alternative financing options and to support the growth of high potential companies.

Since the Global Financial Crisis in 2008, private debt funds around the world have experienced year after year an exponential growth both in terms of invested capital, debt structures, and in terms of number of transactions, companies and investors involved. In that period, capital began to flow more aggressively into private lending strategies, which also attracted institutional investors.

2010s – A decade of growth

Following the 2008 Financial Crisis, the private debt market started to recover and private debt funds experienced a substantial growth.

In 2010s, global interest rates were at historically low levels, and, as investors sought higher returns in a low-interest-rate environment, private debt funds started to play a more significant role, offering them an investment option with an attractive risk-return profile.

A noticeable trend in that period was the rise of direct lending, that is loans directly provided to companies, bypassing traditional banking intermediaries. That was also supported by the emergence of online platforms and marketplaces, that allowed to directly connect borrowers and investors. The digitalisation of private debt market made easier the transactions and give access to a wider range of investors.

Over those years, the “keyword” was diversification. Private debt fund’s managers had to adapt necessarily their strategies to adapt them to different market conditions, to provide tailored solutions to borrowers, and to deal with different challenges: stricter regulations and the effects of major economic events of that period (European debt crisis, China’s slowdown and geopolitical tensions), that influenced the private debt market trend.

Early 2020s – Private debt funds’ “Golden age”

In the last 4/5 years, the demand for private credit has significantly grown: it is believed that private credit market is experiencing its “golden age”. Despite global events occurred last years, such as the pandemic, the war in Ukraine and fluctuations in commodities prices, private debt funds demonstrated resilience and lower default rates relative to public credit. Recently, when interest rates were at historic lows, the vacuum (left by banks) was filled in part by private debt.

Since 2019, investors have turned more than ever their attention on private debt in search of attractive returns even in a volatile macroeconomic landscape, significantly increasing the size of this asset class, which from 2010 to 2022 went from 250 billion dollars to 1,400 billion dollars.

When the global pandemic came in 2020, interest rates dropped significantly globally and, thanks to that, companies had the opportunity to borrow large amounts of money at lower interest rates.

The importance of private debt funds in the macroeconomic global landscape continued to spread, and in 2021 the private debt AUM reached $1.2 trillion.

The boom in private credit was driven in large part by aggressive interest rate increases that started in early 2022, which forced more borrowers to seek alternative lending sources, especially focusing on mezzanine products and distressed debt. In that year, returns from private debt funds outperformed many other asset classes, including bonds and leveraged loans.

The Proskauer Private Credit Default Index registered increasing defaults in Q4 2022 and Q1 2023, which worried investors. However, Q2 2023 defaults fell back, maybe due to proactive measures adopted by companies and lenders.

In addition, during that year, the number of private debt funds that closed shrank decreased, because investors became more careful in their allocations, making larger commitments to fewer managers.

At the end of the year commitments amounted to $203.7 billion, with an increase of only 1.7% compared to the total of 2021. But also in 2022, returns from private debt funds experienced positive trends.

In the same year, the outbreak of war in Ukraine and the following increase of commodities prices have also affected global capital markets and fundraising from private markets.

Despite last year’s events and the current rates above 5%, in 2023 the private debt market has continued to grow. Moreover, in July 2023 occurred a banking crisis, after which banks have further tightened lending standards and restricted the granting of loans, potentially encouraging even more borrowers to turn to private credit.

Forecast – A bright future for private debt market

Despite the slowdown and higher default risk occurred at the start of 2023, this year private debt market experienced positive trends and it is forecasted that more acquisition activity is likely to kick off Q4 2023 and especially in the first half of 2024: the private credit market remains resilient and the outlook is optimistic.

According to Preqin data, the private debt market is expected to grow with an about 10.8% annual increase, reaching $1.46 trillion at the end of 2025, and $2.3 trillion by 2027.

The growth of this market is supported by the increased use of technology in financial services landscape, both for investor reporting and to gain competitive advantage. Thank to automatic systems and cutting-edge AI tools, it will be easier to analyse investment data, in order to help lenders to make investment decisions, conduct due diligence and carry out transactions at speed.

Conclusion

In conclusion, since their emergence at the end of the last century, private debt funds experienced positive trends. That is especially due to the fact that investors in search of solid returns and diversify their risk consider private debt as being a safer alternative compared to other assets, most notably equities and bonds. And also, as private debt loans are mostly floating rate, the asset class is also well protected against rising interest rates and inflation, two issues that most of the world has recently had to face with.

As it is expected that the period of cutback in bank lending, started as a consequence of the Global Financial Crisis in 2008, will last for years, private asset-based lending will continue to represent an excellent investment opportunity for a long time.

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