Managers say more investors are likely to choose leveraged portfolios for their return potential even though leverage could also double losses.
“Investors are ... seeking to put capital in levered portfolios that offer returns comparable to the lower end of the private equity range, especially in these increasingly volatile markets,” said Mark Attanasio, a co-founder and managing partner of Crescent Capital Group LP, a Los Angeles-based private debt firm.
But as investors learned in the downturn, leverage can increase losses, Mr. Attanasio said. “Any time you put leverage to a portfolio you increase the risk, by definition. If you have losses, you magnify those losses. You also increase positive returns with leverage.”
Credit risk is an important to understand when investing in private debt strategies, Messrs. Fann and Nesbitt said.
Mr. Nesbitt called the risk of loan default the primary risk of private debt strategies, particularly lending strategies.
However, losses from defaults minus recoveries historically have been in line with, if not lower than, those on public high-yield bonds and leveraged loans, he said.
Still, manager selection is extremely important. The success of investors' private credit investments depends on whether the manager can hunt out deals, accurately analyze credit and fix problems when they arise, Mr. Fann noted.
Private credit managers -especially those with large private lending businesses —need a big pool of capital to hire large global staffs to create relationships with potential borrowers that will result in lending opportunities, managers say.
To that end, managers also are raising larger and larger private debt funds. According to Preqin, this year so far the average size of a private debt fund was $720 million, up 4% from $692 million in 2015 and up 38% from $521 million in 2010.
Size matters, said Mike Arougheti, a New York-based partner and president of alternative investment firm Ares Management LP.
“If you can't write a $100 million to $200 million check, you'll get many fewer phone calls,” Mr. Arougheti said.
At the end of last year, Ares Management merged its liquid and illiquid credit businesses, in part, to be able to offer new investments.
The firm has about $60 billion in AUM, up from about $20 billion in 2008.