Credit managers are raising mountains of capital for private credit vehicles just as some industry insiders recommend investor caution in light of faltering returns.
In a search for higher investment returns, asset owners continue to commit billions to a wide range of credit strategies including direct lending, distressed and stressed debt, structured products and mezzanine debt. But industry observers say these big inflows are affecting returns as managers find it harder to put so much money to work under tight market conditions.
Private debt assets under management worldwide hit an industry peak of $595 billion as of June 30, the 10th consecutive year of increases, data from London-based researcher Preqin show.
At the same time, private credit returns for newer funds are lower than the funds raised just after the financial crisis. For example, direct lending funds raised in 2014 returned a net internal rate of return of 8%, the same as 2013 vintage direct lending funds but down from 14% IRR of funds raised in 2008, Preqin data show. The same is true for distressed debt and mezzanine 2014 vintage funds, which had a 1% net IRR and a 7% net IRR, respectively, a far cry from the 16% and mezzanine net IRR of 10%.
As a group, private debt strategies have underperformed private equity.
Private debt funds earned a net IRR of 9.53% for the five years ended June 16, compared with private equity fund returns for the same time period of 13.3%, according to data provided by Preqin.
Even so, managers are having little trouble raising credit funds.
Sixty-three percent of credit funds closed in the first quarter of 2017 exceeded their fundraising target, the largest percentage in the last five years, Preqin data show. Dry powder reached $200 billion as of March 31, up 2% from Dec. 31, but second in size to the record amount of unspent capital commitments held by credit managers — $215 billion — at year-end 2015.
“Conditions are competitive and we are seeing a little bit of the late cycle excesses,” said Bill Sacher, partner and head of credit at alternative investment fund-of-funds manager Adams Street Partners LLC, Chicago.
These excesses include high valuations, higher leverage levels and aggressive calculations of expected returns, he said.