Preqin’s latest analysis of the risk/return profile of major private equity and private debt fund strategies has shown that direct lending funds have been providing investors with superior returns given their level of risk. These funds, which have increased in prominence since the fallout of the global financial crisis and the reduction in bank lending, are returning 11.4% on average annually. This is only surpassed by distressed debt funds over the same period (vintage 2002-2012), which are returning 12.6%. When looking at the disparity of returns, direct lending funds have one of the lowest standard deviations of 5.8%, with only mezzanine funds providing a lower standard deviation of 5.3%.
Direct Lending Funds: Other Private Debt Performance Facts
- Direct Lending Has Provided Consistency: Direct lending funds have provided investors with consistent returns for recent vintages. The median annual return between 2007 and 2012 ranges from 11.1% to 11.6%.
- Changing Fortune for Mezzanine: Mezzanine funds of 2009 and 2010 vintage are providing investors with average returns of 9.0%, but for the more recent vintages of 2011 and 2012, these funds are providing average returns of 13.2%. Goldman Sachs also closed the second largest mezzanine fund ever in Q1 2015.
- Distressed Debt’s Passing: With economic recovery taking hold across many nations worldwide, attractive opportunities for distressed investing are falling. Returns from distressed debt funds are 14.5% on average for vintage 2009 and 2010 funds, whereas vintage 2011 and 2012 funds are providing returns of 9.4%.
- Private Debt Dry Powder: Private debt managers put a lot of capital to work through 2014, with dry powder levels falling from $179bn at the end of 2013 to $139bn at the end of 2014. Levels have increased again to $158bn as of the end of March 2015.
- Dry Powder by Type: Direct lending funds command the most spending power, with $52bn in available dry powder. This compares to $45bn for distressed debt fund managers and $38bn for mezzanine opportunities.
- Notable Investors: Although still an emerging asset class, a number of investors have sizeable allocations to private debt. The Netherlands Development Finance Company, New York State Teachers’ Retirement System and California Public Employees’ Retirement System all have over $5bn invested in private debt.
“With historically low interest rates prevailing on government debt within many developed economies, and tight spreads existing on many types of tradable corporate and sovereign debt, investors are on a constant search for yield outside traditional fixed income products. Private debt within the US, and more recently Europe, has provided welcome opportunities for higher returns within the credit space.
The emergence of the private debt asset class has presented many attractive risk/return profiles for investors. The consistency of returns in direct lending is most obvious, with steady low double-digit returns and minimal standard deviation. As this is a small market relative to some other more defined alternative assets, the question is whether this can be maintained as the asset class becomes more crowded.”
Ryan Flanders – Head of Private Debt Products, Preqin