Alternative Fund Administration: The Private Debt Stress Test

Private debt is a very popular asset class, but the sector has never faced a market downturn. Nicholas Pratt explores the operational challenges that could occur when it does.

In 2019, the private debt fund market has seen its first slowdown in fundraising after several years of stellar growth. According to a report from research firm Preqin, private debt fundraising in the third quarter "continued at the lacklustre levels that have characterised 2019 so far".

Yet fundraising levels remain historically high - and although returns from private debt funds have slowed this year, they still outperform other alternative asset classes such as natural resources and real estate. Preqin said the asset class is "proving its ability to provide a sustainable and reliable income stream to investors, and therefore protection on the downside". Assets under management in private debt were $751 billion (€677 billion) globally at December 2018 - down from $769 billion six months earlier. However, flows into direct lending funds had increased.

The resilience of the asset class has yet to be seriously tested but with markets in the late stage of the global economic cycle, this could provide a chance. Fund managers across private capital "are bracing themselves for more uncertainty, especially those in the private debt space, an asset class that has not yet faced an economic downturn", said Preqin.

To add to these challenges, private debt is now almost too popular for its own good. Preqin's Tom Carr, who is head of private debt, says increased competition between funds, combined with the drop in fundraising, means there are more funds chasing a smaller level of capital. This is a particular issue for newer private debt funds, says Carr. "Track record is very important for allocating investors, but there are not many managers with that track record or that have managed these funds through a full market cycle."

With private debt investors possibly facing the challenge of an imminent recession, two schools of thought have developed, he adds.

One is that direct lending funds - which remain the most popular fund type, accounting for 35% of capital - are good instruments in which to invest. "The structure has a good reputation, they are geographically diverse, and the funds are protected by equity," says Carr.

Flows into direct lending funds were $60 billion in the 12 months to the end of 2018, and total assets in the category accounted for $263 billion, or 35% of...