This article is a contribution from Eamonn Greaves, Managing Director, SS&C Technologies. SS&C is a global provider of services and software for the financial services and healthcare industries.
Private credit has been the shining star in the private markets’ universe over the past decade. While private equity fundraising tapered off significantly in 2022, private credit reportedly reached an all-time high, despite a slowdown in fund launches. Watching all the institutional capital flowing into private credit, it’s not surprising more hedge fund and private equity managers are tempted to diversify into the sector. However, as many have already found out, it’s not easy. Between fierce competition and operational complexity, new entrants have more than a few obstacles to navigate.
Growth Drives Competition
In the ten years running up to 2022, private credit (or private debt) funds experienced faster growth in asset under management (AUM) than private equity, venture capital and real estate. The reasons are clear: private lending is popular with borrowers and investors. Privately held companies get a more flexible and often faster funding alternative to bank loans. Meanwhile, investors can earn comparatively predictable returns at attractive, risk-adjusted rates. Volatile equity markets and rising interest rates have further increased investor appetite for this asset class.
Private debt has also become extremely competitive, both in deal sourcing and fundraising, dominated by well-established players. Managers coming into the market with a new fund must have a clearly differentiated proposition to attract investor attention.
Big Operational Differences
From an operational perspective, private credit and private equity are very different. Private credit requires an understanding of debt underwriting and loan facilities. Where a typical private equity portfolio might have 10 – 12 companies, loans in a single credit fund can number in the hundreds. Systems designed to support private equity or real estate funds are not readily adaptable to the volume, complexity and multiple moving parts associated with private debt funds.
Moreover, private company loan data does not lend itself easily to automation. Company information comes in various forms, with little standardisation, resulting in a high degree of paper-based and manual processing. Cash flows, too, can be sporadic and unpredictable, with variable interest rates on multiple loans, different payment schedules and occasional delinquencies.
As we’ve seen across private markets, institutional capital has largely fueled private credit growth. Institutional investors come to the private markets with high expectations for transparency and operational integrity. In an uncertain economy, they are likely to be highly selective and restrained in their allocations. Managers should be prepared for rigorous due diligence. With all the competition inthe market, the ability to demonstrate a sound operational infrastructure can be a scale-tipper.
Put Your Foundation in Place
Sourcing deals or launching a fund without the infrastructure to support the business is risky. Before setting up, prospective private debt managers need to conduct a comprehensive review and add capabilities where needed, with a focus on three key areas:
• Loan servicing and administration: the ability to collect payments and allocate returns among limited partners efficiently and accurately.
• A portfolio accounting solution that can handle a high volume of transactions.
• Efficient support for different fund structures: credit funds are typically closed-end, but some may be hybrids and or may include multiple special purpose vehicles (SPVs).
Fund managers investing globally also need to be aware of the compliance requirements of the various jurisdictions in which their loans originate, as well as be able to account for each fund entity’s investments in multiple markets and currencies. Treasury management becomes more important as well. With a wide range of deals and continual cash movement, funds need to stay on top of their available cash and opportunities to optimise the proceeds from their investments.
The Outsourcing Option
If you haven’t run private debt before, you may think you are looking at a substantial investment in technology and operational expertise to be competitive from day one. That’s a good reason to consider partnering with a technology and services provider with established infrastructure and expertise specifically to support private debt funds globally, including solutions for loan servicing and administration, portfolio accounting, and managing various fund types and structures. If you want to diversify an existing private equity or hedge fund business, working with a provider with experience and resources across private markets would be optimal. You should also be looking for experience with the regulatory, accounting and tax requirements in all the jurisdictions in which you are likely to invest.
Private credit represents a significant opportunity for fund managers to diversify their offerings and capture more of their limited partners’ allocations. With a provider to help you navigate the operational challenges, you can get to market faster and avoid getting caught up in complexity, freed to focus on sourcing deals and raising capital. The provider should also be able to help you gain investor confidence with a technology platform and best-practice processes that stand up to rigorous due diligence. Once the operational obstacles are out of the way, the path to opportunity appears much clearer.