U.S. Private Debt Market Set To Slow Down In 2023?

Data published by Preqin in mid-December shows that $172bn was raised in the first three quarters of 2022 from 137 private debt funds. The number of funds in the market increased by 18%, from 710 to 837 during the year.

It’s a blistering pace that is reminiscent of the private equity market before the Global Financial Crisis. Private debt seems to be the ‘hot topic’ for investors at the moment, despite more encouraging signs from the liquid debt markets. But there is positivity about the industry everywhere you look – the Alternative Credit Council’s annual Financing the Economy report suggests that drivers of long-term structural growth, like the retreat of the traditional banking sector from private lending, and a generally higher appetite for private market exposures from institutional investors, are solid.

In a previous life, I helped wealth managers create customized portfolios of alternative investment strategies, private debt included; we reviewed over 650 private debt funds, ranging from larger, generalist funds, to sector specialists such as litigation finance, life settlements, and aircraft leasing. Just like private equity, there is something for everyone in private debt.

One thing that stood out to me whilst reviewing these funds was that the managers in the private debt market seemed to really earn their ‘2 and 20’. There is a lot of time and effort that goes into administering a private debt fund and analyzing the underlying investments. After all, a private debt investor has significantly less control than a private equity one (mid-investment options are limited) and so the pre-investment due diligence has to be absolutely spot on; there’s very little room for error once an investment has been made.

Managing the middle and back office of a private debt fund requires additional resources; ensuring that UCC filings are completed on time and correctly in asset-backed lending strategies is just one example. The Financing the Economy report also references the ubiquitous ESG considerations, adding another layer of analysis and reporting to existing and potential investors.

Appetite for private debt may be strong, but there is increasing competition, and like their private equity counterparts, funds with existing exposures to sectors where consumer spending is more discretionary are at higher risk of a wobble in the coming year or so. The private debt market has weathered the economic storm of the past twelve months well; this is arguably the first ‘crisis’ for the industry, and portfolio company valuations have managed to remain stable, a ‘so far, so good’ for the market. But inflationary pressures don’t look like they’re going away any time soon, and the specter of a recession looms, which could translate into job losses, impacting demand. In 2023, private debt managers might have to work harder than ever to earn their money.

**The above reflects the personal opinions of the author, and is not to be considered investment or legal advice or advice of any kind.

Greg Poapst, “U.S. Private Debt Market Set To Slow Down In 2023?” (Essential Fund Services International, January 2023)

https://www.essentialfsi.com/u-s-private-debt-market-set-to-slow-down-in-2023/