The Alternative Credit Council and Dechert LLP are pleased to share the findings of our research, which explores current fund structuring and product design trends in private credit.
The ability to tailor finance solutions to meet the needs of borrowers is a key attraction of private credit. Our research finds that many private credit fund managers are also providing a higher level of customisation to their investors. This paper highlights the key areas where this customisation is influencing product design and the drivers behind why investors are seeking more specialised ways to access private credit strategies.
The rapid growth of the private credit sector over the past decade means that investors and asset managers have become more sophisticated and experienced, both in their approach to the asset class and its role within their portfolios. They are now exploring structures that provide ongoing exposure to private credit strategies and enhance the returns that they are able to achieve on their capital.
Our findings highlight how risk management and alignment of the structure with the investment strategy remain critical to how investors and private credit managers structure their investments. While efficiencies are important, the alignment of the investment structure with the liquidity profile of the underlying assets remains fundamental.
This research also provides insights into the growing interest in raising capital from retail investors and the challenges faced by private credit fund managers when developing products that can raise and deploy this capital at scale.
Policymakers and industry are collaborating to address these issues through reforms such as the UK Long-Term Asset Fund and European Long-Term Investment Fund and, over time, these vehicles could see a similar level of growth to US Business Development Companies.
While the development of private credit as an asset class was built on institutional capital invested through traditional commingled closed-ended structures, we anticipate that a growing amount of capital will be invested both through alternative structures and from retail clients. Our paper describes the key questions considered by managers and investors when establishing alternative structures and explores the implications of these for the future of the asset class.
We would like to place on record our thanks to the firms and individuals who supported this research and contributed their time and expertise. We hope that investors, private credit managers and policymakers will find our data and insights useful when assessing the structures used to deploy capital and manage risk within the private credit sector.
Deputy CEO, Global Head of Government Affairs, AIMA & Alternative Credit Council
Investors increasingly seeking customised investment structures
80% of respondents manage capital through a mixture of commingled funds and other vehicles. While the majority of capital allocated to private credit strategies continues to be invested via commingled structures, 95% of respondents stated that they offer managed account structures for single investors. Half of firms offering managed accounts did so at levels greater than $100m with the remainder able to offer them at lower allocations. 69% of respondents expect demand for co-investment to increase. While maintaining such structures entails greater costs for private credit managers, our research indicates that there is growing demand from investors for tailored investment structures and private credit managers see being able to meet this demand as strategically important.
Liquidity supporting permanent capital allocations
Investor demand for permanent capital allocations to private credit strategies is being met by fund structures which offer partial liquidity. Such funds are often described as evergreen or hybrid vehicles which combine elements of open and closed-ended fund structures. 51% of respondents offer their investors some form of right to redemption and 48% stated that they expect investor demand for liquidity to increase in 2023. Evergreen or hybrid structures are attractive to investors as they support efficient capital raising and deployment, while also providing investors with more control over their capital allocations to private credit strategies. Investors and their private credit managers employ a range of liquidity risk management tools to align the liquidity profile of the fund with any right of redemption.
Borrowing plays a modest but important role
Investors increasingly recognise how well-structured borrowing arrangements are an important driver of returns. 66% of respondents use leverage within their investment strategy and there are a range of approaches to how leverage is employed across the sector. 41% include levered and unlevered sleeves within their private credit funds. Where leverage is employed, private credit managers offer investors flexibility and multiple points within the investment structure to accommodate their preferences and enhance their returns on capital.
A growing role for retail capital
41% of respondents currently have retail clients and 66% stated that they will or are considering raising capital from retail clients for upcoming fund offerings. Amongst those targeting retail capital for future fund raises, the majority will focus on high-net-worth individuals and semi-professional retail investors. Private credit managers seeking to raise retail capital at scale still face important operational challenges relating to marketing and distribution, but new vehicles such as the European Long-Term Investment Fund and UK Long Term Asset Fund are expected to boost retail participation in Europe.
Familiarity matters when it comes to fund formation
Luxembourg and the Cayman Islands are the most popular fund domiciles for private credit fund managers, with 59% of respondents stating that they have a fund based in these jurisdictions. The US, Ireland and UK were the next most popular fund domiciles amongst respondents. Our research highlighted how investor preferences on domicile are driven by a combination of factors including familiarity, marketing restrictions, tax neutrality and regulatory certainty. Interest and demand for US investment opportunities continues to grow among non-US investors, with multiple approaches being used to facilitate their investment into the US market.
This research paper is based on data from several sources. The Alternative Credit Council (ACC) and Dechert LLP conducted a survey which received responses from 40 private credit managers.
Respondents collectively manage an estimated $800bn in private credit investments and invest across a broad cross-section of jurisdictions.
The survey data was then explored by the ACC and Dechert in a series of one-on-one interviews.