Private Markets Newsletter - August Edition

Industry Trends

Navigating Evolution: Strategies for thriving in the expanding private credit landscape

Following are the five key trends in the private lending market:

1) The market is growing by an average of 10+%/year, driven by institutional investors and HNIs.

2) Growth brings new types of products, but complexity means costs, as managers offer new features to attract investors.

3) The growth in private lending is driven not only by investors but also by customers, as larger companies turn to private lenders for financing.

4) The debate on whether a recession is coming or has already arrived may be moot for private credit, as the end of 0% interest has already changed the fundamentals of borrowing and lending.

5) Deals are down, but not forever, as the long-term prospects for private credit remain positive due to factors such as huge amounts of investor dry powder, the decline of bank lending, and the need for customers to access capital.

Based on the insights shared during a panel discussion at the 2023 Permanent & Private Capital Summit. Source: Dechert LLP

Q2 / Midyear 2023 Review

US 2Q Private Credit Analysis & Outlook: Direct lending slows but still laps field

The US private credit market in Q2, highlights that direct lending has slowed down but still outperforms other strategies. It mentions that direct lending accounted for 47.3% of private credit fundraising in Q2, down from 60.9% in Q1. However, it remains the dominant strategy in the market. It also notes that distressed debt and special situations strategies have gained traction, while mezzanine and venture debt strategies have seen a decline in fundraising.

Source: Pitchbook

Private Equity Midyear Review: Stalled dealmaking and exits have jammed the capital flywheel, putting a premium on liquidity

The slump in PE activity in the first half of 2023 is due to rising interest rates, a banking crisis, and geopolitical turbulence. Global buyout funds generated $202 billion in deal value, a 58% decline from the same period a year ago. The value of unexited portfolio assets is four times higher than during the global financial crisis. The value of global private capital raised in the first six months fell to $517 billion, a 35% decline from the same period a year ago. It suggests that funds should review their portfolios, focusing on performance, remaining upside, and value assumptions. It also highlights the importance of capturing value from innovation in artificial intelligence and refreshing value creation plans to emphasize margins and revenues. It provides an example of a company that used diagnostic tools to benchmark its costs and staffing against competitors, leading to significant cost-reduction opportunities.

Source: Bain & Company

Market Sentiments

Private Asset investing desperately needs new market infrastructure

There is a need for a robust digital infrastructure to replace the current bespoke model for private alternative assets. Private assets under management are highly concentrated in pension funds and other institutions, while individuals account for just 16% of such assets globally. However, they hold roughly 50% of global wealth and are looking for greater diversification. The current system lacks electronic infrastructure or standards to support transactions, collateralization, administration, registry, and reporting at scale. Building a new industrial model will require changes along the industry's value chain. Several emerging archetypes are discussed, including "walled-garden" intermediated feeder funds, tokenization platforms, direct-to-consumer funds, and industry-level market infrastructure and standards. The future market structure will likely include a combination of distributed ledger technology models, data standards, evolving regulations, and traditional centralized infrastructure.

Source: Bain & Company

Private market undergoing a “Great Reset” as secondary market valuations revert to prior round prices

There is a significant impact of the "great reset" on private company valuations following macroeconomic events in the last 18 months. Companies are now trading at valuations nearly in line with their second-to-last primary fundraising round. Despite this, there are positive signs in the tech and private market landscape, with buy interest on Forge Markets increasing and excitement around AI technologies. AI investment is expected to drive much of the tech sector's financing and M&A activity. Private companies are increasingly exercising their right of first refusal in 2023, and the bid-ask spread remains relatively consistent.

Source: Forge Global

Market Opportunity

Reshaping the CLO Landscape: The rise of Private Credit CLOs and their impact on financing markets

Private credit firms have been transforming the $1.3 trillion collateralized loan obligation industry by taking over buyout debt deals from Wall Street. Recently, HPS Investment Partners and Blue Owl Capital Corp. have issued private credit CLOs, reflecting the increasing size of loans in these CLOs. Traditionally, about 90% of new CLOs each year purchased debt from larger companies, while 10% focused on middle-market loans. However, the middle-market space has evolved into private credit, with firms competing with Wall Street banks for multi-billion-dollar financings. This has led to a push to rename CLOs that buy portions of these large loans. Issuance of private credit or middle-market CLOs in the US has surged to over $11.8 billion this year, accounting for 20% of total CLO issuance in the US in 2023, up from slightly above 10% historically. The growth of private credit deals is expected to continue, attracting more investors to this market.

Source: BNN Bloomberg

Where could $374 billion in dry powder go? Six themes to watch

Private capital in software experienced significant growth over the past decade, with a 24% annual increase and doubling from 2020 to 2021. Despite recent macroeconomic uncertainty, software remains an important and complex aspect of business, transforming operating models and addressing challenges like climate change. Six areas that may shape the future of the software sector include cybersecurity, payments, industrial software, human capital management, supply chain management, and data and analytics. These areas are expected to have an outsize commercial economic effect, and the significant amount of dry powder in tech-focused PE funds suggests continued interest in software investments.

Source: McKinsey & Company

It is time for family-owned firms to put private equity on the table

There is a negative bias against PE firms in the context of family-owned businesses selling their companies. It argues that while there are some bad actors in the PE industry, there are also good ones that offer advantages to business owners. PE firms can provide an attractive solution for owners who want to maintain control and involvement in their businesses, offer liquidity and operational support, and serve as a valuable resource for companies with limited capital. It suggests that owners should consider PE firms as potential suitors when selling their businesses and work with experienced advisors to ensure the right partner and deal structure.

Source: CFO Dive

ESG Trends

Navigating ESG integration in European Private Equity for enhanced returns

There is a growing demand for sustainable investments in Europe, driven by commitments made by EU governments and businesses to achieve sustainable goals, such as the Paris Agreement. The EU has introduced ESG-related disclosure regulations, including the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation, which require fund managers to disclose their investments in sustainable and environmentally sustainable investments. To seize this opportunity and comply with regulations, private equity firms need to integrate ESG factors into their investment strategies, policies, and processes. Best practices include developing ESG policies, conducting specific ESG due diligence, engaging with portfolio companies, monitoring progress against ESG standards, conducting annual reviews, and reflecting ESG reporting requirements in annual reports and client communications.

Source: Engage Hogan Lovells

Market Challenges

Liquidity crunch: How PE/VC funds are navigating today’s market environment

There is a high impact of macroeconomic factors on PE and VC markets since the beginning of the COVID-19 pandemic. Challenges such as high interest rates, low IPO activity, and a depressed public market have led to a difficult exit environment, lower fundraising numbers, and fewer deals. Despite these challenges, fund managers are finding creative ways to adapt, such as using specialty lending or liquidity options. The stock market is rebounding slowly, and there is optimism about the long-term prospects for the industry and its ability to weather temporary market turbulence.

Source: Silicon Valley Bank

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