Emerging trends in the private credit market

Published on November 17, 2023 by Prashant Gupta

The private credit market was growing gradually for many years before it gained significant traction among investors and borrowers after the 2008 global financial crisis. A previously obscure activity of Wall Street has now become a highly-sought-after alternative source of capital, rivalling mainstream avenues of financing for all types of business.

This segment grew to a substantial USD1.5tn by end-2022 from just USD200bn in 2008 and is expected to reach USD2.3tn by 2027, according to Preqin.

However, given the current economic and geopolitical headwinds and market volatility, coupled with increasingly tighter regulatory reforms and advancements in generative artificial intelligence (AI), the priority is to understand what is in store for this vibrant asset class. We have identified a few likely trends.

1. Private credit AuM continuing to grow despite concerns of inflation, recession, economic uncertainty and market volatility

Tighter credit conditions after the global financial crisis accelerated demand for private-market financing as banks continued to reduce lending to small and middle-market firms. More than USD1tn in household deposits has left the US banking system since interest rates started to rise last year, according to the US Federal Reserve, making more banks reluctant to lend. This was aggravated by the bank failures this year, pushing banks to boost capital and reduce lending even more to limit risk.

Corporates are also increasingly shifting away from the public market and turning to alternative sources of capital.

Although the current economic uncertainty and market volatility have slowed private deal activity this year, the private credit asset class remains a hunting ground for investors. As private debt is mainly floating-rate, it is also well protected against rising interest rates and inflationary risk. With investors continuing to obtain decent returns from the private credit asset class, due to its excellent performance, and diversifying their risk, private debt is likely to be one of the main beneficiaries, and we continue to expect growth in this asset class.

2. Demand for bespoke private credit solutions increasing, with a continued focus on ESG

Private credit is a dynamic and complex segment, requiring specialist administration. As this segment has continued to grow, a wide range of niche sub-asset classes such as specialty finance and special situations, including litigation finance, supply-chain finance, sports finance and aviation finance, has also appeared. The trend towards diversification has introduced potential for higher returns.

Investors and regulators are increasingly expecting asset managers – including private debt – to integrate ESG into their strategies and incorporate ESG requirements and clauses into credit terms. We, therefore, expect the private credit space to focus on ESG in the long term.

3. Need for transparency, competition and marketplace efficiency increasing

On 23 August 2023, the US Securities and Exchange Commission (SEC) approved a major overhaul of the private fund segment’s regulatory landscape. It aims to protect private fund investors by increasing transparency, competition and efficiency in the private fund market. The Financial Conduct Authority (FCA), the UK’s financial regulator, recently launched a sweeping review of valuations in private markets. As a result of such increased regulatory requirements, the administrative burden of private market fund advisors has increased significantly.

Growing concern around market practices and the perceived opacity of private market investments and fund reporting are some of the factors that led to regulators becoming more stringent. However, their involvement was urgent, considering the large size of the private-market segment and the large number of retail investors. We expect more regulatory reforms and guidelines to be implemented to safeguard investors as the private credit segment continues to grow.

4. Investor due diligence widening and deepening

Most investors have roots in the conventional equity markets, favour more transparency and enjoy access to information more often and faster, as opposed to waiting for quarterly reports. Furthermore, private credit investments can be tailored to suit a borrower’s requirements and are, thus, often bespoke and complex, resulting in investors conducting rigorous due diligence and demanding comprehensive data before investing. Fund managers are finding it difficult to meet such demands within the specified timeframes.

Nevertheless, as the private credit segment continues to grow and more and more sophisticated investors start participating, we expect investor due diligence to become more complex.

5. Technology adoption increasing with the race towards generative AI

AI is now believed to be set to both enhance and disrupt the asset management sector. With the recent advances in AI, even fund managers providing niche private credit strategies are racing to understand the impact AI could have on portfolio companies, investment decisions and reporting activities.

Managers often need support in areas such as accounting, reporting and due diligence and have been finding ways not only to automate their operations to generate cost efficiencies, but also to eliminate duplication and error.  AI would be a useful tool for asset managers and provide a competitive advantage, but this would depend on how soon and how effectively it is implemented. We expect the private credit space to focus on technology adoption in the long run.

How Acuity Knowledge Partners can add value

We have more than two decades of experience in offering support to global clients in the private credit domain. Our Private Credit team’s expertise spans a number of sectors and credit investment strategies. We work as a strategic partner and solution provider, offering end-to-end support across the research cycle – from deep-dive research and complex financial modelling at the deal sourcing/underwriting stage to comprehensive credit research and writing detailed investment committee memos during deal execution.

We continue to provide end-to-end support after investment on portfolio monitoring (including covenant monitoring and performance dashboards) and periodic portfolio valuation (including data management and coordination with stakeholders).

In addition to providing front- and middle-office support, we support clients with work related to investor reporting, and fund operations and accounting.

References:

• Final Rule: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews (sec.gov)

• UK Financial Conduct Authority reviews private capital valuations amid growing fears over the impact of higher borrowing costs – MNK Risk Consulting

• Private Credit Outlook: Room to Run | AB (alliancebernstein.com)

• Private assets views Q3 2023 – Investing during the slowdown (schroders.com)

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