Alt Asset 1 - Private Debt
What is Private Debt?
Private debt, or private credit, is when funds provide loans to companies, instead of traditional banks, bank-led groups, or public markets. In established markets like the US and Europe, private debt is often used to finance buyouts, expansions, or acquisitions. Private debt funds use a variety of strategies, such as direct lending, venture debt, or special situations, and offer different types of loans like senior, junior, or mezzanine debt.
These loans can go to both public and private companies, as well as to real assets like infrastructure and real estate. Many investors choose private debt strategies to earn income and strengthen their traditional fixed income investments. In the last 20 years, institutional investors' allocations to private debt have grown significantly, from about $58 billion to nearly $1.5 trillion, as mentioned by FS Investments.
Scope of Private Debt Market
The chart showcases the steady growth in global private debt fundraising by strategy from 2011 to 2022, highlighting a diverse range of strategies such as direct lending, special situations, mezzanine, distressed debt, and venture debt. Venture debt, in particular, showed impressive growth, with a notable compound annual growth rate (CAGR) of 27.4% from 2018 to 2023, and an astounding 127.1% growth from 2022 to 2023. Private debt is the 3rd largest asset class and the least volatile, offering investors a stable return profile compared to more traditional and fluctuating asset classes like equities or public debt.
The chart illustrates the trends in US middle-market unitranche spreads and yields from 2018 to the fourth quarter of 2023. The blue bars represent the spreads, which remained relatively stable from 2018 to 2022. The light blue line tracks the yields, which increased significantly in 2022 and peaked in early 2023, remaining above 12% throughout the year. This increase was influenced by the regional banking crisis and rising base rates, driving yields to their highest levels in recent years.
The chart highlights the impressive performance across various private debt strategies from 2011 to 2020. Mezzanine funds stand out with the highest top-quartile returns at 14.4%, followed by distressed strategies at 11.6%. These strategies offer excellent opportunities for investors seeking higher returns. Across all strategies, the median returns are strong, showcasing the resilience and consistent performance of private debt as an asset class.
The chart highlights the resilience of US sponsored direct lending, with a strong total volume of $187 billion in 2023, showing the continued importance of this market. Notably, private lenders achieved an all-time high market share of 59% in the leveraged buyout (LBO) segment, showcasing their growing influence and capability in this space.
Origin of Debt Securitization
Post-World War II (Late 1940s-1960s): After World War II, there was a growing demand for housing credit, which banks and other financial institutions struggled to meet. To address this, they started looking for new ways to increase the availability of mortgage funding.
1970s: Debt securitization began with the structured financing of mortgage pools. Investment bankers developed new investment vehicles that grouped specific mortgage loans, managed credit risk, and structured cash flows to attract investors. Although it took several years to refine these mortgage securitization structures, the concept quickly proved to be transferable to other types of loans.
Mid-1980s and Beyond: Advances in technology and the rise of more sophisticated investors led to rapid growth in debt securitization, making it one of the fastest-growing activities in capital markets. A wide range of debts began to be securitized, more companies adopted the securitization process, and the investor base expanded significantly.
Present Day: Debt securitization remains a key strategy in the financial markets, and few banks or financial institutions operate solely as portfolio lenders.
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