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Alternative Market Briefing

Private debt: Performance expectations low amid concerns over pricing pressure

Monday, March 09, 2020

Laxman Pai, Opalesque Asia:

Private debt investors are more optimistic than they were at the end of 2018, but performance expectations have been lowered amid concerns over pricing pressure, said a report by Preqin.

Among investors Preqin surveyed across all asset classes in November 2019, those in private debt recorded the highest level of satisfaction with performance. Only 11% said they were disappointed with their private debt portfolios.

"However, only 13% told us their expectations had been exceeded, which is down from 25% that said the same in 2017, and 18% in 2018," it said.

This is no surprise given that average returns from private debt funds have been among the lowest for private capital in 2018 and 2019, it added.

The report 'Preqin Investor Outlook Alternative Assets H1 2020' revealed that the general sense is that 2019 returns will continue in 2020.

Investors are more optimistic than they were at the end of 2018, perhaps because returns have improved somewhat in the intervening months. However, investors are almost equally split as to whether returns will be worse (18%) or better (19%) in 2020.

Investors settle for less on account of pricing pressure

Return expectations have been tempered by the increasingly challenging deals marketplace. Deal pricing and competition for opportunities have re-emerged as investors' key concerns going into 2020, cited by 48% and 43% of investors respectively.

A similar proportion (49%) believe that pricing at the end of 2019 is higher than it was 12 months ago, although this is on par with views given at the end of 2018 and continues a long-term trend.

More curiously, half of the investors think that deal opportunities are fairly valued, up 10 percentage points compared with 12 months ago.

Meanwhile, the proportion that thinks deals are overvalued has fallen from 55% in 2018 to 48% at the end of 2019.

Future plans are lukewarm

In the longer term, private debt investors are progressively coming up to meet their target allocations, and intend to hold them there, said Preqin.

The proportion of surveyed institutions that plan to raise their long-term allocation has fallen year on year from 62% at the end of 2016 to 41% at the end of 2019.

"In the shorter term, investors are more enthusiastic. The proportion of investors that intend to invest more in the next 12 months than in the past 12 months had reached a nadir (32%) in our study at the end of 2018," the report said.

At the end of 2019, though, this had rebounded to 44%, with a further 39% that intend to invest as much in 2020 as they did in 2019. But even here, the 17% that will reduce their commitments in the months ahead is the largest proportion that Preqin has seen in five years for the asset class.

A tale of two outlooks

"As we progress into 2020, a consensus on the health and direction of the private debt industry is difficult to establish," Preqin pointed out. This is perhaps due to the radically different value propositions it offers.

The fortunes of the direct lending market are tightly tied to those of the wider private equity and public markets, and so will rise and fall with them in the event of any major market movement.

But distressed debt funds run countercyclically, and so can stand to make impressive gains in the event of a downturn.

An investor's attitude is likely to depend in large part on which side of the market it is more involved with.

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