When the going gets tough and liquidity is at a premium, investors looking to raise capital or rebalance their portfolios often seek to unload their best assets first.
Among illiquid assets, private debt appears to be ‘it’ at the moment. According to a report by StepStone Group, challenges in the liquid markets last year exacerbated the so-called denominator effect, causing institutional investors to be inadvertently overweight in several illiquid assets classes.
“Counterintuitively, the relatively strong performance of private debt meant that accepting a haircut on those valuations would require a comparatively modest mark down (particularly against devalued fixed-income and equity holdings), and thus transactional volume arrived reaching $17 billion in 2022 (more than 30x larger than 2012 levels) per Coller Capital,” the investment manager and consultant wrote in the paper, Private Debt Secondaries–Moving beyond GP/ LP transactions and into the world of liquidity management.
Total secondaries deal volumes last year fell in all asset classes save for private debt, where volumes increased by more than 30 percent.
Although an investor looking for liquidity today might have to sell a private equity portfolio for a 20-30 percent haircut, the asset class that has suffered least is private debt, John Bohill, the StepStone partner who authored the paper, told affiliate title Private Debt Investor.
StepStone and its peers “became buyers of performing direct lending LP interest at prices reflective of private equity returns”, the paper noted. Bohill told PDI that StepStone’s Credit Opportunities Fund 1 is performing strongly, particularly because of its secondaries’ activity. The fund had a 17 percent internal rate of return within one year of its first quarter 2022 closing, and is 90-95 percent invested.
“For more than 10 years, we’ve been in a very benign credit environment without much disagreement,” Bohill said. “Suddenly we’re talking about some elements of a recessionary environment, and we have people disagreeing over the quality of portfolio companies and managers, which creates a volume boost.”
In the last six months, StepStone has been talking with pension fund trustees who are tactically selling some exposure now but who want to increase their private debt allocations in 2024.
New entrants to the credit secondaries market are expecting further growth in the area. In April, Secondaries Investor reported that Goldman Sachs was eyeing the strategy, following hard on the heels of Ares Management and Mubadala Investment Company, which together disclosed a $1 billion tie-up for credit secondaries. Apollo Global Management is also growing its commitment to the strategy.
– Robin Blumenthal and Christopher Faille contributed to this report.