Private Debt: The multi-faceted growth drivers

Key takeaways

The asset class of private debt has grown significantly over the past several years, and our $3.5 trillion assets under management (AUM) forecast anticipates continued momentum (Exhibit 1). We attribute the growth of the asset class to four multi-faceted growth drivers:

Borrower preferences for certainty of execution, flexibility and clarity on pricing – and an expanding addressable market. As the size of the private debt asset class has grown, it is no longer reserved for “niche” financing solutions. Rather, it can now compete in areas where it previously could not – such as the syndicated debt markets. As a result, the “addressable market” of private debt borrowers has expanded.

Investor desires for portfolio diversification and increased comfort with private debt. In its earlier years, we believe some institutional investors were concerned about the potential for “adverse selection” in private debt. Over time, that theory has somewhat faded, as (1) companies with demonstrated access to the public markets have chosen the path of private debt, and (2) losses (using the Cliffwater Direct Lending index) continue to compare favorably with USD public markets (Exhibit 44), as the private debt track record has extended.

Structural shifts in the public debt and equity markets. The public debt markets (HY bonds and leveraged loans) are now serving larger borrowers, as evidenced by average new issue deal sizes that are prohibitively large for most middle market companies. Furthermore, companies are staying private for longer, as illustrated by a long-term decline in new equity listings and longer private equity “hold times” for portfolio companies. This provides an opportunity for private financing to play a larger role in the growth journeys of many companies.

Shifts in the bank lending ecosystem. Since the global financial crisis, the share of bank lending to U.S. GDP has declined notably. And regulatory considerations have driven banks to reassess the most capital efficient uses of their own balance sheet. We believe private debt is well positioned to fill any potential resulting “financing voids”. And importantly, we believe the growth of private debt to become a third and viable funding option for a wide range of companies – alongside the public debt markets and the banking channel – is a net positive for financial stability.