Private Debt Investor: A tale of two markets

What is making Europe increasingly attractive to private credit LPs?

One of the things that makes Europe very appealing right now is simply the fact that it’s not the US. If you look at what has happened over the course of the year, Europe has been significantly less impacted by tariff-related uncertainty and volatility with growth more stable and M&A levels increasing. As such, Europe represents a very interesting diversification proposition for LPs. By contrast, the US is becoming a quasi-syndicated market because of the sheer number of business development companies (BDCs) and the capital that has been raised. In Europe, the vast majority of the capital is held in closed-ended funds and growth in assets under management has been slower. At a more fundamental level, there are a lot of opportunities for high-quality buyouts and big carve-outs in Europe. Capital markets are still hugely underpenetrated and there are many high-quality deals available to private credit managers. The continent’s geography also enables incumbent businesses to be much more powerful – and better protected – than US companies, due to the market inertia that exists between nations.

How do dynamics in the European private credit market differ from those in the US?

It’s highly unlikely that a new business launched in France will become a global competitor within two or three years, whereas that’s a very real possibility for US companies. While the latter is particularly interesting for equity investors, and especially for those focused on the technology sector, it can cause unease for private credit investors. We like stable, predictable businesses, and there are a lot of them in Europe. The slower-moving environment favours national champions and supports a strong base of high-quality companies. There is also better documentation in Europe because those markets grew out of the banking industry, where there is much more disclosure of information and monthly reporting. All of this means that Europe is at a huge advantage. Investors recognise that it’s nice to diversify away from the US, for currency reasons and so that they don’t put too many eggs in one basket. Europe also has a lot of similarities with the US, so people are very comfortable with the market. The age of US exceptionalism – where I would meet with an investor in Texas and they would say they have no need to invest outside of Texas or even outside of the US – is clearly changing. People have realised it wouldn’t be the worst thing to have a bit more geographic diversity in their portfolio.

Do low growth rates in Europe deter LPs from a European strategy?

All Western economies are struggling with very similar themes around government expenditure, particularly in the post-covid environment. But people often underestimate the difference between GDP and the leveraged buyout (LBO) market. The private equity-driven LBO market is very focused on services businesses, and economic performance in that sector is similar in Europe and the US. European growth rates in that space have been trundling along nicely, whereas US growth has really taken more of a hit. There are some particularly interesting growth themes emerging in key European countries which will have an impact on the wider market: German defence and infrastructure spending is likely to rise, and France and the UK’s underlying economies are doing pretty well despite some political upheaval.

Given its competitiveness, what is the best strategy for approaching the US market?

I think the US is very attractive from an opportunistic perspective. There are some exciting themes developing for managers that can look at a broad variety of deals and be very selective in picking credits. I think one of the most interesting opportunities for institutionally funded, closed-ended funds will be to take advantage of what’s going to happen with BDCs. A lot of these BDCs own assets that are fundamentally illiquid, so how do you offer investors liquidity? The opportunity is huge when retail money flows in, but when retail money flows out, BDCs won’t be able to invest and will need to shed assets. The market is going to get more interesting as we start to see more of a two-way flow of retail capital, especially for managers that are well-positioned to take advantage of that reversal.

Almost all the large PE giants have launched credit strategies in the US. What does that mean for how LPs pick managers?

I recently met some investors in Australia who told me they wouldn’t invest in what they called “ugly cousin funds”, which they explained as being credit funds that are trying to get LPs to invest based solely on their PE brand name and history. That reflects a broader theme we’re seeing of LPs becoming more sophisticated in their approach to private credit and focusing more on fund performance and GP alignment. Even five or six years ago, people were fascinated by the novelty of direct lending and there was a lot of marketing about how hard it is to make a loan, but that’s not true. Making a loan is easy – the difficult part is getting paid back and making sure you don’t lose money. Investors are now very aware of that risk, so we’re increasingly getting questions asking for our more than 20-year track record, our industry-leading loss rates over that period, and greater insight into our portfolio. They also want to know what we have learned over two decades and how we responded to tough situations. Warren Buffett has talked a lot over the years about just how hard it is to invest big pools of capital. We believe that buying the private credit market is a fool’s errand because you can’t have a lot of losers in a credit portfolio. The winners might generate 1.3x, and the losers kill you. As such, you have to make sure you’re investing in really high-quality companies.

As a manager, what is needed to operate simultaneously in both the US and European markets and to do so successfully?

Strong access routes to the market are crucial, as is having capacity across multiple products. A really big advantage going forward will be the ability to speak for entire transactions across the capital stack, and to position oneself as a problem solver. There are also some subtle cultural differences associated with investing in Europe, which is a slightly more relationship-driven market than the US. The ability to work well with local teams opens up a lot of opportunities.

Originally featured in Private Debt Investors LP Perspectives Special Report.