Global Head of Fund Solutions
As private credit continues to pick up pace, what should investors and fund managers be thinking about?
The private credit market has grown enormously over the past decade. And – as demand from institutional investors continues to pick up – it is set to expand further. Figures prepared for Intertrust Group by research specialists Convergence, based on data from the end of 2020, placed private credit as an $850bn market in the US alone. By 2025 it is projected to hit $1.5tn, and between now and then analysts expect to see $55bn per year of capital allocations into private equity drawdown funds focussing on credit.
The bespoke nature of private credit makes it almost impossible to manage via Excel spreadsheets, so having the right technology to support the middle and back office is vital. Private credit as a space is also unique because it relies heavily on human capital and human intelligence, primarily because large parts of the workflow cannot be automated.
The team that supports a portfolio in the private credit market needs a very specialised set of skills, many of which are not widely available. Currently there’s a concentration risk: if you set up shop in New York, Boston, Connecticut, that skillset may be easier to access, but in the Midwest or central US, for example, there’s less specialised support and resources. Big investment in technology alone won’t solve this: the team must also be right.
We recently brought together a group of experts for a Distilled Insights panel to discuss Risk Management in the Private Credit Era. The speakers shared insights into the key issues facing fund managers and investors alike.
Fund managers want to focus on value creation
Through our work supporting the private credit sector, we at Intertrust Group see that managers want to focus most on the value-centric areas of the fund: treasury, risk and compliance, so they have better operational control and can keep a handle on costs. They are looking for a partner who can take away all the other lifecycle activities and so free themselves up.
“I think for almost everything you touch in credit today, there is a vendor in the marketplace that can most likely satisfy your needs – not 100%, but I think they could get you 85%,” said Bill Christian, former COO of GoldenTree Asset Management. “I would recommend to anyone that’s growing and has a capability that they think can attract institutional investors that they look at these capabilities before building something themselves.”
Identifying risk challenges in fund development
The ebbs and flows of private credit cycles also present operational challenges. When managers are ramping up the book, the right operational support is needed to handle the volume of activities. In the post-investment period, activity tapers down and is more concentrated on periodic lifecycle events. But the right structure still needs to be in place to ensure success in times of change. In mid-2020, for example, many of our clients’ volumes increased three to five-fold. Without the correct operating model, it would be impossible to handle that kind of change without costs spiralling out of control.
Larger managers face more of a challenge than smaller, new starters in creating the right structure, because setting up a scalable institutional model is much easier than deciding what to retain and what to move from an existing setup.
“Even though you grow from $900m to $42bn, and you buy as much as you can and you integrate, your expense process – because you’re trying to do it in the best way possible – starts to get expensive,” said Christian. “At the end of my tenure, we certainly were looking at capabilities we could outsource, whether it be reconciliation components or our collateralised loan obligation (CLO) business.”
Understanding the needs of private credit investors
On the other hand, investors into private credit are under what John Phinney, chairman and co-president at Convergence, Inc termed “return pressure” – looking for idiosyncratic uncorrelated returns. They make themselves vulnerable to risk if they don’t do their due diligence on the fund structure and its complexity. “I call it the tough stuff,” added Phinney, the former Apollo COO. “The tough stuff requires mature infrastructure, and a very deep understanding of the adviser side and the risk management.” Investors should know how decisions are made and who makes them, and they should be taken through the journey of the fund’s trajectory by the managers, he explained.
The abundance of external solutions and potential partners that help a fund manager can, in turn, create a dilemma for limited partners in the form of vendor risk, Phinney noted. A fund could be using dozens of independent vendors, from fintech firms and regtech firms to compliance firms and fund administrators.
“This introduces a degree of vendor risk to the LP [limited partner] that they hadn’t really thought about. This came to a very sharp point during the Covid crisis when we were overwhelmed with calls, not only from LPs but also from advisers and the service providers, basically saying, ‘the world has changed… we have to be smarter’,” said Phinney.
To help mitigate risk – and in times of increasing ESG considerations and new asset classes like crypto – investors ultimately need to look for complete transparency from a fund. This applies to both how the fund operates and how it is expected to perform. Fund managers must put those investor needs at the centre of their planning.
Why Intertrust Group?
- As a strategic partner, we offer a full-spectrum service tailored to meet all back-office needs throughout the lifecycle of a private capital fund. This against a background of ever-increasing reporting demands.
- Our proprietary innovative technologies are combined with global knowledge and experience to deliver added-value services catering for all asset classes, while increasing manager visibility of portfolios on behalf of a fund’s investors.
- Our expert teams harness tools and cutting-edge technologies to eliminate costly errors in the handling of fund administration and corporate actions, investor relations and portfolio management.
- We offer bespoke solutions for funds of all sizes to meet administration requirements so they and their partners can concentrate on investor relations, fundraising, closing deals and profitable exits.
- We help funds to navigate the increasingly complex regulatory environment with solutions tailored by jurisdiction and specific compliance requirements.
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