Middle market direct lending: Increased investor demand for private debt

With the fixed-income portion of many portfolios no longer producing satisfying yields, investors are finding solace—and greater returns—in funds focused on middle-market direct lending.

Indeed, some investors are increasingly considering credit as its own asset class, separate from fixed income and equities, and direct lending is the investment of choice right now for that bucket.

“Direct lending has attracted a lot of capital,” Kipp deVeer, CEO of Ares Capital Corporation and co-head of the direct lending group of Ares Management, said at Bloomberg’s Middle Market Direct Lending Forum in New York City. “All of a sudden direct lending is a dedicated investable asset class for many players … and I think there’s still a lot of running room there.”

David Golub, president of Golub Capital, also recognized the growing interest, particularly from pension funds, large insurance companies and endowments that have started “to think about private debt as a category that deserves an allocation.”

While fixed-income returns have hovered around zero — for example, both the Bloomberg U.S. Treasury Bond Index and U.S. Corporate Bond Index have been essentially flat over the past year — this space has produced returns of 8 percent to 15 percent, including yield, as estimated by panelists.

What is driving such returns? Simple supply and demand. Since the financial crisis, a lot of regulatory changes have been put in place. As such, the tightened standards have shrunk the supply of willing lenders, while the demand for credit remains great.

Golub’s overall strategy is to keep it simple by focusing on senior secured, first lien, floating rate, lending to resilient companies – strategy that can produce consistent reliable returns, even amidst public credit market turmoil. “All hell can break loose and if you do it right, it’s still a boring business,” he said.

On the other hand, for a portion of his assets, Brad Marshall, senior managing director at GSO Capital Partners, is identifying opportunities in distressed industries, such as in energy and metals and mining.

“Entering at the bottom of the cycle, being at the top of the capital structure and just having that technical expertise I think is going to present some really good opportunities for investors,” he said. “But that investor base has to sign on for that volatility and risk. It’s not as stable as performing senior credit, but I think that’s where you get the most outsized returns.”

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