Investors increasingly recognize the benefits of middle-market loans, in particular their compelling yield and performance attributes relative to broadly syndicated loans. In recent years, we’ve seen many investors define U.S. private debt as a distinct asset class, rather than part of fixed-income or alternatives, and make meaningful commitments to funds investing in middle-market loans. We expect this trend to continue in 2016.
As the U.S. economy continues to perform better than most developed countries, U.S. middle-market loans will remain a desirable asset class for domestic and foreign investors this year. Funds comprised of a diversified portfolio of first-lien, senior-secured loans will be especially appealing, offering stability, current income, asset diversification and downside capital preservation.
Yet it is important to recognize that most current investors have not seen the asset class through a credit cycle. If investors anticipate a slower economy, we expect to see priorities shift to favor risk-adjusted returns over absolute returns on underlying loans. In addition, investors will become more selective in choosing managers and place greater importance on their track records in managing middle-market loan portfolios through interest rate and credit cycles.
Better intelligence will facilitate that choice. Investors who have made multiple middle-market loan investments and their advisors can now review actual track records to evaluate performance versus expectations. Those considering follow-on investments will make additional commitments to managers that have proven their ability to deliver compelling results.
Savvy investors are also expanding their evaluation criteria to consider the alignment between their interests and those of potential managers. This trend will intensify in 2016, with investors preferring managers that put their own capital at risk – and whose earnings are highly correlated to the performance of the underlying assets – rather than giving so much weight to the magnitude of a manager’s assets under management.
Between active transaction volume, growing companies and ample liquidity, the 2016 outlook is generally positive. Although some clouds linger, prudent, disciplined sponsors and investors will find compelling opportunities in the U.S. middle-market.
Originally published in Private Debt Investor’s February 2016 issue