The annual stocktaking of debt funds, which are sometimes called loan funds, was conducted by the consultancy KPMG Luxembourg in collaboration with the Association of the Luxembourg Fund Industry. The findings were released during Alfi’s private equity and real estate conference on Tuesday.
“Fueled by regulation imposed on banks and growing investor awareness, the private debt market continues to go from strength to strength,” KPMG’s Valeria Merkel and Julien Bieber stated in the report. While many expected the pandemic to boost demand for “opportunistic, distressed and special situation strategies”, direct lending remained the most widely used debt fund approach for Luxembourg-domiciled debt funds, wrote Merkel and Bieber, who are co-heads of private debt at the consulting firm.
The report said that, based on data from survey participants, average assets under management grew by +41% from June 2020 to June 2021, “with the market now reaching €181.7bn.” The EU and other European markets were “the geographical investment target of choice.”
Debt fund categories
A slender majority of loan funds are debt-participating, meaning they buy existing loans from banks or other financial institutions, but do not issue loans themselves. The number of debt-originating funds, which directly grant loans, was up slightly between 2020 and 2021.
There was, KPMG reported, “a small decrease in regulated fund vehicles” between 2020 and 2021. A “regulated fund” means the investment fund product itself is directly supervised by a financial regulator, such as Luxembourg’s CSSF. An “unregulated fund” is run by a regulated asset manager, although the product itself is not checked by financial watchdogs. Unregulated funds are cheaper to set up and administer, but can only be sold to a smaller set of savvier investors.
Fund size ranges
Smaller debt funds remain more common.
“The vast majority” of Luxembourg debt fund promoters are located in Europe, the KPMG report stated. “Most of the initiators come from the UK (43%), followed by Germany (20%) and USA (18%) with only 1% coming from Luxembourg.”
There was a huge shift (+34 percentage points) into direct lending between 2020 and 2021. KPMG noted that “direct lending may include other sub-strategies.” There was also a notable uptick in distressed debt and mezzanine debt (which is a hybrid of debt and equity).
Investment by sector
Camille Thommes, director general of Alfi, stated in the paper: “Private debt funds are fast growing themselves, but they also stimulate growth in the real economy, where other sources of financing do not suffice. They add to the diversity in funding and help to balance liquidity supply and demand for businesses of big and small size in a wide range of industry sectors, which makes private debt funds a cornerstone of the European Commission’s Capital Markets Union initiative.”
To illustrate how debt funds support the real economy, KPMG added for the first time survey questions on the sectors financed by debt funds. The mix was diverse, but a significant chunk goes towards various forms of infrastructure and physical plants.
Luxembourg-domiciled debt funds have increasingly focussed on investing in multiple EU member states. Only a tiny minority have a single country approach.
Institutional investors have represented, by a wide margin, the biggest debt fund punters. From a very small base, interest among retail investors has grown at a fast clip over the past couple of years.
The number of Luxembourg debt funds with a small number of investors (5 or fewer) has been growing.
The vast majority--nine out of ten--of the debt funds covered by the survey forecast a return of 10% or less; three out of five expected a return of 1%-5%.
The report authors anticipate that European regulatory pressure, designed to reduce the risk on banks’ balance sheets, will “accelerate the deleveraging of banks in the [non-performing loans] sector. The effects on the private debt market remain to be seen. However, like the additional regulation imposed on banks after the 2008 financial crisis, the shrinking of available credit for players outside banks’ typical risk appetites should trigger more opportunities for the private debt sector.”
To compile the study, KPMG said it “received data from eight depositaries acting on the market and representing 661 funds (or sub-funds) investing in private debt.” Annual data refers to figures as of 30 June of each year.
The “KPMG/ALFI debt fund survey 2021” was released on 30 November.
Editor’s note: Updated on 1 December to correct the spelling of Camille Thommes’s name.