Linear Investments – A deep dive into the trend for direct lending in Asset Management

By Paul Kelly

In May 2022, CityWire Selector reported news of Fidelity International launching into the direct lending space. The announcement detailed how the firm has expanded its private credit 12 through 12 new hires that include senior roles in direct lending. Within the same month, HSBC Asset Management’s (HSBC AM’s) also announced that they raised 1bn(USD) for their UK direct lending strategy that was launched in early 2021. The strategy was launched as part of HSBC’s ambitions to elevate its alternatives capabilities. The strategy was a successful one because HSBC now has the single business unit: HSBC Alternatives. Yet, it is not just Fidelity International and HSBC trying to gain their own footing of the direct lending market share. According to the publication, Private Debt Investor, direct lending is an area of asset management that continues to keep on finding ways to grow and is an area to watch for 2022.

An area ripe for innovation; Linear Investments explores the rise of direct lending within the asset management sector.

In 2021, direct lending activity was deemed to be extremely hectic by Private Debt Investor. The publication continued to share that ‘both the size and number of unitranche transactions escalated in growth and  billion-dollar deals became commonplace within the market, particularly within the US’. Whilst the financial services and asset management sector struggled as a whole due to the pandemic, the direct lending market has been able to rebound to pre-pandemic levels of activity and could well be exceeding it. By consequence, the sector has proved itself to be both flexible and nimble when subjected to great turbulence and market disruptions.

However, it is not just US markets that are enjoying growth within direct lending. In April 2022, DLA Piper reported that until recently, ‘the European leveraged finance market was controlled by traditional banks’. Yet, during recent years, inroads made by private debt funds have disrupted this traditional model. According to the legal firm, in 2021, both deal making and fundraising set new records. These records can be deemed to be even more impressive following 2020, whereby the first half of the year was subject to a market freeze. Now the funds have been able to dive back into the market at lightning speed.

With both the US and Europe experiencing growth of direct lending, there is an expectation that there will be an increase in cross-border direct lending. At present, direct lending is less commonplace within large cross-border deals. This is due to regulatory requirements, multiple jurisdictions and the current implementation of local lending rules. Most particularly, direct lending will have a hard time navigating the fragmented European regulatory landscape. However, in spite of this, there are signs of investor appetite for backing more crossborder direct lending. This is notable from institutional investors who are searching to gain greater geographical exposure through a small pool of top-tier GP relationships. This group is currently achieving the greatest transatlantic market penetration. With the US currently dominating the direct lending market, it is only a matter of time until European debt funds seek to have their market share of this American pie.

As well as experiencing growth, the direct lending market is fueling innovation and creativity for new niches. This has been evidenced through an ESG spin off created by Lombard Odier Investment Managers (LOIM), who partnered with Environment Agency Pension Fund (EAPF) to create a sustainable private credit strategy. The strategy exists to provide diversified North American climate transition-oriented industries with an opportunity to invest in primarily bilateral senior secured private loans. According to CityWire Selector, the fund is expected to provide clients with risk-adjusted returns. In comparison to traditional direct lending strategies, these are less market correlated.

There will also be new entrants into this asset management market share who will be fueling even greater competition. This has already been evidenced this year with aforementioned Fidelity International. However, we expect to see more. Last year, we already witnessed HSBC enter this space, which was formerly a traditional direct lender. The goal has been to search for yield and some of the biggest players in the industry are now using credit funds to increase AUM and by consequence, increase stock valuations.

This is a new area for exploration for the Asset Management space. However, it is not without its setbacks. The very relationship-based and bespoke nature of direct lending strategy means they are reliant on a manager’s capacity and competency to properly source, underwrite, structure, and monitor an investment. This is even more important in direct lending than in traditional credit strategies. This can be timely and overwhelming to managers in asset management who lack experience. At the same time, problems can also occur at any moment within the lending process.

Yet despite the inevitable setbacks, what is inevitable is that off the back of last year’s historic levels of direct lending deals, it is likely to increase. There will be new players, there will be traditional players who will be shifting gears to gain their market share and there will be innovation as ESG will gain an increasing role within these types of loans.

References:

Fidelity hires 12 to bolster private credit and direct lending – Citywire (citywireselector.com)

HSBC AM raises $1bn for UK direct lending strategy – Citywire (citywireselector.com)

LOIM and Environment Agency pension fund launch private credit strategy – Citywire (citywireselector.com)