PDI’s 2022 Future of Private Debt Report: LPs look to explore niche strategies


As the asset class evolves, more opportunities are opening up for new approaches, say Victory Park Capital founding CEO Richard Levy and senior partner and co-founder Brendan Carroll

How would you describe the way in which the private debt asset class is evolving, and how is investor appetite changing as it continues to mature?

Brendan Carroll: We expect the private debt asset class to continue evolving as it has over the past decade, with asset allocators becoming increasingly interested in the strategy. In the past, LPs would primarily look at traditional sponsor-backed buyout financing strategies, but we have seen their interests expanding. One example is non-traditional asset-backed lending to support verticals such as tech-enabled assets or real estate financing. Private credit is helping asset allocators create more diversified portfolios than ever before.

Another growing trend is the emergence of insurance companies and their interest in the asset class. Insurance investors have found a way to make these allocations more efficient for their balance sheets, while complying with regulatory requirements. As the asset class has become more popular because of its attractive risk-adjusted returns, we have seen a growing number of insurance companies in the US and abroad allocating to private credit. This is in part because the strategy exhibits low volatility compared to public debt. Further, many private credit strategies use base rate or LIBOR floating rates, which can be favourable in a rising rate environment.

Richard Levy: As the asset class matures, large credit funds are starting to act more like banks than alternative asset managers. At times, some credit funds may even partner with banks, which was not the case a decade ago. At Victory Park, we are focused not only on sourcing and executing compelling transactions, but also on the deep relationships we develop with our portfolio companies to support their growth.

We have sought to be a debt provider to emerging verticals since 2009, just two years after Victory Park was founded in 2007. We started to observe a digital shift in areas like proptech and fintech, where an increasing number of customers were beginning to originate online. We were early capturing and in- vesting in that trend. At Victory Park, we seek to finance where the world is going rather than where it has been. At the moment, we still see a lot of opportunities in the shift from analog to digital. We also continue to see opportunities in a new green revolution as the next generation of energy companies tackles innovative ways of doing business without the reliance on fossil fuels.

Looking forward to 2023, where do you expect to see the most interesting deal opportunities for private credit?

BC: We seek to finance new investment verticals that are created as a result of the macro environment at any given time. A decade ago, that was fintech and online lending, which became very popular during the global financial crisis when banks were pulling back. Suddenly, we saw those businesses filling a void and we provided credit to the companies we believed to be the most attractive from a risk and return perspective.

Similarly, as people shifted their purchasing habits online, we saw significant growth around ecommerce aggregation sites within the past few years. Complemented by the huge expansion in buy-now, pay-later (BNPL), we found a rapid engine of growth in the industry and moved swiftly to finance compelling businesses in that space. We are nimble investors that focus on providing structured credit solutions to portfolio companies in the technology-enabled space.

We can back businesses early on in their life cycles, so we typically structure our loans as delayed drawdown facilities. That means we are not just funding a company once and being paid back but growing our facility alongside the company as it meets growth milestones. Today, we have portfolio companies that are navigating market volatility and expanding, and we are increasing our exposure accordingly in line with risk management.

RL: The banks have a lower appetite for risk and a reduced need to pursue these types of returns. That means there will be a pull-back by banks in this environment, which will allow private credit to step up, albeit in a riskier climate where managers will need to be more discerning. At the same time, volatility in the equity capital markets means venture and growth equity investors are becoming more cautious. This may lead companies down the private credit path, which may not have been a consideration even a year ago.
That said, we think it is too early to really know where the opportunities will arise, so we are being cautious, patient and examining the massive amount of data we collect daily. Our loans are floating rate, so we are monitoring to see how our borrowers adjust to the higher cost of capital, along with potential headwinds to their top line. Inevitably there will be opportunities, and we will be prepared to pursue them when there is more clarity.

How do you anticipate investors increasing their exposure to private credit investment strategies in the year ahead?

BC: We expect investors that are familiar with private credit and have already been investing in the asset class to continue increasing their allocations. For allocators that have not had experience with private debt, now may not be the time that we will see them enter, as the focus may shift to broader portfolio issues that could arise due to market volatility. However, with interest rates rising and where fixed income is today versus one year ago, we anticipate investors will be looking beyond the traditional sponsor-backed asset class to find premium over liquid markets.

RL: It is possible we will see bigger investors, like insurance companies, sovereign wealth funds and endowments, allocating more specifically within the asset class to new areas like legal finance, for example. That vertical is minimally correlated to the market and may prove popular as investors seek further downside protection in a volatile environment. Since Victory Park’s founding in 2007, we have sought to provide investors with a compelling, risk-adjusted return profile, consistent interest income and a significant emphasis on risk management. In an environment where liquid fixed income returns have risen, debt managers are going to need to demonstrate a premium to those returns while cautiously navigating uncertain market dynamics.

With growing interest in digital assets, what opportunities do you see for private debt investors?

RL: Generally, digital continues to take market share away from an analogue world, whether that is in retail, financial products or elsewhere. It is not a straight-line progression, but if you look at the growing share that ecommerce has taken from retail and newer financial products from incumbent banks, we see no reason for that to stop. We continue to see our venture partners backing innovators and we will finance where we see attractive and sustainable growth. We are seeing quite a lot of in- novation in proptech, where real estate companies are using data and online access to drive different products. The space is gaining interest amongst both retail and institutional investors. There will also be winners and losers in the BNPL space, which has exploded in popularity in recent years.

Additionally, we believe blockchain will create innovation and allow for illiquid asset classes to potentially have liquid outcomes. We have not been lending to entrants in the crypto space, but we continue to observe how our venture partners are using blockchain to innovate.

BC: Over the last 15 years, we have seen customer acquisition processes continue to evolve with the advances in technology. Lending against that means there are always going to be new companies emerging that can facilitate customer acquisition in a cheaper or more efficient way, and that is an opportunity we see globally with very few exceptions.

How will a rising interest rate environment impact private credit investments?

BC: Given the verticals we focus on, we talk a lot about the consumer, whether through our BNPL investments or through ecommerce aggregators. The savings rate of the average US consumer has dropped rapidly in recent months, from record highs 18 months ago to all-time lows today. We see an environment where credit card applications are at their highest level in a decade, but defaults are still not at the levels they were pre-pandemic. If inflation stays where it is, that may change, but we are not there yet.

Our portfolio companies are typically high-growth businesses that historically raise their next round of funding through venture capital or private equity. That has changed given recent market volatility, so we have observed some companies conserving cash and drawing down less debt capital as they become more conservative.

RL: A lot of our peers and portfolio companies have not seen interest rates at these levels before, and they are expected to continue going up from here. We expect there to be opportunities for private credit funds to take market share as banks and equity providers step away. Credit managers need the experience to navigate in a volatile environment. This may mean being more conservative in credit selection, strict covenants, enhanced risk oversight and floating rate loans.

This environment should create opportunity for those credit providers that have experienced uncertain market cycles before (for instance, the glob- al financial crisis) and are prepared to navigate, and potentially some difficulties for those who haven’t.