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The Risks and Opportunities of Private Debt

Direct lending is attracting attention from both private and institutional investors thanks to its steady performance and appealing returns. But the overall size and composition of this market is already difficult to assess, and the addition of new players could make it even harder to track the level of risk for both lenders and borrowers.

NEW YORK – In a global economy increasingly fueled by credit, the market for private debt has emerged as a new frontier for yield-hungry investors. The close bilateral relationships that are a feature of this market offer unique opportunities for both borrowers and lenders. But the growing investor base and the broad distribution of private loans across lending platforms makes it difficult to assess the level of risk and – more importantly – who ultimately holds it.

The worldwide market for private debt – specifically direct lending – has grown tenfold in the past decade. At the start of this year, funds primarily involved in direct lending held assets of $412 billion – including nearly $150 billion in reserves for further investment, according to financial data provider Preqin. This rapid expansion in private debt (which broadly includes special situations, distressed debt, and mezzanine debt, in addition to direct lending) is likely to continue. Private debt’s track record of steady performance and attractive returns over the past decade – with credit spreads that are typically wider than those for broadly syndicated loans – has understandably attracted institutional investors with fixed-income allocations (such as insurers, pension providers, endowments, and sovereign wealth funds).

But private debt is still a little-known corner of finance, with less transparency and liquidity than the markets for speculative-grade bonds and syndicated loans. And reliable data remain relatively scarce. An expansion of the investor base could lead to heightened risks if it leads to higher volatility. Nonetheless, the appeal of private debt to lenders and borrowers alike is pushing this relatively obscure market into the spotlight.

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