Private equity investors believe funds are overly hopeful with return expectations

Private credit is an increasingly attractive area for institutional investors, Coller Capital said in its bi-annual Global Private Equity Barometer, despite the economic uncertainty caused by higher interest rates.

Out of the 110 investors surveyed, 90 per cent planned to maintain or increase their allocation to alternative investments – non-traditional investment areas like real estate and commodities – and 44 per cent expected those allocations to move to private credit, the greatest increase of any area, the report said.

“In times of uncertainty and volatility, [senior direct lending such as private credit] is just structurally better placed and it is significantly less likely to suffer an impairment,” Martins Marnauza, a partner in the investment team for Coller Credit Secondaries, said.

The current addressable market for private credit secondaries reached $3.4tn in 2023, up nearly three times from 2018, and it is projected to reach $5.4tn in 2026, according to Coller Capital.

Higher interest rates have also aided credit portfolios: half of investors stated that higher interest rates have had a positive impact on the performance of their private credit portfolios.

“The latest edition of the Global Private Equity Barometer shows that despite a disruptive macro environment, alternatives remain an attractive asset class,” Jeremy Coller, chief investment officer of Coller Capital, said. “LPs are committed to maintaining their allocation and expanding their portfolios in areas such as private credit and co-investments.”

Three-quarters of LPs expected private credit managers to lend to private equity at a faster rate than banks over the next one to two years, although 90 per cent of investors said they are not prepared to borrow to finance new fund commitments.

“[Low borrowing] doesn’t surprise me at all,” Marnauza said. “I don’t think historically it has ever really been the case that this profile of investors would have operated with large amounts of leverage.”

Despite the optimism for alternatives, investors overwhelmingly believed that general partners (GPs) are overly hopeful with their returns expectations – although the majority of LPs still expected their private equity portfolio to generate returns of 11-15 per cent.

Over half of LPs acknowledged the need to develop in-house AI capabilities to “optimise organisational ability and decision making,” the report said. Fund monitoring and competitor benchmarking are the key focus areas for AI integration, with 38 per cent and 31 per cent of investors planning to implement AI in these activities respectively.

“Fundamentals in the market are shifting – the opportunities offered by generative AI and the challenges of an evolving regulatory landscape have the potential to change the way both LPs and GPs operate in the future,” Coller said.

LPs also expect a recovery in venture capital activity in the coming years, particularly in North America. India and Southeast Asia are seen as the most attractive markets for buyout opportunities.