Direct Credit Investing
Access to the private credit market, emphasizing current yield with an aim toward downside protection
- The bank loan market aggressively re-opened in 2024, putting pressure on pricing. Private credit transactions have seen +/- 100 bps of spread compression; however, all-in yields remain attractive.
- Despite the bank loan market being open, private credit continues to differentiate itself through increased flexibility relative to the BSL market, particularly as the asset class has grown and offers more liquidity. YTD (through September 11), LCD estimates $16B of syndicated loans have been refinanced with private credit transactions, compared to $6.6B at this time last year. The middle market also continues to be an area favored by borrowers where there is less competition from the BSL markets.
- Many borrowers prefer private credit over public credit markets given that 1) you're typically dealing with significantly smaller lender groups and 2) private credit continues to be able to underwrite complexity, which is highly valued by borrowers particularly during choppy periods of performance or volatility.
- Hamilton Lane Credit continues to see record deal flow. There’s been +$12.3B in YTD deal flow through September 11, 2024, representing 105% of the deal flow we saw in all of 2023.
- Deal flow continues to be dominated by a mix of incremental term loans, refinancings and a modest pick-up in LBO activity. On the opportunistic side, we see interesting opportunities in HoldCo PIK loans (junior debt structures) that can offer equity-like returns. These loans can offer managers a way to preserve free cash flow while continuing to execute on growth/buy and build initiatives. While many of these managers could raise more senior debt, they may prefer not to take on extra cash interest in this environment. We continue to emphasize conservative capital structures with greater levels of equity support by sponsors and lower LTVs.
- All-in yields remain attractive, while defaults remain below historical averages. The default rate by amount outstanding in the Morningstar LSTA U.S. Leveraged Loan Index was 0.78% in August, down slightly from July, which was 0.92%. In July, Fitch revised their default expectations for institutional leveraged loans upward to 5.0 - 5.5% before declining to 2.0-3.0% in 2025. S&P Global is expecting their 2025 speculative-grade corporate default rate to fall to 3.75% by June 2025 from 4.8% as of June 2024. Trends leading to this reduction include recent refinancing and repricing activity, which has provided near-term liquidity relief, strong earnings results and a resilient consumer.
Direct Equity Investing
Globally diversified platform targeting the SMID market with unique positioning
- We continue to find ourselves in a favorable supply market as a co-investor.
- What is accounting for the discrepancy between what we’re seeing in the market broadly, which is largely a pullback in fundraising, and increased CI volume?
- GPs are still looking to get deals done with fewer traditional capital sources available to them, which is compounded by a more challenging lending environment.
- Deals need to be over-equitized in hopes of getting recapitalized with cheaper debt down the line.
- What does this all mean? There is a decreasing supply of equity, while there is an increasing demand for it.
- Hamilton Lane, as a large, institutional co-investor, is positioned very favorably given the supply/demand dynamics.
- Our 2023 deal flow outpaced 2022, which was a record year, by more than 40%.
- In terms of size profile, we’re seeing more deals that are small (add-ons, which are easier to digest and finance) and huge deals (take-privates, particularly in tech) due to the pullback in the public markets.
- Exit activity remains muted and the IPO market has remained effectively closed for the last 15 months.
- History shows that no period of subdued IPO activity in the last 25 years has lasted longer than 18 months.
- There is a pipeline of potential issuances ready for when the market reopens, but there are clear divergences by sector, with clean energy having the most investor demand and consumer discretionary having the least.
- GPs are holding onto companies for longer or looking to acquire companies that they previously owned. In uncertain environments, GPs are more comfortable sticking with familiar assets.
- There is a continued bid/ask spread between buyers and sellers on valuation, with the challenged credit market making it tough to get deals done.
- Invest in resilient sectors and mission-critical products and services.
- High earnings and asset quality are paramount.
- Align deals alongside GPs with sector expertise to invest through cycles.
- Price equity returns at levels that are appropriate for the higher cost of debt and reduced leverage levels to drive moderating valuations.
- Remain highly selective and only invest in the highest-conviction opportunities.
Emerging Managers
Early access and introductions to best-in-class emerging and diverse-led managers across primary funds and co-investment transactions
- Emerging managers have used their extended fundraises to deploy capital and demonstrate deal sourcing and execution. Many GPs who launched funds in late 2022 and early 2023 are at a critical crossroad to extend or wrap up fundraising. We continue to emphasize with these managers the importance of a diversified portfolio construction approach but with a continued focus on strong underlying operating performance within early portfolios.
- Emerging managers are increasingly being approached by GP seeding and staking firms to address tail-end fundraising challenges. These arrangements aren’t all created equally and, while they may be advantageous for GPs, they may also raise further concerns about long-term focus and alignment.
- Overall, small-cap manager co-investment activity remains consistent, but we note that emerging manager-specific co-investment volumes continue at a slower pace. We are seeing activity from managers who have recently completed a full fundraise and with whom we partner. Interest rate lowering has provided optimism for these investors, but some indicate that activity won’t return to normal, at least until the upcoming election has passed.
Primary Fund Investing
High-quality primary fund investments with often hard-to-access general partners
- Bankers have been signaling to GPs that the floodgates will open after Election Day and deals are ready to go. The running joke in GP meetings is that these floodgates have been expected to open since Labor Day 2022. Investors looking for off-the-beaten-path deals have had some success, while remaining disciplined. High-quality assets are still commanding higher valuations.
- On the exit side, while still generally slow, some groups have been able to mint realizations through financial and strategic buyers. This continues to be predominantly on the smaller end of the market given that the IPO market remains seemingly shut. However, a mega-cap sponsor recently filed an IPO for one of their higher performing businesses, so there are signs of life across the market.
- There is very little to note in terms of fundraising on the equity front over the summer and into the election. Funds that have been raising continue to raise and are getting to the end of their extension periods. We are beginning to see funds launch, which will have closes straddling the 2024/25 allocation timeline and people who are pre-marketing for H1 closes.
- Credit funds continue to drive our diligence work as GPs continue to capitalize on the growth and demand for private credit.
Impact Investing
Seeking to deliver attractive returns while generating meaningful and measurable impact
- Direct impact deal flow continues to thrive, albeit in a more measured manner compared to 2023's record numbers. Our deal flow sourcing engine is working well; we’re seeing deals from sponsors as well as directly from businesses and advisors.
- Primary impact funds have exhibited a similar pattern, with more modest flows compared to last year’s record numbers.
- In November, CalPERS announced it was allocating $100B towards climate solutions by 2030 as part of a net-zero pledge and it expects to sell current investments that don’t have a credible plan to reduce carbon emissions.
- In Japan, the prime minister has announced intentions to direct a substantial amount of the country’s savings towards sustainable investing.
- Renewable energy sources, in combination with nuclear power, will more than cover the increase in global electricity demand from 2022 to 2025, according to the International Energy Agency, further supporting tailwinds in key impact investment themes.
- Despite political posturing, the outcome of the pending U.S. presidential election likely won’t drastically alter the Inflation Reduction Act given the geographic distribution of its benefits.
Infrastructure & Real Assets Investing
Access to primary, secondary and direct investments across infrastructure and natural resources
- There is a robust opportunity set for investments across transportation, energy, renewables, digital, social and environmental infrastructure sectors. Unsurprisingly, investments centered around digital infrastructure and the energy transition continue to lead league tables given industry tailwinds.
- Rising power demand driven by electrification, industrial growth and voracious demand from data centers and AI applications is reversing over a decade of effectively stagnant electricity demand growth as efficiency gains largely offset demand. Power markets are tightening as reserve margins and supply overhang are rationalized at a time of demand growth. Growth in new capacity is challenged by sizeable interconnection queues, with interconnection costs and lead times rising and transmission remains a large constraint. The Inflation Reduction Act, easing supply chain pressures and improving PPA prices serve as tailwinds for renewables development and investment. Amidst growth in intermittent renewable capacity, renewables’ marginal contribution to reliability declines are requiring additional dispatchable capacity (e.g., BESS & NatGas).
- Digital infrastructure and power markets converge, with rapid growth in data center demand challenged by power availability (plus land and water) presenting challenges and opportunities for infrastructure investors. Base rents per kilowatt of capacity are increasing amidst rapid demand growth and scarce supply, reversing a prior trend of rate declines. Hyperscalers remain key drivers of demand growth amidst the increased adoption of cloud technologies and AI. Attractive development yields (e.g., page 23 of DLR’s IR presentation) persist in the market. Despite significant opportunities for infrastructure capital, selectivity is critical to success. Obsolescence risk exists for legacy data centers as customers require increasingly efficient (lower PUEs) data centers and racks become increasingly dense (kW/rack), requiring the utilization of more advanced cooling technologies.
- Continued digitization in an increasingly connected society drives demand growth for wireline and wireless connectivity. Wireline opportunity centered around dark fiber (e.g., data center interconnect) and in the buildout of FTTP serving underserved markets. A wave of notable dealmaking activity in the FTTP segment, with T-Mobile acquiring sizeable interests in Metronet (KKR/Oak Hill) and Lumos (EQT Infrastructure), followed by Verizon’s recently announced $20bn acquisition of Frontier in early September.
- Environmental: There is a large opportunity set across waste and water. Fragmentation within the waste sector has created compelling opportunities for consolidation and vertical integration across the waste value chain.
- Supply chain and logistics: There is a large opportunity set and a preference for opportunities with high barriers to entry and pricing power. We take a cautious approach to leasing strategies exposed to day rates. Global port throughput shows initial indications of return to growth, despite warranted caution.
Real Estate Investing
Seeking to deliver attractive, risk-adjusted returns across primary fund commitments and transactions within real estate
- In parallel with the first interest rate cuts throughout North America and the Eurozone, investment activity and asset values have shown early signs of improvement. Through the first half of 2024, prices have declined by roughly 10% on a year-over-year basis depending on the sector. However, buyer and seller alignment is now starting to improve and, while acquisition activity has yet to meaningfully rise, the outlook is favorable. Strong tenant demand and improving capital markets liquidity all point to attractive opportunities to end 2024 and begin 2025.
- Following heightened demand, the industrial and logistics market has begun to normalize, with leasing volumes and rental growth moderating. The overall U.S. vacancy rate rose by 30 bps to 6.4%, driven largely by vacant speculative deliveries, however the 30 bps increase marked the smallest quarterly climb since the market started to cool off in late 2022.
- U.S. multifamily is seeing its biggest wave of new supply in decades, which is expected to temper rent growth and improve affordability for renters. By contrast, most European countries continue to see household growth outpace the new supply of homes.
- From an occupier perspective, the U.S. office sector has shown signs of a rebound as the increased return to office initiative takes flight and reached an important milestone in Q3 – vacancy levels have begun to decline for the first time in over five years due to a concurrent acceleration in leasing activity and a slowdown of new supply.
- With U.S. consumer spending outpacing projections, demand for retail space has been relatively resilient, albeit lower than the historical average. Similarly, the European retail sector is showing signs of early recovery, which may be further underpinned by expected interest rate cuts.
- HL deal flow YTD September 2024 is 25% higher than it was during the same period last year. We are on pace for a record year, already having reviewed ~$220B of deals through Q3.
- Volume continues to be driven by the desire for increased liquidity. Liquidity pressures (e.g., slower distributions and the need to maintain commitment pacing) continue to motivate many LP sellers.
- Average pricing across all strategies in 1H 2024 increased ~300 bps from H2 2023 levels to 88% of NAV, driven in part by LPs selling higher-quality and younger funds. Improved pricing continues to contribute to increased secondary volumes.
- While LP volume accounted for 59% of all transactions, GP-led deals had one of the highest periods of sustained activity over the last twelve months, as this part of the market has become mainstream and an attractive option for GPs to extend hold periods for high-quality companies.
- Q3 deal flow continues to be weighted slightly more towards GP-led deals (~52%), which is consistent with levels during the first half of 2024. The pipeline continues to be very robust.
Venture Capital & Growth Equity Investing
Seeking to access top-tier venture and growth equity companies through funds, secondaries and direct investments
- GP fundraising activity increased in 2024.
- 2024 is on pace for GPs to raise a similar amount of capital as 2023, but the number of funds closed so far this year is down, continuing a trend of "flight to quality" as LPs concentrate capital in established, high-quality managers.
- While fewer emerging managers have closed funds this year, the quality of funds which firms have been able to raise capital is high.
- We continue to see a bifurcation of strategy amongst established firms with regard to fund size. Several firms continue to raise larger amounts of capital to capture a growing opportunity set, while a minority of managers have kept their recent funds small or even given commitments back to align them with the new valuation environment.
- Managers remain cautious on new deals.
- Managers in fundraising mode focused primarily on their fundraising efforts, while managers staying out of the fundraising market slowed their investment pace.
- Deal deployment remains low throughout 2024 compared to prior years. The notable exception is artificial intelligence, as nearly all tech startups are pivoting their strategy to present as an AI-native solution, widening the aperture of VCs.
- LPs continue to focus on liquidity driving a growing market for VC secondaries.
- LPs continue to push managers to send back distributions.
- Despite a few tech IPOs earlier in the year, traditional IPO exits have remained challenged as the bar to IPO has gotten higher and abundant capital has enabled companies to stay private.
- GPs approaching their next fundraise need to find ways of generating DPI for LPs. The closed exit environment has opened up the secondary markets as a solution.
- GPs are increasingly collaborating with buyers on creative ways to either sell assets or raise continuation vehicle capital.
Co/Direct Investment Funds: Any PM fund that primarily invests in deals alongside another financial sponsor that is leading the deal.
Credit: This strategy focuses on providing debt capital.
Infrastructure: An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.
Private Equity: A broad term used to describe any fund that offers equity capital to private companies.
Real Estate: Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.
Secondary FoF: A fund that purchases existing stakes in private equity funds on the secondary market.
VC/Growth: Includes all funds with a strategy of venture capital or growth equity.
Credit: This strategy focuses on providing debt capital.
Infrastructure: An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.
Private Equity: A broad term used to describe any fund that offers equity capital to private companies.
Real Estate: Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.
Secondary FoF: A fund that purchases existing stakes in private equity funds on the secondary market.
VC/Growth: Includes all funds with a strategy of venture capital or growth equity.