US investment group Ares has raised €11bn for one of the world’s largest private debt funds, as lightly regulated alternative lenders step up their attempt to supplant traditional banks and bond markets in the wake of the pandemic.
The fund will be Europe’s largest of its type, according to data from Preqin. It will lend money directly to medium-sized companies in the region that want or need an alternative to the typically cheaper funding routes of bank loans and bond markets.
It is the latest sign of a power shift that has taken place since the financial crisis, from investment banks towards private equity groups, which are not subject to the 2008-era regulation that has curbed banks’ risk-taking.
The financial crisis and the regulations issued in its wake “really shrank the banking industry” and “made this type of lending less profitable for them”, said Blair Jacobson, co-head of European credit at Ares.
“Covid is probably the third leg of that, because again, the banking sector will not have an easy time dealing with Covid-related issues in their own loan books,” he said. “We don’t think they’re exactly out of the woods yet either.”
Direct lending funds have attracted a flood of investor money from pension funds and sovereign wealth funds seeking higher returns than those available in the public markets. Last year, Apollo Global Management and the Abu Dhabi sovereign wealth fund Mubadala unveiled a direct lending joint venture that aims to lend $12bn.
Worldwide, direct lending funds raised $82bn in 2019, up from $7bn in 2007, figures from Preqin show. That has facilitated larger deals, such as a £1.9bn refinancing of British insurance broker Ardonagh that Ares backed last year.
Direct lenders are free to take risks that banks would not take, often charging higher interest rates. In the privately arranged loans, they are also able to negotiate more bespoke financing arrangements with individual companies.
Several had been poised for a surge in demand as bond markets froze at the beginning of the pandemic. However, the Federal Reserve’s decision to intervene directly in bond markets propped up the system.
That enabled even some of the worst-hit companies, such as cruise ship operator Carnival, to abandon talks with direct lenders and tap bond markets instead.
The central bank intervention “took away an opportunistic moment in time to put money to work in parts of the market that typically would not come to the private markets,” said Mike Arougheti, chief executive of Los Angeles-based Ares.
“There was an opportunity that was there for a little while, and that opportunity went away. But the broad middle market lending opportunity, or lending to companies that are not able to access the capital markets efficiently or are not getting capital from traditional [sources], that did not change.”
The pandemic has made some companies keener to use private lenders because “there’s a partnership mentality with a single counterparty as you’re working through a difficult situation, as opposed to in the markets when you’re squaring off with a syndicate of institutions with different agendas,” Arougheti said.
The new fund’s total capital will be about €15bn because Ares plans to use leverage to increase its firepower, a common practice in the industry.
Ares’ previous European direct lending fund, a €6.5bn fund raised in 2018, generated net returns of 5.8 per cent as of December 31 on an unlevered basis, according to company filings. Its predecessor, raised in 2015, had a net return of 8.1 per cent, the filings show.
Like several direct lending groups, Ares traces its roots to the 1980s junk bond king Michael Milken and Drexel Burnham Lambert.
It was founded in 1997 by a group including Drexel alumnus Tony Ressler, who seven years earlier had been a co-founder of private equity group Apollo.