Our previous research has shown that there are significant differences of diversification across the portfolios of business development companies (BDCs).

This portfolio variation provides investors opportunities to better manage across the risk/return and portfolio diversification spectrums. In this paper, we evaluate the historical performance of BDCs to better understand this risk/return dynamic.

The selected sample of publicly traded BDC returns, which covers 2019-2023, includes a period of notable volatility. We also make use of broadly syndicated loan (BSL) returns covering the same period. Although we acknowledge that BSL have certain differentiating characteristics, BSLs could provide a reasonable reference that can add further insight into our analysis.

Our review shows that BDCs can offer investors an advantageous long-term risk/reward profile. The observed correlations presented for many of the BDCs within the index further reflects the benefits of variation in portfolio compositions across BDCs demonstrating that private credit, whether it is BDCs or BSLs, could provide additional diversification benefits to a fixed income portfolio.

It should be noted that the ongoing operational management of any BDC is also critical to BDC returns as is the more directly observable asset manager’s credit acumen.

Historical returns – data

The historical returns data in our study, which covers 2019-2023, includes two significant recent economic events. First, the onset of the global COVID pandemic, which led to a period of severely curbed economic activity followed by extraordinary fiscal and monetary stimulus to alleviate the economic impacts from the shutdowns.

Second, the accelerated pace of central banks tightening monetary policies to address the spike in inflationary pressures. The combination of disruptions to the usual supply chain channels and extraordinary stimulus is widely recognized as significant contributors to the market volatility during our period of study.

The returns are based on daily price and dividend distribution data for two publicly traded ETFs that track well-established public BDC and BSL indices. These indices provide transparent insight as to the relevant performance of their respective underlying asset class.

BDCs are reasonable proxies for private credit performance since the underlying assets of BDCs consist predominantly of senior secured loans to smaller and middle-sized corporate borrowers. The private credit markets have key features, as we have previously highlighted, that can mitigate risk while offering investors and borrowers a valuable investment and funding alternative.

ETF	INDEX
VanEck BDC Income ETF (BIZD)	MVIS® US Business Development Companies Index
Invesco Senior Loan ETF (BKLN)	Morningstar LSTA US Leveraged Loan 100 Index

The daily returns are used to compute total returns, relative volatility measures and the compounded annual growth rate (CAGR), which consists of the respective ETF price return and its dividend distributions.

The CAGR provides a proxy for the average annual total returns of the underlying investment portfolio performance as well as that of the respective ultimate underlying investment portfolios of those BDCs that comprise the index.

The dividends effectively represent the net investment income (NII) (i.e., net of management fees, expenses, and debt servicing costs) of the underlying portfolio as regulations stipulate that these funds (including the underlying BDCs) distribute at least 90% of earned investment income.

Note that BKLN and its underlying portfolio of BSL are unlevered. However, because BDCs operate with leverage against their portfolios, we take a simple approach to applying a leverage adjustment to the BKLN returns to make them more comparable.

The leverage adjustments applied to BKLN assumes the initial debt amount (and its service cost) used to finance the underlying BSL to be fixed during the entire period. We made assumptions of initial debt-to-equity ratios (DERs) that are between 1.0x to 1.75x, which is within the range of BDCs.

Note that under the Small Business Credit Availability Act passed by Congress in 2018, BDCs can elect to increase their DER to 2.0x (or decrease their asset coverage to 150%) subject to certain conditions.

The DER effectively magnifies the daily price returns while the assumed debt servicing cost implies an incremental excess yield (or NII) that is earned. This excess yield is based on the difference between the assumed (i) yield on the underlying investments and (ii) the debt servicing cost. Fees and expenses are already reflected in the underlying ETF returns.[1]

BDC and BSL returns – highlights

Table 1 displays the historical return statistics for BKLN (with various initial DER assumptions) and BIZD. We assumed an excess yield of 1.50% for this range of DERs based on insight from arbitrage BSL CLO and BDC financings and what BSL portfolios would reasonably yield.

The reader can also make their own inferences based on our sensitivity analysis between different DER and excess yield combinations shown in Table 3.

Initial observations indicate that the unlevered BKLN results are intuitive and to be expected as compared with BIZD. The BDC index returns appear to be relatively volatile but generated a higher CAGR over the period.

However, once leverage is introduced, and as to be expected, the BSL index returns imply more volatility, including a higher CAGR, as the assumed initial DER increases. But the CAGR increases at a relatively lower rate as compared to its volatility. Note that the volatility of the levered BSL index does, however, come closer to that of the BDC index.

Another noteworthy observation is that, for both indices, the dividend returns (representative of NII) contribute to most of the CAGR, even more so for BSL.

Amongst other factors, this is because the BSL index introduces primarily performing loans, which typically trade at or around par. In that case, there is limited upside in those instances when loan prices trade at a premium, reflecting the credit improvement of the borrower, as those loans will likely be pre-paid (or refinanced).

This phenomenon is especially the case for BSL borrowers as they are larger and have more access to alternative financing sources.

In contrast, private credit borrowers are typically smaller and often with a relatively riskier profile (most without public ratings) and hence less likely to find alternative sources to funding. However, these borrowers do compensate lenders with a relatively higher premium.

In this case, for those lenders (and investors) that can hold for the long-term (like BDCs), they can realize the rewards that the incremental premium these loans yield. BDCs will also often invest in equity securities, which offer some upside return potential.

Chart 1 illustrates the relative underlying performance.

It is interesting to note that the BDC index and levered BSL index had similar drawdowns at the onset of COVID pandemic shutdowns during March 2020. However, as the BSL levered index appears to have recovered sooner, the BDC index accelerated later during 2021.

This can be partially explained by many BDCs having significant investments in subordinated assets including private equity that could offer some upside returns potential. In contrast, BSL had relatively limited upside with returns that ultimately relied on distributed NII. In fact, most of the increase in NII was due to the BSL floating base rates reflecting the Federal Reserve rate increases.

We also collected daily price and dividends for the BDCs that underlying the index. Chart 2 illustrates an example of how wide the range of BDC returns, for a sample of the BDCs in the index, were during this period.

This wide-ranging returns and volatility of performance among the BDCs can be explained, amongst other factors, by the diversity of portfolio compositions and prudent operational management exercised by the BDCs that could have further contributed to NII.

The range of CAGRs and volatilities for most BDCs analyzed within the index were between ~5% to ~21% and ~25% to ~43%, respectively.

The daily return correlation matrix below provides further insight as to the diversity across the sample of BDCs and the BSL index. Although the BDCs are positively correlated with one another, the correlations imply that the BDCs returns do not always move with the same direction or of comparable magnitude. It also appears to correspond to Chart 2 above.

As another example, Chart 3 displays a comparison of returns for two BDCs with quite different portfolio compositions (based on posted Q4 2023 earnings presentations).

Note that the BDC with a higher CAGR (and higher volatility) had significantly more exposure to investments outside of first-lien senior secured loans. Approximately 50% of that BDC portfolio included a combination of second-lien or subordinated loans and equity type investments.

The other BDC had an investment portfolio comparable to a typical direct-lending portfolio with more than 90% first-lien secured loans. The chart is not surprising as it would be expected that riskier portfolios could generate higher returns along with more volatility, holding all else equal.

Chart 4 compares the second BDC mentioned above with the BSL index since this BDC had a more comparable portfolio composition, at least in terms of seniority.

At first glance, the levered BSL returns give some intuitive explanation as to the behavior of the BDC. Also, one can argue that this BDC was riskier with more volatility (at least during 2020), however, this volatility could be explained by a variety of factors, including the fact that the underlying assets are less liquid and generally considered to pose more credit risk than BSLs (of course, with more risk comes higher expected returns). One proxy of market volatility for BDC assets could be the divergence between market price and fair value as applied by BDCs in accordance with their established valuation methodologies.

Underlying investments within BDCs are mostly illiquid and private in nature and hence do not have readily observable market prices. In fact, BDCs report portfolio NAVs quarterly and mainly rely on established fair value determinations for portfolio investments.

History has shown that market prices could deviate from NAVs (for other less liquid and fairly valued asset classes as well) especially so during extreme times of market distress, implying a significant discount. This was the case for BDCs during early 2020, at the onset of COVID.

Alternatively, there are moments where this deviation can work in the other direction (i.e., in cases of market euphoria with market prices implying a premium to NAV) only exacerbating market implied volatility. Periods of significant discounts or premiums to NAV could provide some explanation as to the differences in volatility across BDC investments and BSLs.

Table 2 below illustrates how BDC discounts drifted during our period of analysis with discounts as low as 50% in March 2020, with a subsequent rebound to an average modest premium at the end of our assessment period.

Table 2: BDC Discount / Premium to NAV

As of	Average Discount / Premium
12/31/2018	~10% Discount to NAV
3/31/2020	~32% Discount to NAV
12/31/2023	~3% Premium to NAV

Averages are based on a sample of eight BDCs (ARCC, FIDUS, FSK, GBDC, HTGC, PSEC, TSLX, and OBDC (NA on 12/31/2018)).

As already noted, we utilize the levered BKLN analysis to further demonstrate how the NII and DER are critical in explaining CAGR performance. Table 3 shows the relative sensitivity of CAGR (and volatility) based on various combinations of DER and excess yield assumptions.

Table 3: Levered BSL ETF with varying DER and excess yield assumptions

The CAGR results are not surprising – CAGR increases when the DER and/or excess yield increases. The CAGR changes are more muted for lower excess yield assumptions (e.g., 0.50%) as more leverage is added.

Volatility, on the other hand, increases quite significantly as DER increases for each assumed excess yield, but is less sensitive to changes in excess yield while holding DER constant. In this case, the daily price returns explain most of the changes.

The above results are insightful when comparing the levered BSL index return statistics against the BDC index. Based on the historical returns during this period, the CAGR (and volatility) comparisons between the levered BSL index and BDC index converge closer when approaching a 4.00% excess yield and a 1.75x DER.

However, this would have been an unlikely scenario for a levered BSL portfolio (especially the 4.00% excess yield).

For consideration

Bringing this together, we present some key factors that can account for the variation in historical return performance across these BDCs. Some are likely topics for further Alter Domus research.

Dividends and NII: It is quite clear how significant dividend distributions (representative of NII) contribute to the CAGR of a BDC as was demonstrated through a simple example. This further highlights how important the operational management of the BDC is to CAGR as is the manager’s investment decisions (e.g., level of diversification and credit risk).

Some examples include the efficient management of the BDC’s asset-liability structure (e.g., maturity profiles, payment mismatches, debt servicing cost), operating costs, and level of management fees.   

Historical observation period: Although the period during which these historical returns cover is a significant one, it is nonetheless a sample. A particular vintage or timing of investments such as at the beginning, end or middle of a business cycle can be a key reason for performance.

Market price versus NAV: The historical returns are based on observed market prices, which can be divorced at times from what the underlying NAVs may indicate. This is especially the case for BDCs whose underlying assets are predominantly private in nature and where the NAVs typically rely on fair value determinations, as mentioned earlier.

Hence those prices implied by the market can be relatively more volatile during times of turbulence and illiquidity, particularly for the equity security of a BDC, or alternatively during times of market euphoria. It is important to emphasize, BDCs are typically not directly exposed to day-to-day market price movements as BDCs have a relatively stable asset-liability profile in contrast to regulated banks, for example.

BDC index: The index underlying the BIZD ETF represents a subset of the BDC market and includes those BDCs that are larger, more liquid, and publicly traded. As of 2023, BDCs represented about $315 billion of AUM, where roughly half of that was publicly traded BDCs.

Furthermore, BDCs represent a small subset of the larger private credit market (of almost $2 trillion). While BIZD could be a reasonable proxy for the investable BDC market, it may not be suitable in all cases for the entire private credit markets.

Conclusion

We have previously demonstrated through observations that BDC portfolio compositions can vary significantly based on different metrics. This portfolio variation can provide investors opportunities to better manage across the risk/return and portfolio diversification spectrums.

As BDCs consist predominantly of private credit, we have also highlighted in previous research key features that can mitigate risks within the private credit market while providing investors and borrowers a valuable alternative.

In this paper, we took a simple approach in our analysis for evaluating the historical performance across BDCs. We also made use of BSL portfolio performance, adjusted for leverage comparable to BDCs, to provide further insight. We relied on public market data for our analysis based on ETFs that track the performance of established BDC and BSL indices. We also included return performance for a sample of BDCs that underly their relevant index.

Our review shows that diversity across BDC portfolios can present a range of long-term risk/reward opportunities. The observed correlations further reflect the benefits of variation in portfolio compositions across BDCs.

Thus, BDCs could provide additional diversification benefits to a fixed income portfolio. As we have noted amongst other factors, the ongoing operational management of any BDC is also an important consideration to BDC returns as is of course the more observable asset manager’s credit and portfolio management acumen.

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[1] To be clear, BIZD is an unlevered ETF, which passes through the returns of the underlying BDCs, and hence no further adjustment is made.

The last two years have seen a dramatic about-turn in the private markets industry. In 2021, at the peak, private markets raised a record $1.7 trillion, according to Bain & Co. However, by 2022, managers found themselves operating against a completely different macro-economic environment, as the Ukraine war, rising inflation and climbing interest rates brought the private market bull-run to a sudden halt.

More than two years on and investors who had upped allocations to private markets in 2020 and 2021, fully expecting to have received some distributions back from these commitments by now, have found that assets are still very much in the ground with limited visibility on when realizations will materialize.

This has left a liquidity problem. According to Bain & Co analysis of Preqin data, buyout managers alone were sitting on $3.2 trillion of unexited companies in their portfolios- an all-time high. Extended hold periods and limited exit pathways have seen the average number of companies in portfolios double over the last decade.

Liquidity, once taken for granted, is now front of mind. For many managers and investors DPI (distributed-to-paid in capital), rather than internal rate of return (IRR), has become the new priority.

With the main exit funnels of M&A, secondary buyouts and IPOs still jammed, managers have had to explore other options to realize value and start getting capital back to investors. At Alter Domus, this is something we have seen firsthand from our clients.

In the first of a four-part series exploring the alternative routes to liquidity that managers have available, Alter Domus looks into how the secondaries industry is stepping up to give managers and investors optionality when mainstream transactional volumes are at a low ebb.

Part 1: Secondaries

The private markets secondaries industry is the original provider of liquidity in an asset class that by nature and structure is illiquid.

The current liquidity bottleneck facing investors and managers has made this the secondaries market’s moment shine.

The industry has come a long way from its beginnings, when the sale of an LP-stake in a fund was often seen as a blot on manager’s track record and the last option for investors that had run out of ideas.

Attitudes have changed, and as the secondaries industry has matured, evolved and innovated, managers and investors have recognized the value it adds as a tool to reconfigure investor portfolios, release capital for allocations to new funds and tweak asset allocations.

Indeed, the value and flexibility that secondaries offer the private markets ecosystem have been on full display during the market dislocation of the last 24 months. As primary deal activity and fundraising has dipped, the secondaries industry has moved in the opposite direction.

In the most recent Jefferies Global Secondary Market Review, secondaries deal value for H1 2024 was recorded at a high of $68 billion, a 58 percent increase on figures for the same period in 2023, putting the industry on course to deliver forecast deal value in excess of $140 billion by the end of 2024.

With some $253 billion of capital still available to deploy, the secondaries managers are well-positioned to continue playing a key role in keeping liquidity cogs turning across private markets strategies.

A broad suite of options

Secondaries managers have been there to provide both LPs and GPs with liquidity pathways, and the strong demand has sustained robust levels of activity in both LP-led and GP-led transactions.

According to Jefferies LP-deal activity accounted for 59 percent of overall activity to come in at $40 billion for H1 2024.

The increase in LP-led deal volumes has been driven by myriad factors, with LPs using the secondaries market not only to manage the impact of the denominator effect (where private asset allocations exceed preset thresholds) on their target asset allocations, but also to free up and reallocate capital to favored managers who are coming to market with new fundraisings.

LP willingness to pursue LP-stake deals has been underpinned by relatively moderate discounts to NAV. Investors have not panicked and dumped assets at fire sale prices, with secondaries pricing remaining stable and narrow enough to make an LP-deal reasonable for selling investors.

According to Jefferies, LP-deals traded at almost 90 percent of NAV through H1 2024, and with equity markets stabilizing and interest rates coming down, pricing is expected to improve even further through the rest of 2024.

This has allowed LPs to sell stakes without leaving too much value on the table, and when considering the growth on NAV that private markets portfolios have delivered over the mid-to-long term even when selling at a ten percent discount, LPs can still be realizing reasonable returns on investment as they take liquidity in secondaries trades.

GP-stakes deals on the up

GP-led deals, meanwhile, accounting for around 40 percent of the overall secondaries market, have also delivered strong transaction volume growth, with deal value up 56 percent year-on-year to reach US$28 billion for the first half of 2024, according to Jefferies.

GP-led deals and continuation fund transactions, where sponsors roll-assets into a new vehicle, with backing from a secondaries investor, and offer LPs the option to either take liquidity or roll-over their stakes into the new structure, are now firmly established as a credible alternative to an exit by an M&A transactions or IPO.

Indeed, Jefferies notes that in H1 2024 continuation fund deals represented 14 percent of sponsor-backed exits, the highest share on record.

Rather than selling their best assets at sub-optimal valuations in flat M&A and IPO markets, continuation funds have given managers a pathway to release liquidity without letting go of top performing portfolio companies.

Putting the building blocks in place

Secondaries managers are providing much needed liquidity for private markets, and managers with high quality back-office infrastructure and best-in-class fund reporting and technology will be positioned to take advantage of the flexibility and liquidity that secondaries investment can offer.

Administering and accounting for secondaries has become a more complex, demanding task for manager back-office teams as the secondaries industry has grown and evolved.

Alter Domus has helped a number of managers to upgrade operational models and put the foundations in place to handle rising secondaries volumes while being in a position to take advantage of the liquidity on offer in the secondaries market.

There are a higher volume of secondaries trades for back-office teams to track in the first instance, and deals will not just include LP-led deals, but also GP-led transactions, single asset deals and continuation funds, which introduce additional fund reporting and governance obligations for each and every continuation fund vehicle.
A mix of secondaries deal asset classes, which have broadened out beyond buyout funds to include private debt and real assets, require further accounting and reporting bandwidth.

For back-office teams that are already stretched and are adapting to rising regulatory and investor reporting requirements on a day-to-day basis, the additional demands that come with monitoring assets alongside commitments that have traded in secondaries transactions, demand investment in operational infrastructure.

Alter Domus’ Workflows Application, an AI-powered tool that can automate high volume back-office tasks, making it easier for managers to keep track of growing and increasingly complex secondaries transactions in their funds, as well as continuation funds orchestrated by managers themselves.

A digital link between manager and fund administrator leadx to greater accuracy in data, as well as transparency, improved efficiency of data collation and higher-quality analysis.

Managers can also turn to Alter Domus for more general outsourcing, co-sourcing and technology support to build back-office capability that can be scaled at pace and adapted to unlock secondaries liquidity.

In markets where liquidity is tight, having the infrastructure in place to assist and facilitate secondaries deal flow helps managers and investors to keep capital flowing in through a challenging period in the cycle.

Private debt has encountered explosive growth as an asset class in recent years. The industry started out 2024 with $1.5 trillion in assets under management, up from $1 trillion in 2022, according to Morgan Stanley. 

As direct lenders and broadly syndicated loan managers seek to grow their funds and returns alongside this industry growth and investor demand, the burden of their fund operations can begin to have an effect on their success. 

This is especially the case with loan agency operations, known for their intense level of work across complex credit investments at high quantities.  

Under these industry conditions, using a loan agent becomes much more appealing for many managers, and firms who already depend on a third-party loan agent may look to increase their outsourcing or select a new provider that more closely meets their needs. 

To understand more about loan agency and how a good loan agent operates, read on. 

What is a loan agent?

In the credit and private debt space, a loan agent is the party that facilitates all ongoing operations required to adhere to the loan terms and liaises between the lenders and counterparties to do so. Tasks that are central to loan agency include: 

• Calculating a loan’s interest over time 

• Coordinating loan and interest payments between multiple lenders and counterparties 

• Sending loan communications between lenders and counterparties 

• Engaging outside parties like lawyers or fund administrators to move along loan operations 

There are a few different kinds of loan agents depending on a lender’s needs or depending on the nature of the loan: 

Administrative agent 

A lead administrative agent, or a named agent, fully represents the lender on the loan and is named in documents as the administrative agent. By taking this lead administrative agent role, the partner takes over all loan agent responsibilities from the lender. 

Sub agent  

The sub agent role exists for lenders who want to take the lead role in the loan agency process and be listed as the lead agent on their own deals. For the behind-the-scenes responsibilities that they hope to outsource, they would work with a sub agent who is not named on the loan but handles elements such as payment distribution and managing interest rates. 

Successor agent 

A successor agent steps in when the administrative agent resigns or is replaced, a situation that frequently arises in restructuring scenarios and liability management exercises (LMEs). This change can disrupt the smooth administration of a credit facility and potentially delay the LME or restructuring process. Acting as a neutral third party, the successor agent ensures a seamless transition, aligning the goals of all involved parties and facilitating a the swift progression of the constituents’ objectives and desired outcomes. At Alter Domus, we’ve served as successor agent on many high-profile LME and restructuring deals such as Amsurg, Apex Tool, Boardriders, Brightspeed, Revlon, Trinseo, and Wheel Pros, among many others. 

What to look for in a loan agent

While lenders can insource loan agency responsibilities, many choose to outsource some or all of this imperative, labor-intensive fund operation. By outsourcing these responsibilities to a loan agent, lenders benefit from tighter headcount in their operational teams and the close attention and expertise of teams specifically focused on all aspects of the loan agency process. 

But not all loan agents are created equal. Loan agency involves painstaking and bespoke work to carry out the terms of a loan over the multiple years of its life. When evaluating partners to serve as a loan agent, here are some key elements to help decide if they’re up for the task:

1. A balance of bespoke expertise and ability to scale operations 

As the direct lending and BSL spaces grow and managers hone their strategies along with that growth, more complex loan terms and transactions emerge. It’s encouraging to see our industry mature in this way, but it does make for more complex fund operations, particularly on the loan agency side.  

For a loan agent to work effectively, they need to have direct and deep expertise in these bespoke strategies and debt vehicles. At Alter Domus, we pride ourselves in operating at the intersection of bespoke expertise and high volume. Our servicing teams are segmented out by asset class expertise and work cohesively for an end-to-end approach, as opposed to the siloed operations of our competitors. We have the experience and the team size to achieve the balance needed for fickle loan agency challenges. 

2. Technology-enabled service 

Loan agency services may take plenty of time, attention, and expertise from your provider, but it’s also crucial that your provider has capable technology underpinning their loan agent duties. When a provider relies too much on manual processes in administering loan agency, their lender client absorbs the high risk of error.  

At Alter Domus our loan agency teams rely on our proprietary software platform Agency360 to service our direct lender and BSL clients. There are key benefits to relying on a proprietary tool for these needs. These loan services benefit from key advantages of using a proprietary tool – for example, we control the updates and maintenance of the tool ourselves rather than relying on software from a third party. We also avoid having to pass along rising fees from a third-party platform. 

A reliance on powerful technology should also extend to the client experience. When outsourcing loan agency operations, lenders should still have a view into the service they’re receiving and a 24/7 ability to access their loan data and reporting. A third-party loan agent should offer a tech-enabled and convenient way to check in on their operations and download relevant reporting. 

At Alter Domus, we offer Agency CorPro as a home base for our clients. The proprietary portal platform serves as our purpose-built solution to exchange sensitive asset information and important loan documentation between our teams. That means our work is available to you at all times in a self-service fashion. 

3. Breadth of loan agency and other middle and back-office service capabilities 

An ideal loan agent should offer additional services throughout the loan lifecycle to support your operations. By placing multiple outsourced needs with the same firm, your teams can benefit from a more holistic data and technology experience. 

At Alter Domus, we’re experts in private debt and BSL, and cover the full range of credit middle office services for these asset classes, from loan servicing to fund administration to borrowing base administration. We know that every operational model is different at each firm, and we are able to customize our services and delivery model to any setup your firm prefers, including outsourcing, co-sourcing and managed service models. 

Optimize your loan agency operations with Alter Domus Agency Services 

As a top provider in the market, Alter Domus’ Agency Services offering meets all these needs and more. Our servicing teams are trained specifically in bespoke credit vehicles and are large and experienced enough to handle high volumes of loans. In fact, our peak seasons see us processing more than 100,000 payments in a single day. 

Ready to see what Alter Domus can do for your loan agency needs and beyond? Learn more about Alter Domus’ Agency Services here. To speak with our Agency Services team about how our services can help your middle- and back-office operations, contact us here. 

Private debt has come into its own and showed its resilience over the last four turbulent years of economic recovery and geopolitical conflict affecting the alternative assets space. 

Globally, credit assets under management took off to new heights while other assets like private equity, venture capital, and real estate fought through startling slowdowns. 

Since 2020, Alter Domus’ Agency Services has serviced new origination of over $750 billion, across over 2,500 loans. As a representation of the greater private debt industry, we cover five key trends that zoom in on certain driving factors of private debt’s growth. 

Download our infographic below to see these trends represented or learn more from our loan agency experts at our Agency Services page.  

The rapid growth of the private markets industry during the last decade has placed new demands and pressures on the back-office infrastructure of private markets managers.

As firms grapple with how best to manage the increasing complexity of human capital, technology, reporting and regulatory demands, Alter Domus breaks down what managers should consider when deciding to either keep fund administration functions in-house, or explore working with a third-party partner.

During the last decade, the private markets industry has been on a remarkable growth trajectory.

Since 2018, private markets assets under management (AUM) have grown at close to 20 percent per annum to reach USD 13.1 trillion as of 2023, according to McKinsey figures.

An operational upgrade

The growth and success of the industry has demanded a reassessment from managers of the resources and infrastructure their organizations require to address their client needs (i.e., investors) by delivering timely and meaningful reporting to them while providing the front office with the proper metrics and analysis to drive returns, expand their investment strategies and launch additional funds.

Traditionally, most private markets managers would have been running single strategy platforms and monitored and administrated a relatively small number of funds.

These modest reporting and fund accounting requirements shaped how managers built their back-offices. The need for fund accounting teams was small, run in-house and more than capable of covering reporting and accounting tasks using email, spreadsheets and basic “off-the-shelf” accounting packages.

As the industry has grown, however, there has been a step-change in what back-office teams are expected to cover.

As investors have increased exposure to private markets, and cheque sizes have increased, there has been an understandable demand for managers to produce more frequent, detailed and increasingly bespoke reporting and data.

Back-office teams have also had to adjust to covering the increasing number of funds, assets classes and investment strategies on manager platforms, as well as the additional reporting and accounting demands that come with offering co-investment, fund of one and special accounts access to key investors, not to mention the rising tide of regulatory reporting and the complexity that comes with managing secondaries and NAV loan deals.

The old, nimble back-office model of yesterday is no longer fit for purpose, and managers across the market are having to overhaul and scale-up back-office infrastructure, technology and operating models.

In-house or third-party

As managers review their operating models and assess how back-office capabilities will have to change to meet the demands of a larger, more sophisticated industry, the core question they will face is whether to run fund administration offices in-house, or partner with a third-party administrator in an outsourced or co-sourced arrangement.

In-house administration

An in-house fund administration model does offer managers with certain advantages:

1. Control and customization:

Keeping administration in-house does allow managers to keep full control of their fund accounting and reporting processes, and tailor these processes to meet a fund manager’s unique requirements.

Managers retain total control over how reports and accounts are produced in an in-house model and can access information as required to answer deal team and investor queries.

2. Confidentiality and responsiveness:

The direct access to data and reporting that an in-house model provides also gives managers the comfort of keeping sensitive data and reporting closely held and confidential. It also facilitates swift internal sharing of reports and figures, without the requirement to put a request in with a third-party provider.

3. Cost Benefits:

For some small managers, running an in-house fund administration team can save on costs if managers are still in the early stages of their development and minimum outsourcing costs don’t step down far enough for smaller operations.

For all the benefits that in-house administration offers, however, it also presents challenges that managers should factor into long-term planning for operational models.

Keeping fund administration becomes particularly challenging as managers grow in size, and locations/geographies, expand in new asset classes and consequently have to expand and upgrade their back-office infrastructure and technology to support this growth and at the same time still be in compliance with the increasing regulation framework.

Managers can soon find themselves incurring high, upfront capital expenditure as they make new hires to expand back-office headcount and bandwidth. Bringing in the required specialized staff to handle increasing compliance management and regulatory obligations are another obstacle to scaling an operational model at pace.

Moreover, investor due diligence often uncovers concerns when firms rely solely on internal resources for administration, as many investors view the absence of third-party involvement as a potential red flag. This lack of external validation can raise questions about transparency, operational rigor, and risk management, potentially impacting investor confidence.

Firms will also find that when they reach a certain inflection point, the cost benefits of keeping administration functions in-house start to erode, which is particularly important given that in-house staff costs are borne by the manager, whereas outsourcing costs are typically covered by the fund.

Further expenditure will also be required to keep space with the latest developments in technology. Running proprietary systems becomes costly and complicated to sustain as AUM grows, and installing and updating best-in-breed technology requires upfront investment in in-house technology expertise and systems monitoring.

The upshot for managers is that instead of investing in the core, front-office functions of investment talent and deal origination and deal execution tools, large sums of capital have to be set aside to keep back-office capabilities up to scratch.

Third-party administration

A third-party fund administration model can deliver cost efficiencies and specialist sector knowledge that would be challenging and costly to replicate in-house.

Advantages of an outsourced model include:

1. Access to specialized expertise:

Specialist third-party administrators operate across a number of jurisdictions and service multiple clients across a wide range of strategies.

They thus have the scale and global reach to build teams that are dedicated to regulation and compliance, are constantly monitoring regulatory developments across all key jurisdictions, and have the knowledge and expertise to ensure that clients are always compliant with all national and international regulation, and can avoid the risk of incurring penalties.

The expertise a third-party administrator can bring to the table is deep, as it employs highly skilled professionals with specific expertise and experience in the areas of fund administration, tax reporting, compliance, and risk management. It is difficult to provide similar specialism in an in-house model in a cost-effective way.

 Another important consideration is that third-party administrators offer flexible access to these experts as needs arise, without the burden of full-time salaries. Instead of maintaining in-house specialists for infrequent or unforeseen issues, managers can tap into a dedicated pool of expertise on demand, ensuring cost efficiency while retaining top-tier support for “rainy day” scenarios.

2. Efficiency and cost savings:

When working with an outsourcing partner, managers free themselves from the costs and time required to keep on top of internal hiring and training, as well as the overheads that come with retaining large in-house teams.

Maintaining technology infrastructure is another area where the outsourcing option can save managers high capital expenditure outlays on technology.

Third-party administrators, with multiple clients, can spread operational, team and technology costs across their client bases, which enables them to provide best-in-class service at a lower cost point than a manager administering a small family of funds with an in-house operation but also ensuring best practices execution.

3. Helping a manager to scale:

It is also much easier for third-party providers – because of their scale – to ramp up service provision and managers not only build and expand their own platforms and investment strategies, but also adjust to the rising reporting and regulatory demands associated with growing their franchises internationally, serving a more diverse investor base and manage multi-jurisdictional compliance.

The hiring cycle and training required to upskill an in-house team to manage these growing demands will involve significantly longer lead times.

The scale and breadth of experience within third-party outsourcing providers also means that they will have the experience of handling complex fund structures and bespoke investor reporting requirements.

4. Stamp of quality:

Established outsourcing providers will be known to investors, who will take confidence in the fact that a manager is working with a third-party that has a track record in the industry and can be trusted to produce transparent, objective reporting. Using a third-party provider also means that managers can benchmark fund administration costs against the market, and show investors that a fund is receiving value for money

Outsourcing administrative functions to a third-party expert can also mitigate the risk of internal errors, operational blind spots and even fraud.

5. Top technology expertise:

Outsourcing partners will work across the best-in-breed alternative assets technology platforms and are able to advise on the selection and implementation of the fund reporting, risk management, and regulatory compliance software tools that are the best fit for a manager.

Building this expertise and breadth of experience in-house is challenging, as is meeting the ongoing development and maintenance costs required to keep these sophisticated software platforms functioning and up to date.

The benefits of scale also mean that third-party providers can make much larger investment in cybersecurity, data security, and business continuity plans than an in-house team could manage.

Industry pivots to outsourcing

Even though in-house administration continues to offer certain advantages, the scale, technology expertise and regulatory and compliance experience that a third-party solution can provide for managers has seen the industry pivot decisively towards the outsourcing option, with various industry surveys showing that outsourcing is on the up and expected to continue increasing in the years ahead.

For managers who are reappraising their operational models, it is important to take a long-term view on what their businesses will require in the future.

An in-house model does offer control and customization benefits, but as the reporting and regulatory workloads in back-office teams increase, scaling an in-house model cost-effectively and at pace becomes increasingly challenging.

The scale, technical expertise, technology bandwidth, cost benefits and global experience third-party providers bring to the table are encouraging more and more managers to choose the outsourcing approach when facing an organizational inflection point.

Alter Domus is a specialist fund administrator provider that has helped hundreds of managers to transition their back-office requirements to an outsourced model and has a proven track record of delivering comprehensive, scalable, and efficient services tailored to the bespoke requirements of alternative investment funds operating across a range of investment strategies in multiple jurisdictions.

In addition to core fund administration, Alter Domus also provides extensive audit and tax support, seamlessly coordinating with other financial service firms to reduce distractions for fund teams and allow them to focus on their primary objectives.

As firms face the mounting complexities of human capital management, evolving technology, intensive reporting, and stringent regulatory demands, Alter Domus helps managers carefully weigh the benefits of maintaining in-house functions versus partnering with an experienced third-party administrator.

Credit markets have changed profoundly since the 2008 fiscal crisis, with broadly syndicated loans (BSLs) and private credit replacing bank lending as primary sources of debt for corporate and private equity. 

As banks tapped down lending activity in the aftermath of the 2008 credit crunch to focus on repairing balance sheets, BSL markets and successively private credit managers stepped in to fill the gap and have not looked back.  

According to Preqin figures private debt assets under management (AUM) have increased more than four-fold during the last decade, and currently sit at approximately US$1.6 trillion. Leveraged loan markets in the US and Europe, meanwhile, have seen loan issuance more than double since 2015 to exceed US$1 trillion in the first half of 2024, according to figures compiled by law firm White & Case.  

As private credit and BSL markets have grown, so has competition, and to differentiate their propositions, lenders and private credit investors have adopted more sophisticated and complex credit strategies. 

Previously private credit and BSL would focus on servicing different borrower groups, but as strategies have evolved, head-to-head competition for the same deal opportunities has intensified. Pitchbook figures, for example, show that US companies refinanced more than US$13 billion of private debt in the BSL market during the first four months of 2024, a 180-degree flip from the second half of 2023, when most borrowers were refinancing BSL borrowings with private debt.  

Market evolution drives middle office transformation

As competition across credit markets has ramped up, lenders have had to reappraise their middle office operational and technology infrastructure and ensure that the administration of the individual credits in their portfolios is efficient, accurate, and as frictionless as possible for borrowers and other key stakeholders. 

In a crowded market, where borrowers have a wide pool of lenders to choose from, a reputation for best-in-class middle office service – including tasks such as loan accounting, loan agency, trade settlements, interest rate payments, borrower and lender communications and borrowing bases – can serve as a point of differentiation for companies and sponsors when selecting a credit partner. 

The last 24 months of dislocation across credit markets have served to further emphasize just how valuable and important middle office capability has become for credit managers. 

As interest rates have climbed, so have the costs of floating rate debt structures, which have added to the workloads of credit middle offices, which have in turn had to keep track of agency notices, rate resets and margin changes. Covenant compliance and loan amendment negotiations have also increased in volume as financing costs have climbed, directing further demands into middle office in-trays. 

Managers and lenders that had been able to get through with lean middle office operations in bull-markets have had to reengineer middle office operations to keep up with the higher volumes of increasingly complex and important loan administration workloads. 

Middle office support

Instead of hiring in much larger middle office teams and locking up cash in capital expenditure to keep pace with rising middle office workloads, credit providers can take advantage of the technical and technological expertise of an outsourcing partner to put in place a middle office model that is flexible and scalable. 

Alter Domus, for example, has supported credit provider clients with comprehensive loan servicing and monitoring support for more than two decades, and has built up the specialized expertise and technology stack to cover the ever-intensifying technological and operational asks of middle-office credit teams.  

All aspects of loan servicing needs can be handled by Alter Domus across our middle office service offerings: 

• Our Loan Agency offerings via our Agency Services team allows us to serve in a variety of agency roles including named administrative agent, sub agent, successor agent, and more. In doing so, our teams handle jobs including counterparty communication, oversight of covenant compliance, and agency notices. 

• Our Loan Services offerings provide an array of coverage including loan accounting, loan servicing, trade settlements, and CLO services. This includes support for key structural elements such as the CLO overcollateralization test. Our teams are perfectly positioned to take care of complex, time-consuming day-to-day workflows that are essential to the life of a loan. 

• Our Loan Monitoring solutions provide digitized, normalized financial information from borrowers delivered to your monitoring solution of choice or our modern portal.  

Our middle office servicing relies heavily on our proprietary administration platforms CorTrade, Agency360, Solvas, and VBO to support clients across a broad suite of accounting, modelling, and credit risk solutions. Alter Domus’ tech platform covers all these tasks, and others, with an interface that can operate within a client’s portfolio management system and process a wide range of reporting, data, and internal accounting functions. 

When reviewing middle office infrastructure capability, it is also crucial for managers to ensure that the middle office links in to both the front and back office, and that teams in these three functions are not operating in siloes. 

Each team will often use different systems, technology platforms and servicing teams to execute their core functions, but it is important that all functions are integrated, and that there is a secure, accurate data trail that can be traced from the beginning to the end of the loan lifecycle. 

Our firm has leveraged our credit and technology expertise to help several credit providers build data bridges between the technology and software used in separate functions, and integrate data from preferred front-office, middle-office, and back-office platforms to ensure data veracity. 

Working with a partner like Alter Domus enables credit providers to focus on their core business of originating opportunities, assessing risk, and underwriting new financings, confident in the knowledge that they have the middle office support in place to manage loan servicing tasks to the highest industry standards. 

In what has been a challenging period for alternative investment managers, the private debt asset class has been a standout performer.

According to McKinsey, private debt generated stronger returns than all other private market asset classes in 2023 and was the most resilient for fundraising.

Rising interest rates benefited private debt firms, due to the floating rate structures that gains when base rates climb. This has driven ongoing investor demand for the strategy, proving its ability to deliver attractive risk-adjusted returns across the investment cycle.

The robust performance of private debt strategies through the recent period of market dislocation and uncertainty follows a period of remarkable growth for the asset class.

Private debt assets under management (AUM) have more than quadrupled during the last decade, according to Preqin figures, and currently stand at approximately US$1.6 trillion. And according to BlackRock, the private debt industry is well-positioned to sustain its growth trajectory. AUM forecast is set to reach US$3.5 trillion by the end of 2028 as borrowers continue to favor the bespoke and flexible financing structures offered by private debt managers, and investors, many of which are under-allocated to private debt, move to grow their exposure to the asset class.

Preparing for the next cycle of expansion

For private debt managers, the rapid increase in industry AUM has brought their franchises to an organizational tipping point.

Private debt firms are not only managing larger pools of capital for a more diverse, demanding investor base, but are also executing increasingly complex investment strategies that have expanded beyond bilateral, middle-market loans into big-ticket club deals and opportunistic purchases of debt tranches.

Unlocking capital from a global investor base and expanding deal pipelines into new areas have opened exciting opportunities for managers. However, capitalizing on these prospects will require private debt firms to upgrade their operational infrastructure to sustain their growth.

Managers have not only had to enhance their back-office fund accounting and investor reporting functions to serve an increasingly demanding and sophisticated investor base, but also their middle-office loan servicing and loan administration services to borrowers and the companies to which they lend.

The lean operations that supported private debt through its first phase of expansion will have to be upscaled to ensure that managers can maintain operational nimbleness, and the ability to measure performance while tracking risk, as transaction volumes rise.

Increasing middle and back-office capabilities do pose operational challenges for managers. Staff and technology costs ramp up, while the impacts of additional processes, sign-offs and internal bureaucracy can compromise the agility and responsiveness that have underpinned previous success and growth.

It has also become crucial for managers to establish seamless links between front-office dealmakers, middle-office, and client-facing teams that support borrowers, and back-office teams managing fund accounting and reporting.

Key areas for consideration

As private debt managers enter the next phase of the asset class’s evolution, there are three key questions that should be asked before embarking on an operational overhaul: 

1. Does integration exist through the front, middle, and back office?

While the oversight and investment management of a private debt fund does have similarities with other alternative asset classes such as private equity and real assets, there are specific deal structuring and fund accounting requirements that are unique to private debt. 

Loan structures, for example, will include multiple tranches, varying rates and payments of principals and interest. Managers must also be able to source and analyze data in markets where public information is less available than in syndicated loan and bond markets. 

The fund accounting required to track and report on private credit portfolios and investments is also vastly different from what is required in private equity portfolios, for example.

As managers expand, it is essential that their accounting and operating teams have the requisite experience to handle the specific demands of private debt fund accounting and reporting. 

It is equally important for private debt managers to have the middle-office capabilities to take loan agency responsibilities, such as for individual investments, handle all trade settlements and interest rate payments, and to administer borrowing bases. 

2. Outsourcing or in-house? 

Managers must decide if it is best to outsource both back- and middle-office functions as their operations grow or invest in building additional infrastructure in-house.

Keeping operations in-house gives managers direct control of loan operations, fund accounting, and data, which has its advantages, but does come with high upfront costs and makes it more difficult to scale up back-office resources in the future.

Outsourcing to a third-party provider allows managers to benefit from the global reach and extensive industry expertise of fund administration specialists. It is also important to factor in that when a manager ramps up the size of internal teams, the GP bears those costs. In contrast, when outsourcing, the costs of administration are covered by the fund.

If managers do choose to go down the outsourcing route, it is crucial to have clarity on what infrastructure and technology will have to be retained internally to oversee, engage, and interact with a third-party fund administrator.

Managers must also be clear on the scope of work that a loan servicer and fund administrator can handle. Not all partner firms, for example, can deliver portfolio accounting via their loan administration systems.
Managers should be clear on exactly what support they require and whether the administrator can meet that request.

3. How will data challenges be addressed? 

Data management poses distinctive challenges in a private debt context, as different teams within a firm have different technology and data requirements.

Investor relations teams, for example, want to access performance data to report to LPs, while operations teams prioritize the data requirements of investment professionals and fund accountants want to ensure that books are up to date.

This has seen the asset class move away from single systems, which aim to cover the full loan cycle and serve as a “single source of truth,” to a model where there is an interlinking patchwork of technology platforms and servicing teams.

As data linkages between different operations and teams grow in importance, the middle and back office must become more fluid and integrated.

Ensuring that the data linkages between these teams and their respective technology tools are fully integrated and seamless is complex and impacts how back-office and mid-office functions are structured.

Whether outsourcing or keeping operations in-house, firms must ensure that operating models are structured in a way that aligns the back office and middle office teams and helps to facilitate the “front-to-back” integration required to support multiple complex front office investment management tasks.

Curating an operating infrastructure that covers these priorities and meets the specific demands of each individual private debt manager lays a firm foundation for building a scalable operational model that can grow with a private debt platform. 

The value of a supportive loan servicing and fund administration partner

Transforming an operating model is demanding and can distract managers from their core front office investment management priorities. 

Working with an experienced servicing partner and tech provider like Alter Domus, which has extensive asset class experience, a clear understanding of how private debt managers work, and insight into the key operational priorities they are seeking to address as their organizations grow, eases implementation and ensures that managers are putting the right structures in place. 

We have the resources and expertise to help private debt managers take their operating models to the next level by streamlining processes and harnessing technology, and have supported clients’ operational requirements in the following ways: 

1. Provision of a full suite of services

Alter Domus provides an end-to-end service to private debt managers that covers every operational requirement, including loan administration, portfolio accounting, loan agency, loan servicing, and fund administration, as well as full data integration across these functions. 

2. Technology expertise 

Alter Domus has successfully implemented proprietary technology to support all its services. Alter Domus’s Solvas platform, for example, integrates accounting, modelling, and credit risk solutions to serve as our proprietary loan administration system. 

This means Alter Domus can integrate data and operate within a client’s portfolio management system, providing regular reporting and data feeds that allow clients to update their internal accounting systems.  

3. Data integration 

Alter Domus’s technology expertise means it can also support private debt managers with the design of technology stacks and operating models that support data integration. 

We can help clients to connect the various preferred technology tools of their teams and facilitate the fluid movement of accurate data between different teams and across different technology platforms. This ensures that there is a golden copy of all data throughout the full loan and fund lifecycle. 

Partnering with a firm like Alter Domus can help private debt managers to re-energize their focus on strategic growth and ensure that their support structures are agile and fit for purpose in a private debt asset class that continues to grow, develop, and become more competitive.

There are many benefits for asset managers when partnering with a service provider for a lift-out back-office solution, including gaining access to cutting-edge tech solutions, keeping pace with regulatory reporting demands, and providing their back-office employees with meaningful career paths and training in a larger organization closely aligned to their skillset.

Among the most crucial success factors in such a partnership is ensuring a continuation and improvement in back-office support, and retaining the expertise and experience of back-office teams as they are integrated to a service provider.

A welcoming new home for back-office teams

With a strong track record in successfully delivering lift-out solutions, Alter Domus has already become home to hundreds of employees who have joined the organization via lift-outs and strategic partnerships.

As Joanne describes it, “We are always excited and enthusiastic about welcoming new faces to Alter Domus. We understand that every career is precious, and that initially teams may be apprehensive about such a change in their working lives. Our approach centers around building trust and strong relationships through multiple in-person touchpoints at both a team and individual level to ensure transferring employees feel engaged and connected throughout the process.“

“Another key element of our approach is listening and engaging – what are people’s concerns or questions, what are their goals and ambitions, what would they like to see in their new environment – and adapting our approach based on the feedback we receive, and a deep understanding of their needs.”

We are proactive, responsive, and transparent with all of our customer’s teams who are involved in the project. It is critical to stay very connected with the customer, the team experiencing the lift-out, and the multi-disciplinary Alter Domus team managing the change. From a people perspective, we have two short-term priorities – ensuring impacted teams are supported, and the co-ordination and execution of integration to our systems, policies, payroll and other processes.

Joanne Ferris
Chief Human Resources Officer

Best in-class integration

As mentioned by Joanne, Alter Domus engage dedicated resources across multi-disciplinary functions to ensure a smooth start for new team members. This can include introducing teams to a possible new leader, a potential new workplace, new operating systems and tech, and integration to AD’s payroll, performance cycle, and other people processes.

Employees joining Alter Domus through a lift-out enjoy access to the Alter Domus onboarding app, individualized onboarding packs, as well as invitations to interactive info sessions on systems and processes, career pathing and performance at AD, the Alter Domus Academy and more.

At the same time, teams are introduced to the culture and ways of working at Alter Domus: “We meet teams on a regular basis before, during, and after the lift-out process, and showing who we are – our culture, our values as an organization, and how we work together – is something that we do every step of the way,” says Joanne. “We say that Alter Domus is a ‘second home’ for our clients, and AD is also a place where people feel they can grow and develop their careers when they join us.”

When teams join Alter Domus, they also take part in AD’s monthly engagement surveys from their first month. “Our engagement surveys are a key tool for AD leaders, allowing us to measure and proactively address employee sentiment,” says Joanne. “For teams joining via lift-outs, these are a vital metric for our leaders and project team. Most importantly, this can be a catalyst for great conversations within the team, and generate changes to how we do things.”

Providing a platform for growth

Moving from a back-office team to working within the core business of a service provider also brings benefits and opportunities for new joiners in a lift-out scenario. With a clear focus on best-in-class technology solutions and providing impactful learning and development opportunities through the award-winning AD Academy, Alter Domus provides team members with the resources and support to grow and develop their expertise and professional careers.

“We are proud of the opportunities we provide our people – professional qualification support as an ACCA accredited employer, LinkedIn Learning, internal mobility, and in-house specialized training from the AD Academy – and how these can benefit both new teams and our clients is part of our long-term success in lift-outs and partnerships,” says Joanne.

Measuring long-term success

As a high-performing metrics-driven organization, the initial focus is on ensuring the “hardwiring” – systems, processes, policies, hardware integration and workplace set-up – is complete. At the same time and beyond the initial stages, the teams will move on to more long-term metrics covering efficiency, performance, client satisfaction, and employee engagement.

For Joanne, another key metric is how new team members embrace the opportunity to grow and develop with us: “At Alter Domus, our success is built on the success of our people. Many of the people who have joined us via lift-outs have gone on to progress to more senior levels at Alter Domus, and this is the ultimate testament that our approach works for both our clients and for the new teams we welcome to Alter Domus.”