The cost of private debt funds is tumbling as direct lending strategies become more popular.
Debt funds raising money this year have charged an average management fee of 1.52 percent, a decade low that’s down from 1.76 percent in 2016, and as high as 2.07 percent in 2013, according to a report Tuesday from Preqin. Such investment pools are now cheaper than buyout funds, a switch from four years ago.
The falling fees come as private debt funds proliferate, with a record 324 funds seeking capital in November, a 12 percent increase from the beginning of the year, according to Preqin. Nearly half of these funds employed direct lending strategies, a trend seen as driving this year’s fee compression.
“The debt type typically draws lower fee rates than other, more labor-intensive fund types, and the proliferation of direct lending funds coming to market has increased competition and driven fund managers to lower their fees to distinguish themselves from their competitors,” said Ryan Flanders, Preqin’s head of private debt products, in a company statement. “Management fees for private debt funds now sit far below the rates seen in their private equity counterparts.”
Buyout funds have charged average management fees of 1.94 percent this year, little changed from 2 percent in 2007, according to a Preqin report in July. The cost was 1.91 percent in 2013.
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Direct lending funds closed between 2008 and 2017 had management fees of 1.57 percent on average. For other private debt strategies, funds started during the same period had average management fees above 1.8 percent. Venture debt funds, which Preqin categorized as having a labor-intensive investment process, were by far the most expensive, typically charging 2.3 percent.
Management fees will likely contract in the near term, as “competition for institutional capital remains high among lenders of similar strategies,” Preqin said. Private debt funds raised $65 billion this year through the third quarter, after attracting a record $55 billion in the fourth quarter, according to the financial data provider.
“Fund managers which specialize in niche areas, or fund managers with a strong performance track record, are more able to resist downward fee pressure and to preserve higher rates while still attracting investor capital,” said Flanders.