Capital raising that targets direct lending funds has increased by 62% since January 2020 as asset managers attempt to make up for lost ground amid the COVID-19 pandemic. Capital targeting distressed strategies has more than doubled.

Funds with direct lending investment mandates were targeting $150.3 billion as of Jan. 25, with 266 funds in the market, compared to targeted capital of $93 billion across 204 funds as of January 2020, according to data from Preqin.

This resurgence comes after a dampened year for direct lending fundraising in 2020 as COVID-19 disrupted global economies. In 2020, 82 direct lending funds closed globally, raising a total of $50 billion, down from 95 direct lending funds that closed in 2019, raising $74 billion, the record year for aggregate capital raised.

By number of funds, 2017 was the record year, with 100 direct lending funds closed.

After the disruption of 2020, it is easy to see why fundraising teams are eager to get back to work. So why direct lending now? The search for yield is once again the reason for the year-over-year increase in fundraising for direct lending, as investors turn to the asset class for more attractive yields than other fixed income asset classes can offer, as pandemic-era monetary stimulus has pushed global interest rates lower, market sources say.

In addition, investors now have the experience of direct lending's returns and default picture during the pandemic-induced market collapse as a potential selling point for the asset class's durability, potentially generating further interest, sources say.

Timing is another factor. Some institutional investors had resisted investing in direct lending in 2018 and 2019 on the correct expectation that the end of the longest-running credit cycle was imminent, market sources say. That wait may prove to be a good choice, as in all likelihood the recent crop of fundraising efforts are set to invest in a more attractive vintage of deals.

Preqin defines direct lending as the practice of nonbank lenders extending loans to small and medium-sized businesses in return for debt securities rather than equity.

It is no surprise that fundraising for distressed debt has increased even more sharply than for direct lending, with unprecedented pandemic shutdowns devastating entire industries. Fundraising that targets distressed strategies has more than doubled year over year to $64.2 billion across 66 funds as of Jan. 25, 2021, versus $25.8 billion across 45 funds a year earlier.

Funds targeting special situations proliferated in 2020. The number of special situations funds in market has jumped to 81, targeting $34.7 billion in capital, versus 58 funds, with $32.8 billion in capital.

In a 2021 overview on global credit, BlackRock said a low interest rate environment has led investors to incorporate increased allocations to public and private credit.

"Demand in direct lending strategies continues to grow as investors are looking to capture illiquidity premiums with a focus on higher underwriting standards, established due diligence capabilities, and robust sourcing networks to see a wide range of deals and remain selective on participation," said the report titled "Stay nimble and carry on."

"Distressed and special situations strategies are seeing greater interest as well where structure and capital requirements don’t align with traditional public or direct lending strategies," the BlackRock report said.

Whatever the reason, the result is intensified competition for investor dollars.

On the positive side for fundraising efforts, investors are expected to allocate more to alternative assets. Some 58% of investors say they expect to invest a larger share of assets to private debt by 2025, a survey by Preqin published in November said.

Most market participants agree that larger platforms have experienced greater success in fundraising than smaller ones. First-time funds have struggled as institutional investors allocate capital with asset managers with whom they have had long-term relationships. The near impossibility of in-person meetings and travel due to pandemic restrictions has further diminished hopes for market newcomers, sources say.

Improved economic prospects for borrower companies over the course of the year, as evidenced by third-quarter earnings by private credit providers, has also contributed to positive sentiment for the direct lending broadly. This is despite expectations that more defaults and restructurings among private loans are likely to emerge in the coming quarters.

In one measure of credit distress, market participants see the average default rate of the S&P/LSTA Leveraged Loan Index ending 2021 at 4.76%, up from 3.89% in December 2020, an LCD survey showed.

Private debt is a larger umbrella term for "private equity-structured vehicles that primarily trade in debt and credit instruments." It includes direct lending, mezzanine, distressed, special situations and venture debt funds, according to Preqin's definition.

Recent fundraising news reported by LCD

Blackstone Private Credit Fund, the asset manager's nonlisted business development company structured to target retail investors, has raised an initial $814 million, or about $1.8 billion of investable capital, including leverage.

Alcentra closed its Strategic Credit Fund II at €557 million, lifting assets under management for the firm's Special Situations platform to over €1.5 billion. At the time of the December close, the fund had deployed over €200 million in more than 20 investments sourced from both the primary and secondary markets in European leveraged loans and high-yield bonds, focusing on senior debt.

PGIM Private Capital, the private capital arm of Prudential Financial Inc.'s investment management business, exceeded a fundraising target for PGIM Capital Partners VI LP, closing the fund in December 2020 at $2.23 billion. PGIM Capital Partners VI will pursue middle market financing opportunities primarily in North America and Europe.

Kennedy Lewis Investment Management has closed a credit fund with $2.1 billion of capital commitments, exceeding a $1 billion target. Kennedy Lewis Capital Partners Master Fund II LP will invest in event-driven and opportunistic credit, both performing and distressed, to middle-market North American and European companies.

Varde Credit Partners LP closed a distressed credit fund in November with $1.6 billion in commitments, exceeding a $1 billion target. The Värde Dislocation Fund will focus on market dislocations and economic disruption related to the COVID-19 pandemic.

Chicago-based private equity firm Thoma Bravo LLC has completed fundraising for three vehicles, pulling in a total of more than $22.8 billion. Thoma Bravo Fund XIV LP received $17.8 billion of commitments for large equity investments. Middle-market fund Thoma Bravo Discover Fund III LP and lower-middle-market fund Thoma Bravo Explore Fund LP raised $3.9 billion and $1.1 billion, respectively.