Direct lending strategies can provide benefits to both investors and underlying businesses.
The growth in direct lending strategies stems from an opportunity and a need.
The opportunity arises from the retreat of commercial banks from lending to small and medium enterprises (SMEs). This has been caused by the more stringent capital requirements placed on banks in the wake of the 2008 financial crisis and by Basel III. Many SMEs now find it harder to obtain credit, for example, to invest in vital infrastructure improvements.
Direct lending strategies are gaining ground all over the world. Many managers of direct lending strategies tend to focus on specific sectors and / or geographies. This is largely because direct lending strategies are the province of fund managers who understand their markets intimately, who they are lending to and the value of the assets direct lending strategies are secured against.
How can this level of insight be achieved? Typically investment funds that make use of direct lending strategies will own one or more financing companies that can provide loans to the end clients. These financing companies will manage the loan portfolio and oversee the clients and the risks. Direct lending strategies will typically require that such financing companies are managed by experienced professionals, often with a background in commercial banking and finance, and in the UK they will be subject to additional consumer credit regulations.
While generating returns for their end clients is important, direct lending strategies play an vital role in linking pools of investment capital with areas of the economy where financing is needed. As banks close their branches and cut their commercial loan books to the bone, it is direct lending strategies that are engaging with SMEs and helping them to achieve their financial objectives. Governments around the world are recognising the crucial part that direct lending strategies stand to play in future economic growth.
Direct lending strategies require that the finance companies which are owned by the fund are fully engaged with their clients and their loan portfolios. On-site inspections and regular visits are part of the process of managing the risks effectively. Frequently, direct lending strategies will be focused on asset backed loans where the loan will be secured against assets such as land.
While not strictly hedge funds or private equity funds, direct lending strategies have become an accepted part of the alternative investment mix of institutional portfolios.