Providing firms with capital to finance leveraged buyouts, recapitalizations, refinancing, acquisitions and growth activities, mezzanine debt has long been the private debt vehicle of choice for many investors looking for an alternative to traditional credit market offerings. Although the investment vehicle is of relatively lower risk and produces a higher yield compared to more senior credit investments, its prominence as of recent years seems to be waning. Activity within mezzanine debt peaked in 2008 when $29bn was raised across 43 funds. Since that time, fundraising has declined relative to other areas of private debt, as seen in the 2015 Preqin Global Private Debt Report.
Over 2014, mezzanine funds raised aggregate capital of $8.6bn. This total comes in behind those of direct lending and distressed debt vehicles, which raised $29bn and $17bn respectively. The growth witnessed in direct lending, specifically unitranche financing, is one likely catalyst for the decline of mezzanine fundraising totals in 2014.
As of Q1 2015, MezzVest, the mezzanine investment arm of CapVest Capital Partners, is targeting a €100mn direct lending fund investing in senior, unitranche, payment-in-kind and second lien loans. In recent months, Preqin has witnessed several fund managers in the mezzanine space expanding into other areas of the capital structure.
Strategic moves by investors reacting to the markets have also been noticed during this market shift. Investors surveyed by Preqin in Q1 2015 conveyed a strong preference for direct lending and special situations vehicles, with 62% and 50% of investors indicating a preference for these strategies respectively, followed by mezzanine (30%) and distressed debt (28%). The average size of mezzanine funds decreased between 2012 and 2014 from $503mn to $342mn.
The decline in mezzanine debt fund size may indicate that fund managers are focusing on fewer deals than in the past, combining debt and equity components to capture suitable returns. Though the number of funds and aggregate capital raised are trending lower, there is still a substantial amount of investment in the space, as 68% of mezzanine funds in 2014 closed at or above their fundraising targets. In Q1 2015, Goldman Sachs Merchant Banking Division successfully closed their GS Mezzanine Partners VI fund, raising $8bn to invest in mezzanine opportunities, a sizable play in a seemingly tightening space.
Given both the decreased number and average size of funds along with a mixed sentiment from investors targeting the credit structure, the future of mezzanine funds is uncertain. Though figures show that capital could be redirected into other private credit strategies in 2015, there is still a serviceable market for mezzanine funding, though pressure for fund managers to reach further across the capital structure is clear.