Middle Market Direct Lending

Benefits of Pursuing Both Sponsored and Non-Sponsored Transactions

Middle market direct lending, embraced by institutional investors, has developed into a mature asset class over the last two decades. The strategy has many attractive attributes: the potential for strong risk-adjusted returns, current income payout, lower volatility compared to other fixed income alternatives, and less correlation to traditional asset classes. With the proliferation of investors allocating capital to the space, it is imperative to recognize that not all direct lending managers are the same.

Direct lending transactions can generally be defined as falling into one of two categories: sponsored and nonsponsored. This is a crucial distinction. Both origination methods can positively benefit portfolio diversification and economic returns. Each has distinct characteristics, and we intend to highlight the dynamics and considerations of each in this article.

Key Takeaways

  • We believe it is important for investors to understand the differences between sponsored and non-sponsored direct lending approaches.
  • There are advantages and disadvantages to both. As a lender, we think it’s wise to pursue both approaches. Both can positively benefit portfolio diversification and economic returns.
  • To successfully pursue both sponsored and non-sponsored direct lending strategies, a manager should have robust underwriting capabilities, flexibility, appropriate scale and bespoke sourcing capabilities.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Stocks tend to fluctuate dramatically over the short term. Bond prices generally move in the opposite direction of interest rates. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Investing in private companies involves a number of significant risks, including that they: may have limited financial resources and may be unable to meet their obligations under their debt securities, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of realizing any guarantees that may have obtained in connection with the investment; have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns; are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on the portfolio company and, in turn, on the investment; generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.

Views expressed are those of Franklin Templeton and BSP. The information provided herein is provided for informational purposes only and is not, and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any fund or investment vehicle (each, a “Fund”) managed by Franklin Templeton or BSP. A private offering of interests in a Fund will only be made pursuant to such Fund’s offering documents (the “Offering Documents”), which will be furnished to qualified investors on a confidential basis at their request for their consideration in connection with such offering. Investors should have the financial ability and willingness to accept the risk characteristics of a Fund’s investments.