A Survey of Private Debt Funds

After banking regulation was tightened following the major financial crisis, there was an exodus of corporate loans from the banking sector. As a result, companies had to look for new, alternative sources of financing. Private debt is one of the most important types of alternative financing options. It is a financing method where debt capital is raised thru closed-end funds and directly lent to companies. Despite its explosive growth in recent decades, the private debt market is still under-researched.

In the jointly published research paper "A Survey of Private Debt Funds" with Prof. Dr. Jörn Block from the University of Trier and Prof. Dr. Steven Kaplan and Young Soo Jang from the Chicago Booth Business School, we surveyed 191 private debt managers from Europe and the USA who manage approximately 35% of the total assets under management for private debt. We examined both US and European funds, as they represent the largest private debt segments and operate in different regulatory and economic environments. We asked the managers many exciting questions: What are private debt funds and what do they do? What do they invest in? How do they compare to banks and CLOs? What is their relationship with PE funds and how do they interact with them? Additionally, we have outlined the differences between the private debt market in Europe and the USA.

Among other things, we have found that private debt funds primarily provide cash flow-based loans to companies that would not be financed by banks. They seek high returns relative to their risk, use less leverage than banks and CLOs, and monitor their investments thru financial and negative covenants. The presence of PE sponsors helps them to allocate loans more efficiently. US and European funds are similar in many ways, but European funds are less reliant on private equity sponsors and compete more with banks.

Since the private debt market is much less regulated than the banking sector, it is important to understand the characteristics and developments of private debt in detail. Our paper provides important insights on this. Private debt funds constitute a significant part of the financial system. They can have potential impacts on financial stability and monetary policy. Our paper provides important insights into the selection, evaluation, assessment, and monitoring of private debt deals, the behavior of private debt during times of crisis, and a comparison between banks and private debt funds. These insights can help investors and private debt fund managers make better decisions. Additionally, they are important for central banks and other policymakers.

Real Estate Investment Trusts: Regulation and Capital Structure

The paper deals with REITs, their capital structure, and the impacts on debt that could have regulatory requirements. The data used comes from a combination of Thomson Reuters data with manually collected data on REIT status and regulatory information. Overall, the debt of REITs in 20 countries from 2007 to 2018 is analyzed. Country-specific data, manually extracted from the annual EPRA reports, are merged with company data to analyze the impact of various REIT restrictions on a company's debt levels.

The observation of statistically significant differences in the mean levels of debt between NON-REITs and REITs leads to further investigations. My results show that variables beyond traditional capital structure determinants influence the debt levels of REITs. It can be observed that explicit debt restrictions and the level of profit distribution ratios have a significant impact on debt decisions. This supports the view that the restrictions from the EPRA reports are mandatory. Various combinations of regulatory variables, which show significant effects on indebtedness both in isolation and in combination, are being tested.

The main finding is as follows: Companies operating under a regulation that prescribes a maximum debt-to-equity ratio, in addition to mandatory high dividend payouts, have, on average, lower debt-to-equity ratios. Furthermore, the presence of sanctions for non-compliance with regulatory requirements has a negative effect on the leverage ratios of REITs, indicating that the regulation is binding. The analysis clearly shows that traditional capital structure determinants are of secondary importance. This relationship underscores the impacts on debt and financing decisions caused by regulation. These effects are supported by further analyzes. Results based on an event study show that REITs, statistically speaking, have lower debt ratios compared to NON-REITs. Based on a structural break model, the following effect becomes clear: REITs increase their debt ratios in the years leading up to REIT status. As a consequence, the ex-ante period is characterized by a bunker and adjustment process. In the event, the transformation into REIT status follows. Using an event study and a structural break model, the analysis highlights the dominance of country-specific regulation.

The employes of Faculty IV congratulate Dennis Umland on receiving the Joseph A. Schumpeter Prize 2022 for the research paper "Currency Returns and FX Dealer Balance Sheets."

Summary:

The submitted article demonstrates that the high average returns on speculative carry trade strategies, where money is borrowed in low-interest markets and then invested in high-interest markets, can be understood as a risk compensation for the balance sheet risks of currency traders.
It is empirically shown using traditional asset pricing methods that carry trade strategies generate particularly poor returns during times when currency traders are only weakly capitalized, meaning they have an equity ratio close to the minimum requirement. Therefore, carry trades must be traded at a higher average return so that currency traders are willing to take on these capital risks. The study further shows that these capital risks are almost entirely borne by the three most active currency traders.
The results of the study are particularly relevant for banking supervision, which oversees compliance with minimum capital ratios among financial intermediaries and could influence them. The article shows that the required capital ratios introduced with the aim of increasing financial market stability at least increase a capital risk relevant to financial intermediaries, and that they take this into account in their decision-making behavior. The observed concentration of these capital risks on the most active traders could also be of significance for microprudential supervision.
In addition to the direct consequences for banking supervision, the article is relevant for central banks due to its contribution to general price formation in currency markets.
Previous macroeconomic models, as well as approaches to exchange rate determination based on interest and purchasing power parity, have not been empirically convincing in the scientific literature. The empirical refutation of uncovered interest parity, which postulates that exchange rate changes should, on average, correspond to the interest differentials of the two involved currencies, is well known. The submitted contribution explains this by unaccounted capital risks, which prevent intermediaries from capitalizing on the expected profit opportunities, thereby preventing parity. Consequently, while interest differentials can be an important factor in exchange rate determination, their effect cannot be directly measured due to the overlaying risk premiums.

The employes of Faculty IV congratulate Felix Haase on receiving the Joseph A. Schumpeter Prize 2022 for the research paper "Predictability of bull and bear markets: A new look at forecasting stock market regimes (and returns) in the US."

Summary:

Alternating phases of expansion and recession are not only characteristic of the economic cycle of a country but also of financial markets. A division into financial market regimes allows researchers and market participants to examine more homogeneous and stable causal relationships. The question of which regime we are currently in can only be reliably answered in hindsight. In the research paper co-published with Prof. Dr. Matthias Neuenkirch, "Predictability of bull and bear markets: A new look at forecasting stock market regimes (and returns) in the US," we address the challenge of identifying regimes in financial markets in real-time and predicting possible regime shifts. For this purpose, we combine three promising methods from empirical capital market research, which aim to reduce both model uncertainty and the instability of model parameters.

Our approach was able to timely and profitably identify regime transitions in the US stock market. Particularly non-linear models and an efficient aggregation of a multitude of macroeconomic and market-specific variables proved to be helpful tools for capturing regime dynamics. In line with previous findings, predictability of returns could only be demonstrated during recessions and turbulent market phases. Our results thus indicate that fluctuations in information efficiency in stock markets are not just a temporary phenomenon, but can also be transferred to medium-term trends. These findings are not only useful for investors but can also help central banks and governments to identify systemic risks in financial markets at an early stage.

Alternating phases of expansion and recession are not only characteristic of the economic cycle of a country but also of financial markets. A division into financial market regimes allows researchers and market participants to examine more homogeneous and stable relationships. The question of which regime we are currently in can only be reliably answered in hindsight. In the research paper co-published with Prof. Dr. Matthias Neuenkirch, "Predictability of bull and bear markets: A new look at forecasting stock market regimes (and returns) in the US," we address the challenge of identifying regimes in financial markets in real-time and predicting possible regime shifts. For this purpose, we combine three promising methods from empirical capital market research, which aim to reduce both model uncertainty and the instability of model parameters.

Our approach was able to timely and profitably identify regime transitions in the US stock market. Particularly non-linear models and an efficient aggregation of a multitude of macroeconomic and market-specific variables proved to be helpful tools for capturing regime dynamics. In line with previous findings, predictability of returns could only be demonstrated during recessions and turbulent market phases. Our results thus indicate that fluctuations in information efficiency in stock markets are not just a temporary phenomenon, but can also be transferred to medium-term trends. These findings are not only useful for investors but can also help central banks and governments to identify systemic risks in financial markets at an early stage.

Matthias Scherf, MSc, research associate at the Chair of Banking and Finance, has been awarded this year's Joseph A. Schumpeter Prize. He receives the award for his research paper titled "Stock market reactions to COVID-19 lockdown: A global analysis."

The award ceremony traditionally takes place as part of the graduation ceremony of Department IV, which, due to COVID-19, also had to be canceled this year. "I am pleased that the selection jury, chaired by Prof. Lazlo Goerke, has once again awarded the prize to a young colleague who has contributed to scientific knowledge with great commitment and dedication," said the then Dean of FB IV, Prof. Ludwig von Auer.

Arina Wischnewsky, M.Sc., receives the award for her research paper titled "Shadow Banks and the Risk-taking Channel of Monetary Policy Transmission in the Euro Area." For her contribution, the young scientist receives a prize of 2,000 euros.

Dr. Marc-Patrick Adolph, former employe in the field of Economics, receives the award for his research contribution "Structured Eurobonds – Optimal Construction, Impact on the Euro and the Influence of Interest Rates." The young researcher receives a prize of 2,000 euros for this.