Sitting down with Alternative Credit Investor, Ares’ Felix Zhang and Sonya Lee discuss the blockbuster Pathfinder III fundraise, and deploying capital in the ever-expanding, increasingly competitive asset-backed finance market…

In June, $644bn (£480bn) alternatives firm Ares Management raised $8.5bn for its Pathfinder III fund, marking the fastest fundraise in the history of its alternative credit business. Yet, as competition intensifies across the asset class and capital becomes increasingly concentrated in certain segments of the market, the manager’s focus is now shifting from fundraising to deployment.

Overall, Ares raised $12.7bn of investor capital to be deployed into ABF at the fund’s final close. This figure was inclusive of the $8.5bn of limited partner commitments and $4bn from investors reinvesting capital from the previous Pathfinder vintage for an additional two years.

The fundraising process was “fast and furious”, Sonya Lee, partner and head of product management and investor relations, alternative credit at Ares, tells ACI. The fund is also the “largest global asset-backed finance (ABF) fund in the market today”.

The fundraising reflects the broader emergence of ABF, which has been touted as one of the biggest growth engines for private credit in recent years, with the asset class expected to account for 29 per cent of assets under management in private credit portfolios by 2029.

That growth is prompting pension funds and insurance companies that have traditionally invested in direct lending to turn their heads towards ABF. According to Ares, many Pathfinder III investors already had exposure to direct lending, although the fund also attracted new entrants to the private credit asset class.

Read more: The next frontier in ABF: A $20tn opportunity and the challenge of scale

Battling competition

However, the rapid growth of ABF is also drawing more managers into the market, increasing competition for assets and putting pressure on spreads.

While acknowledging that competition is increasing, Felix Zhang, partner, alternative credit at Ares, argues that this is unlikely to be a challenge for the firm as it looks to deploy Pathfinder III.

At its current scale, the firm has few direct competitors spanning all of its markets, as many managers focus on individual asset classes, while Ares employs a relative value approach across segments, he explains.

“The market opportunity is so large, and the addressable market so vast, that despite the growth in ABF fundraising, there is still relatively little scaled competition across most asset classes,” Zhang tells ACI.

He acknowledges that transactions below $100m typically attract between 10 and 15 term sheets chasing the same deal. However, due to the capital Ares has raised, “with transactions around $500m or $1bn, there are only a handful of managers that are able to provide capital solutions on that scale”.

In terms of deployment, Zhang says the key areas where Ares expects to invest Pathfinder III include sectors with dramatic capital needs, such as fund finance, infrastructure and the capex cycle.

However, Ares believes the most compelling opportunities within ABF lie in the non-investment grade market. Historically, most of the capital raised for ABF has come from insurance investors, whose investment mandates are dependent on ratings and restricted to certain types of assets.

This, Zhang says, is where capital concentration is emerging, and why Pathfinder III is expected to be invested entirely outside the insurance market.

“Many of the large insurance capital pools are all doing the same thing, and it becomes a race to the bottom in terms of spreads,” says Zhang. “That creates an opening for the flexibility of non-insurance capital to fill the void in areas where insurance capital is not looking.”

He adds that the types of transactions being sourced for Pathfinder III differ markedly from previous vintages.

“The level of conversations we are having as well as the types of deals we are sourcing are different from Pathfinder I or II. The average deal size historically was $50 to $100m, today it is $100m to $300m,” Zhang says.

Overall, despite ABF becoming one of the most sought-after areas of private credit, Zhang argues that the opportunity set remains far from saturated, with every newly originated asset creating an additional financing requirement, “leaving significant white space for deployment”.

Read more: Ares replaces head of infrastructure debt