(Bloomberg) -- Chile’s private debt market has boomed for almost a decade, but far from exhausting its growth potential, the industry is set to get a new boost over the next year.

Assets under management in 174 private debt funds rose to to $6.8 billion in the second quarter from $6.2 billion in 2022 and just $2.6 billion in 2018, according to data from ACAFI, the Chilean Association of Investment Funds Administration.

The industry is stepping into a gap left by tightly regulated banks and other lenders for loans to small and middle—sized companies, as well as shaking up the market for mortgages, car loans and short-term and invoice debt. From the investor side, it has offered market beating returns at a time when local shares have failed to keep pace with inflation for much of the last five years, while bond yields weakened. Now pension funds are looking to get a bigger slice of the market and yields elsewhere are declining, fueling growth in the industry.

“As rates fall even more and the political and economic environment improves, investors will take on more risk, such as greater credit risk,” said Jose Miguel Correa, head of private debt at BTG Pactual Chile.

Private debt funds can offer annual returns of 9% to 10% after fees in “normal scenarios,” said Alfredo Harz, the head of investments at Sartor Finance Group. Jose Correa Achurra, CEO of Activa Private Debt added that, in the past few years, they have made annually between 300 to 500 basis points over what a public debt instrument with a similar duration could yield, he said.

Pension Funds

The private lending funds are fulfilling a fundamental role in the economy, said Harz. 

“Banks have been subject to significant regulatory and credit demands, leaving the small and medium-sized business segment relatively unattended,” he said. “That prompted a large number of companies, which could no longer turn to banks or lacked the size to issue bonds, to seek other private financing mechanisms.” 

And the industry is set to receive a new driving force over the next few years from Chile’s vast pension funds.

The pension system had $192 billion in assets at the end of the second quarter of 2023, $109 billion of which were local assets. Of those local investments, only 1.7% were invested in alternative assets, including private credit. That percentage is up from 0.8% at the end of 2019.

Now, the industry regulator has requested the central bank increase the limits on alternative assets as the industry struggles to generate the returns on savings required to make decent retirement payments. The limit currently ranges from 5% for the most conservative funds to 13% for the riskiest, high-return ones, according to the industry regulator.

Private debt funds tracked by the ACAFI are composed of direct financing for housing, real estate, automotives and machinery, invoices and short-term debt and others. The greatest growth in funds was seen in those for short-term and invoice debt, which has growth 14% since 2022 reaching $1.2 billion in the second quarter of this year, followed by housing with a growth of 13% to $1.6 billion.

Activa’s Correa sees room for growth in the local real estate and housing sectors of private debt as it has become harder to get a mortgage loan and bank financing is limited. 

“Banks today are very cautious in the real estate sector, and we believe there is an opportunity there,” he said. 

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