An influx of cash into the middle market in recent months has eroded returns to those investors lending to small and mid-sized businesses, dampening one of the routes institutional investors have turned to in the hope of finding additional return in a low-interest rate environment. Investors' hunt-for-yield has fuelled the rise of private credit, leading pension funds, endowments and other institutional investors to add allocations of the debt to their portfolio. But growing volumes and competition are driving down the yield benefit that had made investing in private credit attractive in the first place. The average first-lien credit spread on direct lending deals, one of the contributors to middle market loan yields, has decreased. After the pandemic popped the average spread to a high of 593bp over Libor in the second quarter of 2020, they have since decreased to 547bp over Libor in the first and second quarter of this year.
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