Preqin Ltd. 2018 / preqin2 SHIFTING GEARS: INVESTORS HEAD TOWARD THE US LOWER MIDDLE MARKET ABOUTF ollowing Preqin and NXT Capital’s report Growing Interest in the Lower Middle Market in 2017, this year’s report, Shifting Gears,revisits attitudes towards, and appetite for, the US lower middle market* among the institutional investor community 12 months on. The results of the survey conducted in Spring 2018, coupled with Preqin’s market-leading data on the private debt industry, show thatlower-middle-market direct lending in the US is increasingly at the forefront of investors’ minds due to the market’s perceived resilienceto cycle change and attractive risk/return profle.Preqin Contributors: Tom Carr | Douglas Paolillo NXT Capital Contributors: Robert Radway All rights reserved. The entire contents of Preqin Special Report: Shifting Gears: Investors Head toward the US Lower Middle Market, June 2018 are the Copyright of Preqin Ltd. No part of this publication or any information contained in it may be copied, transmitted by any electronic means, or stored in any electronic or other data storage medium, or printed or published in any document, report or publication, without the express prior written approval of Preqin Ltd. The information presented in Preqin Special Report: Shifting Gears:Investors Head toward the US Lower Middle Market, June 2018 is for information purposes only and does not constitute and should not be construed as a solicitation or other ofer, or recommendation to acquire or dispose of any investment or to engage in any other transaction, or as advice of any nature whatsoever. 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Although every reasonable efort has been made to ensure the accuracy of this publication Preqin Ltd. does not accept any responsibility for any errors or omissions within Preqin Special Report: Shifting Gears: Investors Head toward the US Lower Middle Market, June 2018 or for any expense or other loss alleged to have arisen in any way with a reader’s use of this publication. *The lower middle market is defned by NXT Capital as companies with sub-$50mn in EBITDA and/or typical transaction sizes between $30mn and $150mn.ABOUT PREQIN Preqin is the leading source of information for the alternative assets industry, providing insight and analysis gathered by itsglobal teams of dedicated researchers. Our products and services are utilized by more than 60,000 professionals located in over90 countries for a range of activities including investor relations, fundraising and marketing, and market research. Founded in 2003, the company is a frequent source of intelligence used in the global fnancial press, through its onlinedatabases, regular publications and bespoke data requests and operates from ofces in New York, London, Singapore, SanFrancisco, Hong Kong, Manila and Guangzhou. preqin ABOUT NXT CAPITAL NXT Capital is a leading provider of structured fnancing to the U.S. middle market. Since its formation in 2010, the companyhas originated approximately $20bn in total fnancing volume spread over 600+ transactions. With $12bn of committed capitalat its disposal, NXT provides a full range of structured fnancing solutions on a direct basis through its Corporate Finance andReal Estate Finance groups. NXT manages capital for third parties through its asset management platform and ofers investorsproprietary access to primarily frst lien senior secured loans that are not broadly traded or otherwise generally availablewithout a loan origination platform. Investment oferings include levered and unlevered funds, separately managed accountsand CLOs.NXT’s investor base includes public and private pension plans, insurance companies, endowments, foundations andother institutional investors. NXT Capital Investment Advisers, LLC, a subsidiary of NXT Capital LLC, is registered with the SEC asan Investment Adviser. nxtcapital Preqin Ltd. 2018 / preqin4 SHIFTING GEARS: INVESTORS HEAD TOWARD THE US LOWER MIDDLE MARKET Tom Carr: What is most interestingabout this year’s surveyRobert Radway:Shifting Gearsofers manyinsights, but one of the top takeaways isthe growing investor knowledge about USmiddle-market private debt and how theasset class is maturing.It is clear that investors have a greaterunderstanding of US middle-market privatedebt and its benefts. They are beginningto recognize diferences between variouslending or product strategies, as well asincreasingly distinguish between managersthat have proven origination platformsto deploy funds and that demonstrateinvestment activity that is consistent withtheir articulated strategy. As a result, we no longer spend as muchtime educating investors about middle- market private debt as an asset class.Instead we spend time exploring whetherour approach and the investment vehicleswe ofer can help investors accomplishtheir objectives. For example, NXT hasraised multiple funds and separatelymanaged accounts that ofer access tothe middle-market loans we originate andmanage, which generally involve lower- middle-market companies. We couplethat focus with the possibility of investingin both levered and unlevered vehiclesto suit specifc investor preferences andparameters. TC: Why is US middle-market privatedebt appealing to investors RR: This year’s survey identifes three keyreasons why investors that are currentlyallocating to US lower-middle-market directlending plan to continue doing so, and whymore than half expect to increase theirinvestments to this part of the private debtmarket.Investors are looking for higher risk- adjusted returns than other fxed incomeassets, as well as portfolio diversifcation.They are also seeking protection fromrising interest rates based on the foatingrate nature of the underlying loans. A well- constructed lower-middle-market portfolioof senior loans meets these criteria. Resilience is another aspect of US lower- middle-market private debt portfolios thatappeals to investors. According toShiftingGears , investors believe such portfoliosofer a greater degree of protection ina downturn compared to both broadlysyndicated loans and/or upper-middle- market private debt in general. We believethis speaks to investors’ recognition thatlower-middle-market corporate loanstypically include more conservativestructures and covenants.TC: Given today’s investment climate,does lower-middle-market private debtstill ofer attractive opportunities RR: NXT is seeing a strong fow ofappealing direct lending opportunitiesand our origination and deal selectionstrategies are achieving expected results,so we frmly believe that lower-middle- market private debt continues to meetmany investors’ needs.This year’s survey confrms that investorsagree. Risk-adjusted returns remaincompelling and nearly 70% of investorssurveyed indicated that returns eitherexceeded or met their expectations.This helps explain why more than 95%of respondents have an allocation forprivate debt and 86% have an allocationspecifcally for US lower-middle-marketmanagers. Equally important, two-thirds of investorsplan to increase the size of their privatedebt allocation over the next two years,and more than 50% anticipate expandingtheir allocation to the US lower middlemarket. T