The amount of money raised by European funds that lend directly to smaller and mid-sized businesses fell by nearly one third last year.

Investors sank €22 billion (£19.3 billion) into 19 funds providing financing to the smallest SMEs and larger mid-market companies in 2018, compared with €32.5 billion for 23 vehicles in 2017 – a drop of 32.3 per cent.

Direct funds have emerged in Europe and the US to provide financing to smaller and mid-sized businesses.

The largest fund raise of this type over the past 18 months in Europe was by Ares, which closed a €6.5 billion fund. Ares struck one of the largest deals in this sector in 2018, with a €364 million loan to UK veterinary group VetPartners – topped up with an equity stake – to fund a management buyout. The company was scooped up by private equity giant BC Partners just a few months later.

In its new report, law firm White & Case warns that direct lenders and relevant debt providers have not been tested in a true market downturn – and 2019 could be the year.

Meanwhile, loans backing leveraged buyouts (LBOs) in the M&A sector across Europe rose by 37 per cent to €56.5 billion. Bonds backing LBOs accounted for €10.5 billion of new issuance in Europe in 2018, up from just €2.2 billion in 2017.

Overall, the total European leveraged loan issuance market was down 28 per cent year-on-year to €202.5 billion, while high-yield bond issuance also dropped to €71.2 billion – down 37 per cent compared with the previous year.

Loans accounted for 74 per cent of European leveraged finance in 2018, according to Debtwire research, with high-yield bonds at 26 per cent.

Services (€21 billion), industrial products and services (€18 billion) and consumer foods (€16 billion) were the top three sectors, accounting for 27 per cent of leveraged loans between them.

In the UK, the leveraged loan market was worth €56.4 billion in 2018 compared with €76 billion in 2017; high-yield bonds totalled €16.5 billion in 2018 compared with €29.5 billion the previous year.

White & Case predicts that the leveraged loan sector will be stronger in 2019 with a lot of cash out there waiting to be put to work and low default risks, despite many concerns.