4 min read 4 Jul 23
Private credit – historically seen as a niche asset class – is growing exponentially. Indeed, total assets under management allocated to private debt are expected to hit $2.3 trillion by the end of 2027, increasing at a faster rate than alternatives overall, according to forecasts by Preqin1.
As investors seek to gain access to diversification benefits and reliable streams of income, demand for private credit assets has surged in recent times. The asset class is known for its resilience and adaptability, as its performance through the current cyclical downturn has shown.
Private credit has become a stalwart in institutional portfolios since the Global Financial Crisis while banks have generally retreated from tailored lending. Most large traditional institutional investors have a dedicated private debt allocation, but the investor base is broadening, and capital is increasingly coming from alternative sources – including smaller institutions and individual investors – as accessibility to private credit improves.
By their nature, private markets are opaque and can seem difficult to access – especially given the liquidity restraints and general lack of transparency entailed when investing in the space. Private assets can be more difficult to invest in, while the large number of different asset types available within private credit alone adds to this complexity. Expertise is crucial, as private credit requires meticulous risk evaluation and management.
With interest rate rises and ongoing volatility defining the new normal, private credit may be seen as an attractive source of diversified, stable income and uncorrelated returns. But these potentially superior yields can come with a price some investor types are unable to pay.
For smaller institutions, the inherent illiquidity of private credit can be a barrier to entry as closed-end and illiquid fund structures may not always meet the regulatory or portfolio requirements for different types of investors. Managers often demand hefty minimum capital commitments for illiquid private credit assets, which can also impact portfolio diversification for smaller investors.
Gaining entry to the private credit universe needn’t be a challenge. As private markets develop while public markets shrink, improved accessibility is helping redefine alternatives, opening the doors to unique opportunities across the private credit spectrum through various fund structures that provide easy and clear access to the asset class’s expansive toolkit.
We now see institutional clients, such as pension funds, looking to these more flexible structures to access an asset class which was only available through closed ended funds, as they seek stable, long-term income via diversified cash flows.
These different fund structures can be used to help address different investor needs. As well as offering flexible exposure to alternative and differentiated types of income-bearing assets across the cycle, they provide diversifying benefits and potentially help investors meet their long and near term goals.
For example, an open-ended fund structure with a multi credit approach can provide simple access to the broad range of options within the universe – from private corporate lending to consumer finance, real assets lending and structured credit, which have very different underlying risks and performance drivers. Beyond illiquidity, other private credit risks can include high management fees, overvaluation due to high demand, and the risk of default if a borrower fails to meet their loan obligations.
However, investors needn’t reach for the riskiest of segments in their quest for real income. An actively-managed portfolio can tap into the benefits of both liquid and illiquid assets, while offsetting some illiquidity risk for smaller institutions. Open-ended funds can help clients manage their capital flows as there will be no capital calls, while specifically tailored strategies may help investors avoid exposure to leverage and increased risk in their portfolios.
Private credit assets have generally provided higher returns than their more liquid counterparts such as public bonds, but certain liquidity characteristics and the size of the loans and ABS markets – the fact that these assets are easier to sell compared to direct lending – may also offer additional returns. It is still important to consider which areas within private credit are adequately developed, provide diversification to an asset owner's unique risk factors, and can generate a healthy yield pick-up relative to public market assets.
Through active management, an experienced private credit investor well-versed in analysing the varying complexities of the asset class may capitalise on periods of market dislocation that can normally be found in illiquid assets alone, while also providing potential for additional protection for cashflow management. This flexibility bolsters the resilience of private credit portfolios, potentially enabling them to thrive in all kinds of environments, providing opportunities for investors seeking secure income – whether in challenging conditions or a bull run.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.