How private credit is proving its worth in a volatile environment

Long-term investors, such as pension schemes, face a challenge securing stable income streams against a backdrop of elevated market volatility and disruptive macro events. Consequently, the full breadth of income sources are now being evaluated and private credit is emerging as a potentially compelling option.

Over the past few years, global markets have been upended by a series of disruptive events: the COVID-19 pandemic, geopolitical tensions (from Ukraine to the Middle East) and instability in the banking sector. These shocks have been accompanied by dramatic shifts in fiscal and monetary policy, creating a complex environment for investors.

The end of the “lower-for-longer” interest rate era has brought new challenges. Inflation remains elevated, interest rates are falling (albeit slowly) and market volatility remains persistent. Yet, amid this uncertainty, pension schemes have seen improved funding ratios, largely due to higher interest rates reducing liabilities. The key question now is how to preserve these gains and continue generating reliable income.

The role of private credit

Private credit offers a flexible and diversified approach to income generation. It encompasses a wide range of asset types – from corporate lending and consumer finance to real asset lending and structured credit – each with distinct risk-return profiles. This diversity allows investors to tailor their exposure to match their specific risk tolerance and income needs.  

“Many private credit instruments are floating rate, meaning they adjust with inflation and interest rates, preserving real income.”
 

One of private credit’s key advantages is its potential to deliver real income in both high and low interest rate environments. Many private credit instruments are floating rate, meaning they adjust with inflation and interest rates, helping to preserve real income. At the same time, features like rate floors may protect against downside risk, ensuring income is not eroded during periods of low or negative rates.

In contrast, traditional fixed income assets such as government bonds and investment grade (IG) corporates often struggle to keep pace with inflation, especially in today’s elevated rate environment. Private credit, by comparison, can offer higher yields and better inflation protection.

Liquidity and risk management

Investors don’t need to accept excessive risk to benefit from private credit, or necessarily sacrifice liquidity. For example, leveraged loans offer daily liquidity and trade similarly to public credit markets. Infrastructure debt and asset-backed securities (ABS) can provide investment  grade or crossover credit exposure with the potential for attractive yields, often outperforming lower-rated public high yield (HY) bonds.

Private credit also tends to exhibit lower volatility than public markets. Because these assets are typically held to maturity and are less influenced by short-term market sentiment, they may generate more stable returns. 

Complexity and opportunity

Private credit is not without its risks; credit, liquidity and prepayment risks must all be considered. A manager’s experience and expertise in managing these assets are therefore crucial. What makes this proposition so interesting is that within the private credit universe, certain segments have the potential to offer a “best of both worlds” scenario: higher returns with manageable liquidity.

For instance, the loans and ABS markets offer active secondary trading and are comparable in size to developed HY markets. These instruments often include callable features, allowing for quicker repayment and reinvestment opportunities. This “pull to par” effect can enhance returns, especially during periods of market dislocation.

A strategic long-term solution

In uncertain times, private credit provides a valuable tool for long-term investors seeking stable, inflation-protected income. Its flexibility allows asset managers to pivot toward the most attractive opportunities, adapting to changing market conditions while maintaining a focus on long-term goals.

As inflation and recession fears persist, the ability to deploy capital patiently and strategically becomes even more important. Private credit’s combination of income generation, lower volatility, and adaptability makes it a strong candidate for investors aiming to secure a stable financial future.

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.