Private Credit: A Growing Asset Class Gaining Traction

This article is intended for investors interested in learning more about private credit, an asset class currently gaining traction.

According to the US Federal Reserve, "private credit or private debt investments are debt-like, non-publicly traded instruments provided by non-bank entities, such as private credit funds or business development companies, to fund private businesses[1]".

Outlook and recent deals

Lately, some landmark deals have been achieved in the private credit space. For example, CoreWeave (a company that is well positioned in the generative AI boom with its GPU cloud) secured a USD7.5 billion debt financing facility led by Blackstone and Magnetar[2] in May 2024; Apollo, KKR and Stonepeak consider lending billions to the Intel Chip Joint Venture [3].

Key players in the private credit sector foresee a favorable environment ahead. Recently, Ares Management Corp. said it anticipated a pickup in deals in 2024. “The pent-up demand for M&A, the significant amount of private equity dry powder, and the demand from LPs to return capital will be conducive to an improved transaction environment this year,” said Chief Executive Officer Mike Arougheti in May 2024.

Here are the key points highlighting the current appeal of private credit:

• Historical high returns that are likely to persist in the future, in our views[4]: Recent estimates suggest high-single digit to low-double digit returns for 2024. Over the past decade senior lending has returned around 9% on an annualized basis, more than twice the return on public loans, and has outperformed global equities[5]. This extra return is notably due to higher floating interest rates and illiquidity premiums of private investments.

• Filling a gap: Banks are tightening lending standards and have step back from markets such as corporate and real estate lending over the last decade, which should create more opportunities for private credit providers. Moreover, private funds can execute ever larger and more complex transactions.

Why invest in Private Credit?

Several factors make private credit an attractive option for eligible risk-conscious investors, in our views:

• Strong deal flow: Increasing financing needs from private companies create opportunities for private lenders.
• Defensive positioning: Private credit traditionally invests in sectors like healthcare and business services, which tend to be more stable than other industries during economic downturns, with lower loss ratio.
• Floating rate instruments: Most private credit investments are linked to floating interest rates, which is beneficial to private credit investors in a rising interest rate environment.
• Access to unlisted companies: Private credit provides financing – and hence sources of returns to investors - to emerging or mature private companies, creating diversification.

Here are some additional considerations:

• Limited liquidity: Private credit investments are typically not easily tradable, which means investors need to maintain a long-term investment horizon.
• Expertise required: Proper due diligence is crucial when investing in private credit, so unless investors are knowledgeable in this asset class, they might better invest through a portfolio of private credit funds. It is particularly relevant to have specialists in case of a company workout, which hopefully happens rarely due to the quality of the sponsors borrowing in case of an LBO deal for example.
• Complex deal structures: Private credit deals – and funds - can be complex and generally require significant expertise in understanding the underlying risks and return potential. It is recommended that interested investors consult with relevant experts, like banks having a first-class private debt offering and corresponding expertise.

In conclusion, private credit seems to be a promising option for investors looking for yield distribution and portfolio diversification. There are risks involved with such investments though. We think that choosing the right partner is essential, as in our views the quality of the private credit fund manager is crucial for the long-term success of private credit investments.

This article is brought to you by the Advisory Solutions Team. 
Contributors: Maxime Bonnet - Head of Advisory Solutions, Paul de La Baume - Investment Advisor

Sources:

[1] The Fed - Private Credit: Characteristics and Risks (federalreserve.gov)

[2] CoreWeave Secures $7.5 Billion Debt Financing Facility led by Blackstone and Magnetar - Blackstone

[3] Apollo, KKR, Stonepeak Weigh Investing Billions in Intel Chip JV - Bloomberg

[4] Past performance is not a reliable indicator of future returns

[5] Source : Cambridge Associates LLC, Cliffwater LLC, UBS. The ten-year performance for MSCI All Country World Index (USD gross) was 8.1% as of September 30, 2023.