Chasing Alpha: Private Credit Momentum to Gain Speed
The private credit market continues to gain momentum as borrower and lender interest grows, and technology innovation improves market access for both, according to the panelists on the Coalition Greenwich webinar “Growing Demand and Access to Private Credit,” hosted by Head of Market Structure & Technology Research Kevin McPartland.
“This is a very ripe environment for dedicated private credit players,” stated Paul Ghaffairi, CIO, Pursuit Funds, which focuses on niche alternative credit products for the mass affluent market. Despite the current “gold rush atmosphere,” private credit is “still a very small percentage” of the overall capital markets. “It’s early days yet,” he said.
“It's a huge ecosystem, and it's constantly growing,” added Bryan Pham, Head of Institutional Sales at leading private credit platform, Percent.
“We are significantly overweight on private credit,” revealed Aaron Rosen, Portfolio Manager, AOG Institutional Fund, which allocates assets across all illiquid alternatives. The interval fund’s private credit exposure has risen to around 50% today from nearly 15% 18 months ago. “We're finding that we can continue to source private credit opportunities at equity-like returns. From an underwriting perspective, the terms and collateral have been remarkably attractive,” he added.
Broad-Spectrum Growth
Interest is coming from all quarters, and investment strategies are varied too.
Steve Larsen, Founder, Columbia Advisory Partners, has been introducing mass affluent and high-net-worth investors to alternative investments for portfolio diversification. “I wouldn't say private credit has hit the mainstream CNBC crowd, but once we introduce it to investors, they're very interested,” he said.
While big players like Blackstone are stoking the market’s growth, these larger funds are having to “compete with banks, resulting in a lower return for the end investor,” pointed out Pham. On the other hand, platforms like Percent are focused on smaller loan sizes of sub-$20 million and underlying borrowers with up to $20 million in EBITDA.
“There’s not as much competition in this niche, so you’re able to get higher alpha,” said Pham. And that “without necessarily adding the risk that others perceive.” Percent’s research shows that “leverage tends to be the main reason” for default in private credit—not the deal or borrower’s size.
For investors, returns and tax efficiency are both draws. For instance, most of Percent’s deals provide a monthly current income, which “is a value-add” for investors.
Meanwhile, Pursuit is focused on specialized asset- and cashflow-backed alternatives. “We focus on very high income from predictable cash-flowing businesses and short-duration assets to differentiate ourselves,” stated Ghaffari.
He added, “Three years ago, with a zero-interest rate environment, we were happy to get 10–11%. We now can originate paper at SOFR plus 1,000–1,500. In a very disciplined credit regimen structure, you should be able to get into the mid-teens. I see that as the really exciting part of the next couple of years.”
Easing Access
What are the mechanics for advisors and wealth managers to access private credit?
Players like Percent are offering operational ease by plugging deals directly into say, an internal fund vehicle or interval fund, or even launching and managing a customized SPV on their behalf.
According to Larsen, interval funds are “the easiest way to access private credit. “Outside of that, most RIAs will use a platform because those will typically integrate with a billing and reporting system to get to the clients… It is very operationally focused as far as what can we roll out that's not going to make the client jump through all kinds of hoops.”
Public vehicles such as business development company (BDC) structures and interval funds “are a much better way for individuals to access private credit versus private funds,” agreed Ghaffari. “Interval funds that are highly regulated give the client a lot of surety and protection that this isn't just the Wild West.”
Besides, technology-led platforms have helped “democratize private credit,” he observed. Added Percent’s Pham, “We're looking at hundreds of opportunities and funneling that down to one deal. The ability to streamline that process and make it widely available to institutions and also investors that have not had access to direct deals is a changing part of the environment.”
Increasing Transparency
As for the risk-reward equation, transparency is crucial for market participants. “We’re trying to bring the transparency of the public bond market to the private credit market,” stated Pham.
For instance, Percent creates surveillance reports on its asset-backed security (ABS) deals and corporate loans and runs collateral verification checks. “Having all this transparency leads to more protection for the end investor besides making it easier for their due diligence process,” averred Pham. It also allows platform users like Rosen “to act much quicker than we had before.”
Ghaffari also noted that the “silver lining” with smaller-sized private credit is the ability to “covenant the credit directly,” a key part of its underwriting.
For RIAs, liquidity is also key for risk management. “We've got to make sure there's money ready for redemptions at any given time, but that also has to be coordinated with the client's financial plan,” stated Larsen.
Big Banks Could Lower Alpha
How will the entry of mainstream banks impact the private credit market?
“More capital chasing after the same arenas is going to water down the return potential,” Rosen observed. On the other hand, given their constraints on taking risks, they will find it difficult to go after “smaller managed opportunities,” so the market will remain segmented.
Regardless, as Pham said, their entry affirms the fact that “Private credit is here to stay.” And that it will only continue to grow.