Following the significant volatility seen in 2022 and its aftermath, investors looked outside of the normal asset classes of stocks and bonds to boost returns and provide diversification for their portfolios. One asset class, private credit, has gained notable momentum in recent years. According to Cambridge Associates, the private credit asset class - an alternative to traditional lending - has experienced rapid growth, accounting for $1.6 trillion today across a wide range of risk and return profiles. Some analysts expect private credit to increase to $2.6 trillion by 2029. The rise of private credit reflects a broader shift in global finance, from centralized banking to decentralized, flexible capital solutions.
State Street Investment management defines private credit as privately negotiated loans between a borrower and a non-bank lender. Private credit enables borrowers to access capital with customized financing details they may not be able to secure from traditional lenders like banks. It’s also given investors another avenue to access income-generating investments within the fixed income portion of their portfolio – and is now seen as a viable alternative to traditional fixed income, especially in a low-interest rate environment. Borrowers seeking funding via private credit may not have easy access to traditional bank lending and/or the ability to sell corporate bonds. Borrowers that don’t have an extensive credit history or have limited access to bank financing and debt markets, such as startups and small to medium-sized companies, can turn to private credit for funding. Other reasons borrowers turn to private credit include flexibility for borrowers and lenders, ability to avoid equity financing, access to specialized lending, and less regulatory oversight.
For investors, private credit may provide an opportunity for higher yields, improve downside protection, and diversify beyond traditional public fixed income investments. As with any investment, there are benefits and risks, with private credit being no different. Benefits of private credit include higher yields than public debt, illiquidity premium (compensates for illiquidity risk), floating rate (which may protect against interest rate risk), portfolio diversification, and potential downside protection (private loans are secured by collateral that may help limit downside risk in the event of default).
Risks of private credit versus traditional fixed income investing include credit risk (present in all fixed income investment), market and cyclical risk, less transparency than public markets, private credit funds are often illiquid (funds typically offer quarterly redemption opportunities versus daily liquidity), and the potential of regulatory changes. With respect to illiquidity, some private credit investments are structured as interval funds, meaning they allow investors to purchase shares daily but only redeem them at set intervals (typically quarterly). However, these redemption periods are limited; investors are not guaranteed to have their redemption request fulfilled in its entirety, especially during periods of market volatility.
Please reach out to your financial professional to further discuss private credit to determine if it is appropriate for your investment portfolio and fits within your risk tolerance and financial goals.