An evolving investor base is creating an environment in which private credit can flourish.

The private credit market really started to take off post-financial crisis, when we saw the regulatory framework change for banks. This made their lending more selective, reduced liquidity, and created a funding gap that allowed alternative lenders like us to step in and fill.

Since then, private credit has grown and includes many sub-asset classes. For us, private credit covers commercial real estate (CRE) lending, fund finance, private placements for corporates, and infrastructure debt. Still, we are talking about any financing by non-banks outside the public markets.

With the rapid growth of private credit, how would you describe the market today?

Direct lending is by far the largest component of the market, but private credit covers everything from aviation finance to music royalties, mezzanine debt, and special situations. Our focus in the investment-grade space can be attractive to investors seeking to complement their fixed income allocations as they look for a pick-up in returns compared with public markets.

Private credit is patient capital, and everything comes in cycles. There have been some headwinds in direct lending and CRE lending, but we see green shoots of recovery, especially in the latter area.

Any concerns for the risk of defaults going forward?

We have seen economies slow, and interest rates rise, which has corrected real estate valuations and highlighted some issues across portfolios.

Loans that were originated before 2022 will have benefited from a period when interest rates were at, or close to, zero percent. Those coming up to refinancing will have a very different interest rate environment. As a result, there will be some stress, and perhaps even distress, in the market. However, managers across private credit have maintained underwriting discipline, particularly in the senior debt space.

As you move up the capital structure and take on more risk, we anticipate the headwinds to have a greater impact, but for the most part, we think the asset class is well-positioned from a defaults perspective.

What is your area of highest conviction?

We take a holistic approach, so we speak to our macro team and colleagues in real estate equity and public credit to reach a house view on where we have the most conviction. Right now, investment-grade private credit is a high conviction for us.

Fund finance particularly appeals to investors because those loans usually have two- to three-year durations. This means a potential basis point uplift to the equivalent corporate bond market with a short duration in an otherwise illiquid asset class.

Within fund finance, many deals are rated AA because the loan is secured against a fund’s investors’ commitments, generally without recourse to the actual underlying investments in the fund. The risk of default is incredibly low, which attracts investors.

Similarly, we have high conviction rate for CRE lending. While this may seem counterintuitive, with real estate values correcting in 2022 to 2023, we believe now is the best time to lend.

There is certainly a polarization in the market between those best-in-class assets and others that are maybe secondary or tertiary, and in certain cases, the gap between these assets is growing. Many private credit or alternative lenders don’t have the same legacy books that the banks have, and, in our case, since we are focused on the investment-grade space, this does lead us toward the high-quality end of the market.

Regarding private placements and infrastructure debt, we see a lot of interest in infrastructure debt, particularly regarding inflation-linked loans or renewables. In private placements, we see an increasing number of companies looking to refinance from the public markets. As with private credit, more generally, this allows us to offer bespoke loans that give investors greater downside protection potential.

Where do you see the growth opportunity for the asset class?

The investor base is evolving. Defined benefit pension schemes moved into the investment-grade private credit space as they were attracted to the historically reliable and predictable cashflows and the illiquidity premium relative to the public markets compared to the same rated loans. But that world has changed, mainly due to rising interest rates. Instead, we see a huge appetite from insurers, who adhere to a slightly different regulatory framework but present significant opportunities.

We have a rich heritage in the insurance space, offering investors expertise in navigating the regulatory framework and reporting and rating methodologies. For insurers, these three R’s – regulatory, reporting, and rating – are key in matching adjustment eligibility investment grade lending and are essential for investors to consider when selecting a manager.

Another theme is the emergence of a credit secondaries market, which brings liquidity to an illiquid market. However, we must be careful what we wish for there because by bringing liquidity to an illiquid market, we risk diminishing some of what makes private credit attractive versus public markets.

We are seeing the emergence of defined contribution pension schemes as investors. Although we are in the early stages of this process, we see it as an area of growth across private credit in the coming years. Regulators must ensure that personal pensions and/or individuals are properly protected.

We have a strong presence in Asia-Pacific and are seeing growing borrower and investor appetite. There is a huge, relatively untapped investor base for private credit and a substantial amount of pension money available in Asia. This could create a significant opportunity as the market gains a greater understanding of what private credit can offer.

This Q&A has been taken from the Private Debt Investor’s “Future of Private Debt” issue.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.

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