Private Markets, Longer-term Investments Should investors fear losses in private credit?

We think near-term challenges warrant careful investing. Yet the long-term case for private credit as a diversifier and potential improver of a portfolio's risk-return characteristics remains intact, subject to awareness of the risks.

Some investors fear higher defaults and losses in private credit in 2024.

• Lagged effects of interest rate rises have led investors to worry that private credit assets may experience more defaults or losses.
• Rising default rates in the US syndicated loans market have led some private credit managers to use payment-in-kind interest to mitigate losses.

But manager focus on the most resilient creditors can reduce risks for investors.

• Private credit managers tend to favor senior secured debt that is among the most insulated from company losses.
• New loans offer attractive yields. The median private credit transaction in October originated at an all-in spread (additional yield over benchmark interest rates) of 600bps and a yield-to-maturity of 11.8% on an unlevered basis, according to JPMorgan.
• Many managers are focused on lending to sectors that are less sensitive to growth, generate more cash flow, and need less capital investment—cybersoftware is just one example.

So, we think long-term opportunities in private credit outweigh near-term challenges.

• We continue to see a place for private credit and direct lending strategies as a strategic source of income in well-diversified portfolios.
• Investors should consider the risks inherent to private markets before investing, including illiquidity, long lockup periods, leverage, and overconcentration.

Did you know?

• Newly originated private loan data show financial sponsors are using less debt than in 2021, while putting in more equity relative to debt in leveraged buyout transactions than at any time since 1997.
• Many private loans are provided to deals sponsored by private equity houses. The latter offer operational expertise (like global provisioning to lower portfolio companies' costs of buying materials), additional due diligence, and considerable equity to reduce debtors' risks and provide a cushion in shakier economic conditions.

Investment view

We believe existing private credit investors in well-diversified funds, run by experienced managers, should be suitably compensated in terms of yields, investor protection, and stricter terms on new loans to offset potential losses elsewhere. We continue to see a place for private credit and direct lending strategies as a strategic source of income, diversifier of returns, and potential improver of a well-diversified portfolio's long-term risk-return characteristics, subject to awareness and management of the risks.

Main contributors - Matthew Carter, Karim Cherif, Christopher Swann, Antoinette Zuidweg

Original report - Should investors fear losses in private credit?, 16 January 2024.