Happy Sunday Noyackers, and thanks to everyone who responded to last week’s polls.
I wasn’t surprised to learn that coffee led the way for your morning beverage of choice (33%), although tea came in a close second (22%).
“Black medium roast and lots of it! ☕️” – Troy, NWW Reader
What did surprise me, though, was that 36% of you already had some form of life insurance, higher than I expected. Another 46% are considering it after last week’s issue.
At the risk of starting a fight, here’s what I’m curious about this week…
Wherever you get your coffee, grab a cup and enjoy while we discuss the state of private credit after the Fed’s recent rate cut.
We’ll also look at a few ways you might be able to invest in this niche asset class.
Let’s roll!
What is private credit, again? 🤔
If you’re not familiar with private credit, here’s a super-quick refresher:
- In the olden days, when a company needed to borrow money, they did so through banks.
- Banks served as the middleman between investors and companies, facilitating commercial loans or bond offerings.
- Eventually, investors realized they could cut out the middleman and lend directly to companies – and thus, private credit was born.
Linking investors that supply financing directly with the companies that need financing has proven insanely popular.
Since 2008, private credit has grown from a $250 billion asset class to more than $1.7 trillion today.
Private credit AUM growth.
And it’s no surprise that private credit is popular.
By cutting out the middleman, investors can save on fees while offering more flexible financing solutions to companies.
All this adds up to opportunities for high returns, with private credit strategies averaging over 11% annually since 2018.
⏬ Rate cuts could change things…
Private credit has been one big party for the past few years.
But interest rate cuts (like the Fed’s 50 basis point cut two weeks ago) risk spoiling the fun.
Here’s why…
Most private credit loans are floating rate.
That means that when interest rates go down, private credit loans earn less interest, reducing investor returns.
Compare that with fixed rate loans, which ‘lock in’ the amount of interest you’ll earn regardless of how rates change.
What’s more, rate cuts are happening because officials are worried about a possible recession.
If a recession happens, companies might have a tougher time paying back their private credit loans – possibly leading to carnage in the credit markets as borrowers default.
But it’s not all bad news 🙃
Okay, I’ve laid out the bear case for private credit as rates go down.
But this isn’t the full story – and there are actually some surprising reasons for optimism in this asset class:
Lower rates could reduce defaults
Falling rates are annoying for private credit investors because they directly reduce the amount of interest earned.
But the upside is that it’s easier for borrowers to manage higher debt burdens as rates fall.
That could help reduce defaults for companies that borrow through private credit, potentially leading to better performance than other debt asset classes.
Better relationships can help companies navigate trouble
Private credit is a very relationship-driven asset class. Investors work closely with companies to tailor their loans, offering more flexibility than banks.
If a recession hits, those close relationships could be a lifeline for the asset class, allowing companies to work through tough times with their lenders rather than defaulting immediately.
Lower rates could increase M&A activity
Okay, this one is a bit technical, but bear with me…
- One of the big uses for private credit loans is to fund mergers & acquisitions (when two companies join together or one company buys another).
- Lower rates tend to incentivize more M&A activity (since financing is cheaper).
- Ergo, a low-rate inspired M&A rebound could be a boon for private credit.
As Brad Schneider, Head of Private Credit at Cresset Partners, put it in a recent research note:
A reduction in interest rates could lead to a boost to the valuations of private equity-owned companies, which may provide the long-awaited spark for increased M&A activity. A return to normalized deal flow could ease competitive pressures, and that may lead to improved loan pricing terms and accelerated deployment of capital, which are all positives for private credit investors.
For all these reasons and more, I’m actually quite optimistic about the state of private credit right now – even when factoring in slightly lower interest payments.
💸 Investing in private credit
The tricky part about investing in private credit is right in the name – a lot of these vehicles are private, off-limits to everyday investors.
But if you know where to look, there are actually a few ways to invest in private credit through public markets.
Business development companies
Despite the odd name, business development companies (BDCs) function almost identically to private credit funds, generating returns by lending directly to companies.
The difference, though, is that BDCs are often publicly listed, meaning you can buy them on an exchange.
Some of the largest publicly listed BDCs include:
- Ares Capital Corporation (ARCC)
- Blackstone Secured Lending (BXSL)
- Blue Owl Capital Corporation (OBDC)
There are also plenty of non-listed BDCs, which don’t have the day-to-day volatility of exchange-listed assets.
In fact, we’ve written in-depth reports on three non-listed BDCs – click the links below to be taken directly to our analysis:
- Blackstone Private Credit Fund (4/5 stars)
- Apollo Debt Solutions BDC (3.5/5 stars)
- Blue Owl Credit Income Corp (3/5 stars)
One note – BDCs can and do invest in equity securities as well, although it’s less common.
Be sure to read the prospectus of whichever fund you’re interested in to ensure that it aligns with the exposure you want.
Private credit ETF? Watch out 👀
Aside from BDCs, investors might soon be able to access private credit through an ETF structure.
Recently, Apollo and State Street partnered up to file for an actively managed ETF that invests in both public and private credit, the first of its kind.
We still have to wait and see if the SEC will approve the ETF – but if you’re interested in investing in private credit, keep your eyes peeled for updates.
