“56% of global respondents plan to increase their allocations to private credit.”
- BlackRock 2019 Global Institutional Survey
The fact that over half of the institutional investors in BlackRock’s survey said that they were rebalancing their assets towards private credit should come as little surprise: figures provided by Deloitte show that, if it continues on its current trajectory, private credit is set to surpass real estate as the third largest alternative asset, by 2023.1
What makes it so compelling?
For one thing, private credit is a much broader asset class than the name suggests. Aggregated private credit figures are composed of corporate direct lending, real estate debt, consumer lending and a range of other specialized forms of finance, from agriculture to infrastructure. For investors with higher risk appetites, distressed and secondary credit can create opportunities for sub-strategies that generate equity-like returns.
This range of investment options allows investors in the traditional “60/40” allocation of equities and bonds to lower volatility and enhance returns by diversifying into private credit. Because most private credit is floating rate, it also offers minimal duration risk. And implemented correctly, investing in private credit provides considerably more downside resilience than public equities as covenant-bound loans can be made to specific firms whose returns have little correlation to the overall market.
The shift towards private lenders
One of the manifold consequences of the Global Financial Crisis was a rethink of private credit. Traditionally, large financial institutions such as banks and insurance companies dominated in the sector. However, as is by now well documented, the mismanagement (and misrepresentation) of this debt by those same institutions was a contributing factor to the financial crisis that followed. More stringent regulation was introduced, forcing banks to shore up their balance sheets and reduce their holdings of private credit.
From a dominant position in the market, banks and other financial institutions’ share of the private credit market has fallen to less than 10%2. It’s not as though the middle market requires less debt than it did a decade ago: Prequin estimates that private credit more than tripled between 2007 when it was $205bn, to 2018, when it hit $638bn. The difference between then and now is the greater participation of non-banking institutions – none of which suffer from the moral hazard that that underpinned much of the behavior of banks and insurance companies in the lead up to the GFC.