Private Credit and Its Growing Opportunities for Investors

Private credit has reshaped the investment opportunity landscape. It has been one of the fastest growing asset classes over the past 15 years, offering attractive yields and diversification benefits to investors seeking alternatives to traditional fixed-income securities. By the end of 2023, private credit had reached a market size of $2 trillion, almost ten times the valuation it had in 2009 at $200 billion. In this article, we take a glance at the basic view of private credit investment opportunities and how it has opened doors in this ever-dynamic and evolving market.

Table of Contents

What is private credit?

The rise of private credit

Factors driving the growth of private credit

Why private credit is attractive to investors

Investment opportunities in private credit

Risks and considerations

Current trends and future outlook of private credit

Wrapping Up | Private credit FAQs

What is private credit?

Private credit is a form of non-bank lending, non-public debt financing to companies, real estate projects, or any other borrowers. In contrast to more traditional public markets, like bonds traded on exchanges, private credit involves direct lending or private placement deals. It's usually negotiated between the lender and borrower. This kind of finance is often underwritten through specialized asset managers, private equity firms, or other institutional investors who seek out opportunities beyond traditional bank lending. Key attributes of private credit include:

• Direct lending: Transactions are carried out directly between the lender and the private credit borrower without financial intermediaries, like banks or public exchanges.
• Illiquidity premium: Private credit investments are illiquid; it cannot be traded easily, and thus, generally yields more to compensate investors for reduced liquidity.
• Custom structures: The deals can be structured and include either senior debt loans, mezzanine debt, or unitranche financing (whatever best suits the borrowers).
• Shorter maturities: The credit loan generally has a much shorter maturity than the publicly issued bonds, offering investors their money back a lot sooner.

Private credit differs in several ways from the public markets. The latter involves the issuance of securities to the general public in exchange for capital, which is further traded on public exchanges. This would include important differences in liquidity, regulation, access, and transparency between private credit and public debt markets. Public debt securities are highly liquid, while private credit investments are usually illiquid. Public credits also have a wider investing base, while private credit investment is largely open only to institutional investors and high net-worth individuals. 

The rise of private credit

The private credit market has grown incredibly over the past three decades. This growth has been facilitated by increased regulatory scrutiny of banks, the search for higher yields by investors, and the growing complexity of corporate financing needs. In areas where traditional banking has become more constrained, private credit providers have moved in to fill the gap, offering customized solutions and greater flexibility to borrowers.

The private credit market size currently exceeds more than $3 trillion in assets under management as of November 2024, while private credit is becoming ever more influential across key classes. Big funds have made dramatic forays. A series of bold recent expansions in BlackRock illustrates particularly that great scale befits this market of growing relevance. Its announced $12-billion purchase of HPS Investment Partners in 2024 has shown very clearly just how strategic this opportunity already plays. 

Factors driving the growth of private credit

Private credit’s huge growth is fueled with several important factors interdependent and influencing one another. In January 2024, the Bank of England estimated that the private market had grown nearly fourfold since 2015, reaching approximately $1.8 trillion. Much in growth levels took place around a period or term relating to low incomes on interest-bearing securities, resulting in minute costs of loan borrowing and hectic rates of yield consumption by fixed investors.

Bank retrenchment

One of the key drivers behind the growth in private credit has been the retreat of traditional banks from certain areas of lending. Stricter regulatory frameworks, such as Basel III, have compelled banks to be more conservative in lending. This has led to a financing hole for the small to mid-sized enterprises, real estate developments, and other borrowers. Providers of private credit stepped into this gap to provide flexible financial solutions to borrowers who may otherwise have struggled to access financing. 

Investor demand for yield

The low-interest-rate environment has been one of the main challenges facing institutional investors, including pension funds, endowments, and insurance companies. The yields of traditionally attractive fixed-income assets, like government and corporate bonds, have remained at historic lows. This explains why so many investors are gravitating toward private credit as an attractive alternative. 

Flexibility and customization

Unlike traditional bank loans or public debt instruments, private credit agreements can be tailored to meet the specific needs of the borrower. The terms include longer repayment periods, interest-only payments, or structures that benefit the borrowers. Private credit lenders can structure deals in a manner to suit their degree of risk tolerance and desired return objective, therefore creating win-win situations.

Why private credit is attractive to investors

Private credit offers a unique combination of benefits that appeal to a broad range of institutional and individual investors. Below are the key reasons why private credit continues to attract significant attention and capital.

• Compared to traditional fixed-income investments, returns have the potential to be higher
• Diversification benefits of a wider investment portfolio
• Ability to generate stable cash flows in various economic conditions
• More control and greater influence over investment decisions could be possible

Combined, these attributes point to why private credit has become such a popular asset class for those seeking to improve returns, better control risk, and exercise more control in a complex investment world.

Investment opportunities in private credit

Private credit is a diverse asset class that offers various investment options to fit different risk appetites and return objectives. 

Some of the main routes available to investors include the following:

1. Direct lending

Direct lending provides loans directly from private credit funds to smaller and medium-sized corporations. These loans often take the form of senior debt, ensuring that the private credit lender has priority in repayment in case of default. For individual investors exploring how to invest in private credit, direct lending funds are a natural starting point, as they are widely available through the best private credit funds managed by reputable asset managers.

2. Real estate debt

Private credit also finances real estate projects, from commercial and residential to mixed-use projects. Real estate debt investing encompasses bridge loans, construction financing, and mezzanine debt, offering higher yields with greater risk. Real estate-focused private credit funds provide diversification and access to the lucrative property market without requiring asset ownership or management.

3. Special situations and distressed debt

Special situations and distressed debt represent higher-risk, higher-reward pockets within private credit. An investment in these areas would include the provision of capital to companies in financial stress or restructure, generally at discounted prices. For instance, this has been demonstrated by the recent sale by the Florida State Board of $2 billion of private credit investments that target businesses in distress, as reported by The Wall Street Journal.

4. Infrastructure and real assets

Private credit is increasingly used to finance larger companies and large-scale infrastructure projects and assets, which also include development of renewable energy, transportation networks, and utilities. Most projects usually involve highly capital-intensive work at the initial stages and come with long-term steady cash flows appealing to institutional investors.

Risks and considerations

While private credit can offer tantalizing investment opportunities, of course, there is another side to the coin. One of the main risks associated with the growth in private credit is slackening lending standards. According to the Financial Times, Nick Moakes says the quest for a higher yield can lead some lenders to ignore fundamental creditworthiness, hence increasing the prospect of defaults.

Moreover, private credit investments are highly illiquid, which is a big concern for investors. Unlike liquid public securities, private credit investments cannot be easily bought or sold on a secondary market. This has also put the private credit market under the growing scrutiny of regulators. There is systemic risk, particularly if there is a severe economic downturn. In the future, it is expected that regulators may take some steps to increase transparency and reduce risk as a way of ensuring stability in the financial system. 

Current trends and future outlook of private credit

There is a great increase in the role of private credit in infrastructure and real estate project financing. The Financial Times has pointed out that insurance companies are continuing to look for higher-yielding investments to meet their long-term liabilities. Private credit offers an attractive alternative that may serve as a stable source of return over the long term. 

Looking ahead, several key trends are likely to shape the future of the private credit market:

• Diversification: The asset class is expected to diversify further in emerging markets, renewable energy, and other innovative sectors.
• Strategic partnerships: The coming of ecosystem partnerships together with open architecture business models is likely to thrive further in times to come.
• Scale and technology: Achieving scale and leveraging technology will be crucial for competitive differentiation.
• Technological advancements: Advanced technologies may include Artificial Intelligence, machine learning, among other technological capacities enhanced toward better and modernized underwriting decisions, improved efficiency of operations, and risk management.

Wrapping up

Private credit is a rapidly expanding asset class that provides an attractive alternative for investors compared to the more traditional fixed-income investments. With the potential for higher returns, diversification benefits, and active management, private credit can present an attractive opportunity to investors looking at ways to enhance their portfolios. Nevertheless, there is a need for awareness regarding the risks inherent in them, such as illiquidity and probable credit risk. Investors should do thorough research and due diligence to find the best-suited investment opportunities within the private credit market. 

Private Credit FAQs

What is a credit fund?

A credit fund is an investment pool that gathers funds from various investors and lends it to the borrowers or invests in debt securities such as loans, high-yield bonds, or other forms of credit assets. Credit funds generate returns focused on interest payments and loan repayments and typically invest in diversified credit categories including but not limited to corporate lending and real estate debt.

How does private credit compare to traditional fixed income?

Private credit differs from more 'traditional' fixed income. The latter normally involves public traded government or corporate bonds, whereas in private credit, financing is given to a private company or project. Given the higher risks for lenders and the limited liquidity, returns from private credit are usually better, but again, this generally implies a heightened possibility of default, which is far less probable with traditional bonds.

Private credit versus private equity: What sets them apart?

Private equity investments are made in the firms, usually by the purchase of ownership in the hope of achieving growth or restructuring and cashing out at an advantageous valuation. Private credit consists of loans given either to companies or projects in anticipation of receiving interest on those loans. While private equity risks are indeed associated with high rewards, private credit is an investment yielding relatively stable income-generating returns without ownership of the company.

How does private credit function within a portfolio?

The main benefits of private credit are diversification due to the lower correlations with equities and fixed income, therefore reducing overall portfolio risk. Private credit also generates regular income through interest payments, which is appealing in today's low-interest-rate environment. One must consider, however, the illiquidity associated with private credit, which can be a problem for investors who need liquidity in their capital.

How is the private credit industry affected by interest rates?

Interest rates can affect private credit through both the cost of borrowing and return. As rates rise, the cost of borrowing is higher, which might reduce demand for loans. Private credit investments with floating interest rates benefit from higher rates since they provide a higher return. On the other side, private credit investments with fixed rates will have reduced returns in a rising rate environment, and higher rates might increase default risks, especially for highly leveraged borrowers.