In this week's blog, we examine the booming private credit market, examining some of its definitions, the types of institutions and investors involved, and why we feel that P2P backed by an underlying growth asset such as real estate has more than earned its inclusion in that defined basket of opportunities, that falls under the umbrella of private credit.
The global private credit market traditionally refers to loans and debt financing provided by non-bank lenders, such as Peer-to-Peer Structures, private equity firms, hedge funds, or asset managers, to companies or individuals. From an investor's perspective, private credit offers an alternative to traditional fixed income, often yielding slightly higher returns due to the risk-adjusted nature of the investment. Investors are drawn to private credit for its potential for stable cash flow, diversification, and reduced correlation with public markets. So what's driven this surge in private credit, and why are entities such as Moody's now projecting a $3 Trillion global market cap for the asset class by 2028? Simmering down a pan full of complicated reasoning, what you are really left with… is inflation.
Traditional fixed-income instruments, such as government and corporate bonds, serve distinct roles for certain investors. They offer lower yields and are highly liquid, providing a predictable income stream with relatively low risk. However, in periods of rising inflation, such as we have just experienced over the last 18 months, traditional fixed-income investments struggle to keep pace with inflation, leading to negative "real" or actual returns.
Private credit investments typically offer higher yields due to their complexity and bespoke nature. The go-to line is that private credit is increasingly attractive in a high-inflation environment as it can typically deliver inflation-beating returns. Use of the word typically there; as we all know from recent experience, there are always scenarios where macro events push the definition of actual returns against ultra-high inflation. Still, these are medium-term investment strategies, where sophisticated investors are looking at the opportunity over the longer horizon beyond the extremities of situations such as the recent rates crisis; what they are looking for ultimately is consistent returns over the target rate of inflation, a rate which thanks to the efforts of the Bank of England, the UK is now on track to maintain.
According to a recent Goldman Sachs private markets survey, their affiliated investors believed they were under-allocated to private credit, based on a study of sizable wealth custodians such as pension funds and asset managers. Ultimately, these businesses need long-term income, inflation protection, and high yields, which has set up a widespread financial press debate in these post-pandemic years. Is there a concern that people are leaning into the risk curve because they have no choice? Have fund managers become overly enamoured with an illiquid private credit market that’s grown too fast, underpinned by businesses particularly susceptible to recession economics?
The experts, and indeed we certainly don't think so. Digging slightly deeper than the popular media narrative, private credit can help diversify a portfolio and is less volatile than public fixed income. It also has a quicker return on capital, with private credit investments traditionally having a shorter average lifespan than traditional instruments so that investors can get their capital back more quickly. One of the vulnerabilities continually highlighted in private corporate credit markets is that you are essentially funding midsized firms with limited balance sheets and varying credit profiles, so there is a danger of over-investing in business loans for people closed out of traditional funding lines. However, we see the inclusion of real estate peer-to-peer as an asset class within an asset class, a sub-sector, further diversifying the risk profile of private credit markets due to the secured nature of the individual investments. As mentioned, an investment mechanism underpinned by growth assets such as land and housing is not unsecured business lending to distressed corporate borrowers with already leveraged assets.
Private credit is also an asset class that can be a good source of yield for pension funds, and that may be where there is a modicum of truth to the popular narrative. Pension funds may have to adopt and diversify further into private credit to repair the damage caused by the pandemic, the war, higher energy prices, inflation, interest rates, this era of calamity, this succession of trials we have faced, has potentially created a global difference between pension obligations and the resources set aside to fund them. This will undoubtedly be rectified over time, but it will only be remedied by exploring new markets and embracing opportunities, and that is ultimately what we see in private credit.
Invest & Fund has returned over £200 million of capital and interest to lenders with zero losses, showing the rigour that governs our business.
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