Until recently, the world of private credit was ruled by Wall Street banks in their chase for higher yields and more exclusive offerings for their institutional clients. Often taking the form of closed end funds with long lock-up periods, private credit investments seek to generate higher yields by directly lending to a portfolio of companies, that are either unable or unwilling to receive funding from more traditional sources such as issuing bonds, or bank loans. In exchange for these lending services, private lenders are able to collect much higher yields, historically in the range of 8-13%.
This illiquid asset class is often reserved for pension funds, endowment funds, and HNW investors with long time horizons, who are not concerned with having access to their funds for 10 years or more. Allocations to this asset class have benefited institutional investors greatly over the last 10 years, during periods where yields have seen historic lows.
European developments in private credit
But the genie cannot be kept in the bottle indefinitely, and as the appetite from non-institutional investors for alternative strategies grows, players are emerging that seek to satiate it.
Blackstone, one of the largest names in the investing world has recently launched a European private credit fund. Having received regulatory approval in Luxembourg, the fund aims to provide institutional-level strategies to wealthy Europeans. As of May 2022, HNW European investors have had access to this restricted fund and are now able to benefit from an asset class that has grown from $50 billion in 2001, to 1.2 trillion as of 2021 as per PIMCO data.
But what about retail investors? Although developments in the space will surely continue, for the time being, retail investors can gain exposure to private credit markets through index tracking ETFs. The Virtus Private Credit Strategy ETF provides exposure to the asset class through investments in BDCs (business development companies, which are often structured as close ended funds investing in the private credit space. The ETF yields 11.54% as of October 20th, with distributions paid on a quarterly basis, making it an excellent substitute for a high yield bond ETF such as HYG, on a relative yield basis.
Should European Investors consider Private Credit?
The asset class has seen significant growth over the last 15 years, with over 30% of the Total Credit market in the US being made up of Private Credit as of 2021, leading some market participants to believe that future growth at the same rate is unsustainable. Firms such as Blackstone take a different view, however.
As per an April 2022 report, the firm believes that Private Credit will continue to grow, as it is still a relatively small portion of overall credit markets. One of Private Credit’s main advantages are partnerships formed with the portfolio companies, which allow for flexible terms and a more active role in the operations of the companies. Contrasting this with publicly traded credit such as Leveraged Loans, which give investors little say over the operations of their borrowers, Private Credit investments form long-lasting partnerships between investors and borrowers, allowing them to command a premium yield even in a rising rate environment.
Source: Morningstar, Cliffwater, as of December 31st, 2021
The benefit to European investors is compounded, considering the relatively low-interest rate environment as compared to North American Yields. Although North American investors may have more incentive to add public floating rate debt after the recent hiking cycle, European investors are still yield-starved, with the ECB rate only at 1.25% as of September 2022.
