What is Private Credit?
February 9, 2023
Estimated Reading Time: 5 Minutes
Chicago Partners constantly researches new methods to try to capture returns for our clients. We are proud to offer access to a variety of investment opportunities, including private credit. As traditional fixed income assets such as bonds offer lower yields, private credit investments can offer investors higher yields and further diversification due to their unique characteristics.
Private credit refers to debt financing provided by non-bank lending sources that is not traded on a public exchange. Businesses seeking loans from private credit lending are often in unique situations that prevent them from being able to borrow traditionally. Many of these situations are a result of the regulations that arose from the 2007-2008 financial crisis. Private credit lending can provide borrowers with a flexible and customized financing solution that they would not have been able to access otherwise. There is a significant amount of opportunity outside of the public markets for investors to capture returns that can compound over time. (Source: Hamilton Lane)
What are the Benefits of Private Credit?
Potentially Higher Returns
Private credit can offer higher returns compared to traditional fixed income investments. (Source: Goldman Sachs Asset Management) Specifically, because the borrowing companies cannot access traditional means of lending, they are willing to pay more to have access to capital. Because private credit investments are considered highly illiquid, investors receive an “illiquidity premium,” or compensation for the additional risk they take on by having their money locked up for longer. Private credit funds often offer periodic purchases and redemptions, usually serving as a source of fixed income for investors.
Private credit is largely uncorrelated with public equities and bonds. By offering further diversification across industries and geographies, it can help reduce the overall risk and volatility in a portfolio. This can be especially important for investors who are looking to generate income without exposing themselves to the market risk associated with stocks. There is a much broader, more diverse selection of private companies than public companies. (Source: Hamilton Lane)
What are the Risks of Private Credit?
It is important to note that as with any investment, private credit can come with risks. Proper research and due diligence can help mitigate these risks.
Private credit is not usually covered by credit rating agencies, so it is up to fund managers to determine whether the borrowers are in a position to pay off their loans. As with all forms of lending, there is a chance that the borrower could fail to make interest and/or capital payments, so it is crucial that private credit managers diligently assess the potential credit risk of any given private credit investment.
Interest Rate Risk
As interest rates rise, fixed income securities prices tend to decline, especially under a fixed rate payment structure. There is always a risk that outside factors can negatively impact interest rates. Private credit investments, though, tend to utilize a floating rate structure, as the borrowers are often looking for more specific and personalized arrangements. Thus, private credit can provide a helpful hedge against the typical interest rate risk that traditional fixed income can be prone to, usually due to inflationary pressures.
Private credit is considered highly illiquid, so investors usually hold private credit investments for long periods. Because of their relatively illiquid nature, private credit investments are usually more suitable for investors with a longer time horizon.
It is important to note that private credit requires specialized analysis and due diligence before deciding whether it is a suitable investment opportunity. Private credit fund managers must properly understand the borrower, the industry, and the loan structure. This analysis usually involves a review of the borrower’s financial statements, management team, and business plan, as well as an assessment of economic, market, and industry conditions.
Chicago Partners Wealth Advisors has a dedicated investment committee that thoroughly researches and vets private credit investment opportunities. If you are interested in adding private credit to the fixed income portion of your portfolio, please reach out to us for a free consultation. As with all of our clients, portfolios are entirely individualized to your goals and objectives, so we can help determine whether private credit fits your needs.
Important Disclosure Information
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