Since the Global Financial Crisis hit in 2008, the private credit market has grown exponentially, reaching $848 billion at the end of 2020. According to Preqin, it’s set to hit $1.46 trillion by the end of 2025.
So, what is private credit, and is it suitable for you as an investor?
Here’s what you need to know regarding the potential risks and rewards before investing in private credit.
What Is Private Credit?
Private credit is an asset class consisting of high-yield, illiquid investment opportunities. Private credit is also commonly referred to as private debt, non-bank lending, alternative lending, or shadow lending.
Opportunities include:
- direct lending
- distressed debt
- infrastructure debt
- mezzanine debt
- real estate debt
- special situations
- venture debt
Both the investor and borrower benefit from private credit lending. The investor gains competitive interest rates while the borrower gets access to much-needed capital. Plus, there’s no requirement to meet the bank’s rigid criteria.
Private credit has predominantly grown rapidly in the U.S and U.K, but also in emerging markets, despite the recent COVID crisis. This growth is largely attributed to the banks’ reluctance to lend to smaller borrowers since 2008. However, the direct and speedy nature of private credit for borrowers and the significant return for lenders boost its appeal. Bloomberg reports all-in yields of 7%–9%, compared to ~3% with other investments.
What this Opportunity Means for Investors
According to Schroders, almost 85% of European pension funds do not have any allocation to private credit investments despite being more lucrative. This presents a major hurdle for smaller investors. Enter alternative investment managers like Yieldstreet, which have changed the industry in recent years. Their private credit investment platform is open to smaller investors looking to invest in private credit (across numerous asset classes, such as art, commercial, real estate, and more). Traditionally, this was only accessible by those who were extremely wealthy.
What You Need to Know Before Investing in Private Credit
- Risks
For investors, the primary risks associated with private credit are investment risk, liquidity risk, and market risk.
Investment risk
These are the risks facing your capital and expected yield, resulting from the risks facing the private debt fund manager. This is why analysis and evaluation are key during the manager selection process.
Liquidity risk
As mentioned, private credit is an illiquid asset. Although it does present some liquidity risks, this tends to stabilize over time in a fairly predictable manner. This means private credit assets can often be used as a tool to manage overall program-level liquidity.
Market risk
Private credit investments generally have a more stable return profile, and the returns are asymmetrical (the upside is often capped). Meaning, they are more susceptible to financial market factors, including currency, interest, and inflation rate fluctuations. This is because the impact is less likely to be concealed or compensated by the underlying investment.
- Rewards
Investing in private credit also comes with many advantages, including reduced overall risk, meeting risk/return objectives, and yielding a higher return.
Reduced risk
Although there is some risk associated with private credit (as with all investments), the risk is minimized through diversification in non-traditional assets.
Meet risk/return objectives
Investment opportunities can be customized from a wide range of risk-adjusted returns and yields to meet desired return objectives. This enables investors to strike a happy medium on the risk spectrum.
Higher return
Private credit is also widely known to have a generally higher yield than other investments due to an illiquidity premium. This is additional compensation received for the risk of investing in a less liquid asset that cannot easily be converted into cash.
- Strategy
Private credit continues to rise in popularity and is quickly becoming a permanent fixture in investment portfolios. As you can see, it offers a unique set of risks and returns to both investors and borrowers.
It’s important to carefully consider the potential risks of all investments and select the right strategy for you. Each strategy has a unique set of risks and returns, so it’s vital you pay close attention to this.
Is Investing in Private Credit Right for You?
Interest rates are at rock bottom and not expected to rise in the near future. Plus, we have an ever-volatile stock market. Therefore, investors are hunting for alternative investment options that come with a level of certainty and a noticeable return. Private credit appears to be an attractive investment to many because it ticks all of these boxes.
Investment platforms like Yieldstreet are opening up these alternative investment channels to a wider audience than ever before. It has never been easier to diversify your options and take advantage of investments once held behind closed doors.
