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Making private credit less private

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This is a sponsored article from Nuveen.

Private credit has seen significant inflows for much of the past decade, growing from US$600 billion in 2013 to a total value of US$1.4 trillion by the end of 2022, according to EY1, and recent events have only added to the asset class’s attractiveness. But as the name suggests, private credit can only be accessed through deeply established relationships, making it difficult for non-institutional and private wealth investors to access unless they partner with experienced asset managers that can navigate this market effectively.

Interest in private credit is growing

Many factors have driven investors to diversify and expand their fixed income portfolios, especially in the last decade or so of low rates. Investors now face high inflation, volatility and uncertainty in this new high interest rate environment.

Against this backdrop, investors are increasingly investing across the credit spectrum to broaden their sources of yield and differentiate their fixed income risk exposures. Private credit markets have traditionally attracted more institutional investors, but access to these markets is growing. In reaction, experienced private capital managers are developing innovative solutions to allow non-institutional investors to participate.

However, we believe wealth managers investing on behalf of individual investors should consider three important factors as they look to unlock the benefits of private credit in multi-asset portfolios efficiently.

Private credit has offered higher yields than public credit

A primary reason to use private credit is to harness the illiquidity premium. The yield premium that private credit pays over its public liquid-credit counterparts can vary significantly over time, but on average should lead to higher levels of investment income, all else equal.

According to Refinitiv, the yield spread between directly originated, first-lien term loans to middle market companies and syndicated loans to large companies has averaged 1.9% since 2013 and stands at 2.3% as of 30 June 2023.

Private credit provides important diversification

Allocating to alternatives has long been popular with institutional investors. Private capital, in particular, has the potential to offer low correlation to stocks and bonds, meaning they can act as a ballast, potentially offering investors stable, diversified income when other asset classes are in challenging cycles.

Many individual investors are looking for similar solutions after traditional portfolios comprising a 60/40 split between stocks and bonds took a heavy hit in 2022. Russia’s invasion of Ukraine, an energy crisis and surging interest rates in reaction to rising inflation took their toll on equity and fixed income public markets.

Adding private credit to publicly listed assets diversifies risk across asset classes and provides further opportunities to diversify within the asset class. The structure of debt investments – referred to as the capital stack – generally comprises three components.

The lowest level is an equity stake, followed by the two debt segments of the stack, junior loans and senior loans. Senior loans generally make up the bulk of a loan; these are often less risky, and senior loan investors are the first paid in the capital stack. Junior loans, in the middle layer of a debt investment, tend to have higher yields as they are unsecured, meaning they can be higher-risk positions. The different entry points for investors seeking to access private capital have different tiers available to them based on capital and appetite for risk.

Market conditions are creating opportunities

Conditions for private credit investors have been improving since the 2008 global financial crisis. Tighter regulations on banks have meant that traditional lenders have had to become far more conservative in their lending, providing more opportunities for alternative lenders to fill that gap.

Debt investors have also benefitted from recent shifts in market conditions due to the floating rate nature of senior loans. While surging interest rates have proven challenging for many asset classes, private credit has benefitted, as higher interest rates equate to improved returns. While market commentators are confident that many central banks have reached or are nearing the end of the hike cycle, the impact of higher rates will be felt for longer.

Entry points for investors

Given the sharpness with which interest rates rose, borrowers have seen costs increase faster than expected. This could see a rise in defaults as borrowers struggle to pay back loans, underlining the need to invest with an experienced private capital manager that can identify and access reliable borrowers in stable industry sectors.

For example, since the pandemic, defensive sectors such as technology and healthcare have delivered resilient returns for private credit investors. Indeed, Proskauer’s Private Credit Default Index recently defied expectations and reported that defaults eased from 2.15% in Q1 2023 to 1.64% in Q2 20232.

Partnering with experience

Private credit can help meet the growing demand for yield, return and diversification. But choosing the right credit manager is critical due to the uniqueness of individual deal structures and the wide variety of idiosyncratic factors. Extending private capital to borrowers is an active management process. A manager’s underwriting skill, experience and access to deals are critical in mitigating risk, especially when markets are under pressure.

Today’s economic conditions highlight the need to work with private capital managers who focus on high-quality issuers who can navigate the pressures of a rising-rate, inflationary environment in their underwriting processes. The current environment also requires extra diligence in discerning how a company’s revenue and profit margin will be affected by a return to more normalised conditions.

Nuveen has been an active private capital investor for more than 40 years, with around US$89 billion in assets under management in private credit as of March 2023. Churchill Asset Management, focused on the U.S. middle market, and Arcmont Asset Management, a European-focused private debt investor, are two affiliates of Nuveen, providing investors with a global presence, deep experience and longstanding relationships to identify and complete private capital investments.

For more insights on private credit from Nuveen and to see our full investment capabilities, visit our website here.

1 Are you using growth and resilience of private capital? | EY – Global
2 Proskauer’s Q3 2023 Private Credit Default Index Highlights the Resilience of Private Credit in a Turbulent Economy – Insights – Proskauer Rose LLP

Important Information
Past performance is not a guide to future performance. Investment involves risk, including loss of principal. The value of investments and the income from them can fall as well as rise and is not guaranteed.

Private equity and private debt investments, like alternative investments are not suitable for all investors given they are speculative, subject to substantial risks including the risks associated with limited liquidity, the potential use of leverage, potential short sales, concentrated investments and may involve complex tax structures and investment strategies.

This information does not constitute investment research as defined under MiFID.

Nuveen, LLC provides investment solutions through its investment specialists. GAR-3193950PF-O1023WX

This is a sponsored article from Nuveen.

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