Riding the Sea Change: How Private Credit Can Deliver Equity-Like Returns With Lower Risk

Demand for private credit – loans or debt investments made by non-bank institutions, typically in private or unlisted companies – has grown significantly in recent years. AlTi’s Nancy Curtin, Antonio Casal and Jeff Fulk explain the asset class’s potential benefits for ultra-high-net-worth investors, and where to find the best opportunities.

The private-credit market has grown by 50% in the past four years to $1.7 trillion – and asset manager Blackstone Inc. expects it to balloon to $30 trillion in size looking forward¹. Driving much of this growth is a huge demand for credit by companies as they grow and invest. This robust demand for lending is being met by new buyers as well, with greater participation from ultra-high-net-worth investors, and increases in allocations by large institutions such as insurance companies and pension funds. What’s more, private credit’s promise of potentially attractive, equity-like returns and diversification benefits made it the most sought-after asset class, according to a survey by Hedgeweek, with six in 10 family offices worldwide looking to increase their exposure².

Further fueling this growth is the fact that banks are retrenching amid liquidity constraints, regulatory scrutiny, and higher cost structures. In the wake of this retreat, demand for capital may outstrip supply, creating new opportunities for private-credit investors. This has enabled non-bank credit platforms and their investor clients to step in and fill the demand void. Banks currently account for as much as 90% of the asset-based credit market because they finance the real economy, but as they grapple with capital requirements, we expect private lenders to take a greater share.

Furthermore, this void is growing, particularly in the US, where the economy has remained strong, increasing the need for capital and debt refinancings. Not only do companies in general require access to capital to grow, but other trends – such as the reshoring of supply chains, the need for new energy infrastructure, and the building of the digital infrastructure and power layer essential for Gen AI – are increasing the need for investment. As demand for capital increases over the next decade, this will drive greater demand for credit. And the numbers are staggering. Blackstone expects $1 trillion to be spent on data centers over the next five years and sees similar growth in capital needed for the power and energy transition³.

This increasing demand, and the shrinking supply of capital from banks, have enabled the potential for greater returns for credit. Although, as with any investment, there is a downside risk, after years of near-zero interest rates and a cost of money at all-time historical lows, the balance of power has shifted – it is now a lender’s, not a borrower’s, market. Even as inflation comes down, credit is offering potentially attractive, equity-like returns compared to its risk, with the possibility of yield premiums for private credit compared to public markets.

Returns on private credit can be better than in public markets partly because corporates prefer the ease of private-market deals. Raising capital in public markets can be time-consuming and expensive. Borrowers often find private-credit solutions more attractive, as terms can be tailored to their specific business needs. Also, they like the ability to deal with one credit-provider platform, which often allows for speedier execution, less complexity, and greater confidentiality.  

Equity-Like Returns, With the Income and Lower Risk of Credit

The potentially higher returns from private credit are also partly due to the illiquidity premium – borrowers compensating investors for the less-liquid nature of the investments. However, in the past few years, new, semi-liquid private-credit fund structures have been developed, which give investors exposure to the top private-credit managers without the need to lock up capital in closed-end, long-term vehicles.

Now, evergreen, semi-liquid funds run by some of the most experienced and successful private-credit platforms in the industry allow individual investors access to portfolios of potentially high-yielding loans from the outset of their investment. Funds that permit investors to deploy capital immediately into income-generating assets may significantly enhance returns compared to closed-end structures that take longer to become invested.

Private credit differs from public credit not just in returns. The former has demonstrated lower loss rates relative to public credit over time. And it has been less correlated with public markets, such as equities as well as public credit, providing diversification benefits that may help to reduce portfolio volatility and improve risk-adjusted returns. What’s more, private credit comes with the added potential benefit of often higher-quality credits and lower levels of price volatility.

However, like traditional fixed income and public credit, private credit generally offers the possibility for interest payments from contractual cash flows. This ability to take income can be attractive to many investors. 

Different Strategies, Different Benefits

The private-credit markets are large and varied, offering opportunities across a range of strategies that investors can use to enhance return and diversify risk. Investors are most likely to be familiar with direct lending – providing credit primarily to private, non-investment-grade companies. This strategy invests in the most senior part of a company’s capital structure, which can provide steady current income with relatively low risk.  

Asset-backed lending can also be lower risk, as credit is secured by collateral. These assets can include equipment, real estate, inventory, or accounts receivable. This collateral security provides an additional potential benefit: if hard assets rise in value as prices rise, they can protect investors against inflation.

Mezzanine lending and special situations are types of private credit that are at the higher-risk end. This is because the debt is typically subordinated, meaning that in the event of a default or bankruptcy, claims are lower in priority than they would be with the more senior debt of direct lending. However, because of the higher risk, the debt often comes with incentives that could support attractive total returns, such as equity kickers.

Special-situations lending is typically debt to borrowers undergoing transitions or corporate events that drive a very specific credit need. This lending could be riskier because the borrowers need a higher degree of customization and complexity. However, investors in this space can lower their risk by pooling a range of these credit opportunities to provide diversification, which can reduce the impact if one investment does not deliver. 

How to Lower Risk and Maximize Return

In fact, diversification is a good tactic for all types of private-credit investments (and portfolios overall). Being highly diversified minimizes the impact of a single impairment on portfolio returns.

Investors also need to ensure that they have sufficient liquidity to meet their individual needs – and it is best to be conservative. When investing through vehicles, do so alongside other investors who are like-minded and longer term in their time horizon, and with prudent credit managers who are thoughtful about constructing the portfolio with an adequate liquidity buffer to offer protection in times of market stress.

What’s more, investors should always work with trusted partners. To ensure we offer our clients only the best opportunities, our due diligence process at AlTi is rigorous. We assess the quality of the manager, their underwriting track record and experience, their work-out expertise, and whether they have successfully managed portfolios across different economic and default cycles. We also examine the quality of the assets or the companies they are lending against, and whether they are investing their own capital alongside that of investors.

We believe that adhering to these considerations can help minimize portfolio downside when investing in private credit – and open up a world of opportunities for potentially strong, risk-adjusted returns.