INVESTING
For the three quarters of data available for last year , the index paints a picture of private equity returns in decline , with buyout funds returning 2.73 % to investors in the first quarter , 2.29 % in the second quarter and 0.41 % in the third . Venture capital ’ s performance was even bleaker , after it returned 0.00 % in the first quarter , while losing 0.16 % in the second quarter and losing 1.48 % in the third .
On the flip side , private credit ’ s return to investors rose through the first half of the year — it gained 2.28 % in the first quarter and 2.61 % in the second — before it also dropped in the third , to 1.88 %. But even that third-quarter decline was roughly 140 basis points better than private equity ’ s return , and with less risk .
That private equity has had it rough in the last couple of years is irrefutable , as rising interest rates have made borrowing for these deals expensive . “ They ’ re not able to sell their portfolio companies , merge
them with larger companies or whatever their strategy may be because the financial markets just haven ’ t been open to that ,” says Jay Sammons , a private markets portfolio manager at Gratus Capital in Atlanta . “ Meanwhile , private credit , or specifically direct lending to middle-market companies , is done on a floating-rate basis . As interest rates spiked , the returns to private credit right now are outpacing the returns to private equity . I do not expect that to persist , but at this moment in time , that ’ s what you ’ re seeing .”
That lending rate is based on the Federal Reserve ’ s secured overnight financing rate ( SOFR ), which is currently 5.31 %, plus roughly 600 basis points , he says . But even if the Fed ’ s rate eventually resets back to zero , Sammons continues , there ’ s typically a 1 % floor built into private loan contracts , “ so in a low-rate environment , you ’ re still seeing roughly 7 % total returns , before fees .”
Currently the return is roughly 12 %, he says . It ’ s no surprise then that private credit attracted $ 1.5 trillion last year , and is expected to grow to $ 2.3 trillion by 2027 , according to Morgan Stanley .
Velvet Rope Access To AI
Anastasia Amoroso , the chief investment strategist at New York-headquartered iCapital , says the wealth management
“ As interest rates spiked , the returns to private credit right now are outpacing the returns to private equity .”
— Jay Sammons Gratus Capital
community ’ s love affair with private credit is going to continue . “ There are now investment structures that are semi-liquid and accessible to private wealth . That ’ s what ’ s driving the interest , and I suspect that more and more advisors will see and use the entire income continuum ,” she says .
If the average advisor allocates 3 % to 5 % to alternatives , and private credit is just a sliver of that , the allocation will no doubt remain small relative to everything else in a traditional portfolio , she says . It ’ s just that more clients will have that investment — which may well provide a vital source of capital to nascent industries , such as artificial intelligence .
“ There ’ s definitely some opportunities to invest in artificial intelligence in public markets ,” Amoroso says . “ But there ’ s a whole host of startups that are being scaled up in private markets . Why leave out this AI opportunity in private markets when you can look at the aggregate ?”
Portfolio Protection When Needed
With the SOFR floor and the floating rate keeping private credit a strong performer in the debt category , the issue of what happens when the Fed starts cutting interest rates is a bit moot . Yes , the return will drop , but it will still be higher than that of other forms of debt , sources say . And while other forms of lending may be cheaper , the speed and privacy of private credit are highly desirable to some borrowers .
The bigger question is what would happen if the economy slips into recession or is exposed to some unforeseen shock . Janet Yellen might have called a soft landing in a January interview with CNN , but if she ’ s wrong , some of the small and midsize companies now attracting private credit investment could later struggle to pay their debt obligations — and perhaps even default .
But advisors can protect client portfolios if they choose well from the myriad sub-asset class offerings , Sarti says .
One option , for example , is to stick with shorter loans that are more stable .
“ Our favorite sub-asset class in the private credit spaces are short-term loans . In real estate , those are typically 12-month loans ,” he says . “ There are more structures available for the average investor to access that space . There ’ s more in the way of liquidity . There are lower net-worth requirements , et cetera , and the average investor can access those at lower dollar minimums as well .”
Another area Sarti delves into is corpo- Continued on page 58
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