Private credit has emerged as a strong source of returns for fixed income investors in recent years. Changing market conditions could act as headwinds but private banks remain bullish on a continued run for the asset class.
In recent years, the withdrawal of traditional lenders has driven the growth of non-bank lending in the form of private credit. According to a BlackRock report, the size of the private credit market has skyrocketed from $875 billion in 2020 to $1.6 trillion in early 2023.
On the side of investors, there is a never-ending chase for yields and superior returns should default rates remain benign. From 2008 to the first half of 2022, direct lending – a form of private credit – has generated risk-adjusted annual returns of 11.5 percent compared to 5 percent from leveraged loans and 7 percent from high yield bonds, according to data compiled by Morgan Stanley.
Weaker Outlook
But in 2024, the asset class could face pressure. According to Bank of Singapore investment strategist Neo Bee Leng, total returns going forward could be weighed down by the expected decline in base rates; competition from traditional lenders who have returned to the market; and a rise in credit costs.
«On the negative side, skeptics have expressed concerns around the quality of the covenants (e.g. the validity of the EBITDA being underwritten), the lagged valuations of portfolios including how defaults are defined which impact the reported value of the portfolio,» Neo said in a note. «We note that regardless of the metrics used, credit costs and defaults in 2023 have picked up relative to the lows in 2022.»
«Manageable» Risks
Nonetheless, private banks remain confident. Neo said that Bank of Singapore does not believe that the aforementioned challenges will «detract from the value proposition of private credit as an attractive income diversifier in portfolios». Many other players, including Pictet, J.P. Morgan Private Bank and Lombard Odier have also advocated for selectively adding exposure to the asset class.
«Concerns over the industry’s rapid rise, and its fate if the economy slows and default rates rise, warrant close monitoring,» said Lombard Odier head of private assets Thierry Celestin in a note. «However, we think these risks look manageable since private loans are typically secured against the borrowers’ assets, while default rates remain contained for now.»
Market Liberalization
Traditionally reserved for the ultra-rich, the minimum threshold for private credit investments can be as high as $250,000. But some firms are developing offerings to liberalize access to the asset class.
Digital wealth platform StashAway launched private credit access for high net worth clients in Singapore in 2022 and Hong Kong in 2024 with entry levels that are a fraction of the typical minimum investment amount. US asset manager T. Rowe Price is looking to liberalize even further with a private credit fund that is in the «early stages» of being introduced to retail investors, according to a «Bloomberg» report.
