Credit information that isn't publicly available: How to strategize investments in it
The private credit market, a realm of off-market loans not typically accessible to the general public, is gaining traction as an intriguing investment option. This alternative lending landscape differs significantly from traditional bank-based lending, offering unique investment opportunities, risks, and participant requirements.
Investment Opportunities
Private credit typically involves loans originated by non-bank lenders, such as private debt funds, business development companies, and insurance companies. These lenders often focus on small to medium-sized businesses that are overlooked by banks, providing access to a growing segment of the market, particularly the middle market (companies with EBITDA roughly $50–100 million). This segment has expanded significantly in recent years, now representing over 12% of Collateralised Loan Obligation (CLO) issuance, up from about half that a decade ago.
Moreover, private credit loans can offer higher yields and floating rates, appealing to investors seeking income and scalability outside traditional corporate bonds. The emergence of tokenization, converting loans into blockchain-based digital tokens, is also on the horizon, potentially increasing liquidity and transparency in the private credit market.
Risks
Despite the potential rewards, private credit investments are generally riskier than traditional bank loans due to less liquidity, fewer covenants, and concentration in smaller or less rated borrowers. These loans are less regulated and usually cannot be sold as easily as syndicated bank loans, exposing investors to liquidity risk. However, they often contain tighter documentation compared to broadly syndicated loans, which may mitigate some credit risk.
Private credit is also sensitive to macroeconomic conditions and shifts in regulations affecting banks, which might influence borrower credit quality and lending capacity as banks retreat from riskier lending.
Participant Requirements
Traditional bank lending involves stringent regulatory and capital requirements, with loans often distributed via syndication among multiple lenders. In contrast, private credit allows lenders to bypass these syndication and regulatory constraints, offering more customized loan terms tailored to borrower needs and investor risk appetites.
However, investing in private credit typically requires more sophisticated due diligence capabilities and a longer investment horizon due to limited liquidity and higher complexity of deals. The emergence of private credit CLOs focused on middle market loans also enables investors to gain exposure via structured products, potentially lowering entry barriers.
Accessibility and Fees
Private credit is not immediately accessible to everyone and would-be investors must typically be accredited individual investors, institutional investors, or investment professionals. To become an accredited investor, an individual and/or a spouse must have a net worth of over $1 million, not including their main residence, and an individual must also have an income of $200,000 or more over the last two years or a couple must have had $300,000 or more.
Additionally, private credit funds can charge significant fees for their services, including acquisition fees, annual management fees based on the investment amount, and more, which are well in excess of what investors could find in the best index funds.
The Appeal of Private Credit
Despite the higher fees and risks, the potentially higher return is the main appeal for investors. Private credit funds invest in the debt of small and medium-sized companies, which may be higher risk and therefore pay higher rates. By adding private credit to a portfolio, investors may be able to increase their portfolio’s diversification and reduce its risk, especially if the investment is less correlated to the overall market.
Moreover, private credit can give investors access to investments that they might not otherwise be able to reach, potentially enabling them to earn a higher return. Platforms such as Yieldstreet, Percent, and Fundrise can help investors get started in private credit with lower amounts of money.
Since the financial crisis of 2008-2009, banks have pulled back from business lending and have applied more stringent requirements to give loans, creating a void for private-credit investors to step in and fill. Some business development companies (BDCs) are publicly traded, allowing access to anyone who can invest in the public market, with high dividends and high risk.
In summary, the private credit market offers investors potentially higher-yield, flexible, and less liquid investment opportunities targeting middle market borrowers underserved by traditional banks. These opportunities come with greater credit and liquidity risk and typically require more active management or structures such as CLOs to gain diversified exposure. As the market matures and innovations like tokenization become more prevalent, private credit may become a more accessible and attractive investment option for a broader range of investors.
Investing in private credit can provide unique business opportunities, as it revolves around non-bank lenders offering loans to small to medium-sized businesses often overlooked by banks. This targeted approach to lending can lead to higher yields and floating rates, making it appealing to investors seeking income and scalability outside traditional corporate bonds.
Individuals interested in private credit must meet specific accreditation requirements, such as having a net worth of over $1 million or an annual income of $200,000, and may face significant fees for the services of private credit funds. However, as the market matures and innovations like tokenization are introduced, private credit may become a more attractive and accessible investment option for a broader range of investors.
