Credit where credit is due: private credit jumps to the fore
Private credit is all the rage among investors.
BlackRock (NYSE: BLK) just agreed to pay $12 billion for private-credit shop HPS Partners. And the first two private-credit ETFs began trading this week: BondBloxx Private Credit CLO (NASDAQ: PCMM) and Virtus VPC Private Credit (NYSE: VPC).
The appeal of private credit is yield. Yields are high because private credit represents loans made to entities with risky finances, meaning they have to pay up for their borrowings. Most of the borrowers are small and medium-size companies, and fund managers pool the loans.
Private credit has taken off since 2008 as an alternative to fixed-income assets that were unappealing because of low interest rates.
The private credit market totaled about $2 trillion as of last year, double the total of just four years earlier, according to industry sources.
A Franklin private credit fund
Have a look at the Franklin BSP Private Credit Fund (NASDAQ: FBPAX), with $161 million of assets. It had a yield of 9.41% as of Sept. 30, compared to 3.81% for the 10-year Treasury.
Like almost all private credit funds, you can’t take your money out of Franklin’s fund whenever you want. That’s called an interval fund.
As of September, Franklin expected to offer to repurchase 5% of outstanding shares per quarter. That means you might be forced to hold your shares if too many people want to sell at once.
One could argue that selling limits are beneficial for investors because they allow fund managers to pursue assets that will appreciate over the long term. They won’t have to dump assets when a market shock causes a severe but temporary drop in asset values
But the selling limits also mean lower liquidity for investors. And, of course, there are plenty of fixed-income investments, including high-yield, that do have very high liquidity. “Investors have survived decades without semi-liquid securities in their portfolio,” says Michael Sheldon, an independent investment strategist.
Higher yields mean higher risks
Similar to any other high-return investment, private credit funds’ higher yields come with higher risks.
On the plus side, many of the loans in private credit funds are senior secured and/or collateralized. That gives investors a margin of safety should the loans go bad.
Also, by purchasing a private-credit fund, you’re getting automatic diversification because it consists of multiple loans. The Franklin fund cited above has more than 180 holdings.
To be sure, high-yield bond funds also give you diversification, and you can take your money out of them daily. Still, junk-bond fund yields aren’t as lofty as those of private credit funds, and the bonds aren’t collateralized. The Vanguard High-Yield Corporate Fund (NYSE:VWEHX) yields 6.01%.
Private credit loans generally have a floating interest rate, while high-yield bonds generally have fixed rates. That makes private credit funds more attractive when rates go up and makes high-yield bonds more attractive when rates go down. The Federal Reserve has cut rates for two straight months, but the future is unclear.
Determining whether you want to invest in private credit, like any other asset class, boils down to how much return you seek and how much risk you’re willing to take to get it.
