Understanding the Risks and Rewards of Investing in Private Credit

What Is Private Credit?  Private debt, or private credit, is the provision of debt finance to companies from private lenders like individuals or private debt funds, rather than banks, bank-led syndicates, or public markets. In established markets, such as the...

What Is Private Credit? 

Private debt, or private credit, is the provision of debt finance to companies from private lenders like individuals or private debt funds, rather than banks, bank-led syndicates, or public markets. In established markets, such as the US and Europe, private debt is often used to finance buyouts or real estate developments. It is also used as expansion capital or to finance acquisitions. 

Private debt expanded rapidly after the Global Financial Crisis (GFC), when banks, due to their capital constraints, curtailed their leveraged lending and concentrated corporate operations on larger clients, creating a gap in the market that private fund lenders filled. 

Private debt funds pursue a range of strategies, for example, direct lending, venture debt, or special situations financing. They characterise their activities by the type of debt provided which includes mainly senior, junior, or mezzanine loans. Lending private debt can be to both listed or unlisted companies, as well as to real assets such as infrastructure and real estate. 

The Rewards of Investing in Private Credit 

Private credit offers an attractive risk-return profile, outperforming public loans and enhancing overall returns for investors. Let us explore some of the compelling reasons as to why this asset class is on the rise. 

  • Attractive Risk-Return Profile – Private credit, a critical source of financing provided by non-bank lenders, has been outperforming public loans over the last decade. This is attributed to reduced liquidity, loans to small and mid-sized companies, and the complexity of originating, underwriting, and structuring private loans. This premium may enhance overall returns for investors with longer time horizons. 
  • Diversification Benefits – Private credit loans are not publicly traded and are typically valued on a quarterly basis, insulating them from short-term market volatility. With little exposure to panic selling, investors can focus on the performance of individual businesses instead of market sentiment. The low correlation with publicly traded investments helps shield returns from wider market disruption. 
  • Resilience and Income-Generating Abilities – Private credit has demonstrated resilience during challenging periods, such as the COVID-19 pandemic. Calendar year returns for private credit in 2021 were 9.90%, compared to its public benchmarks at 5.28% for the Bloomberg High Yield Bond Index and 5.20% for the S&P/LSTA Leveraged Loan Index. * 
  • Potential for Higher Returns Than Traditional Fixed Income – In a rising rate environment, traditional fixed income investments may struggle to meet return and yield targets. Private credit, however, can be a meaningful complement to an individual investor’s portfolio, offering enhanced returns, lower volatility, and higher resilience. 

Assessing the Risks of Private Credit 

While this sector offers potential for high returns and portfolio diversification, it also comes with certain challenges such as credit and default risk, illiquidity, market volatility, and regulatory concerns. Let us explore these risks in more detail. 

  • Credit and Default Risk – Private credit investing is directly tied to the success of the business. Capital deterioration can impact the value of your investment and increase risk. If the company fails, it may default on the loan, leading to potential losses. 
  • Illiquidity and Lock-Up Periods – Private credit is a highly illiquid investment, meaning it can be challenging to sell these investments without facing a significant loss. It is important to understand from the outset that debt investing is a long-term commitment. 
  • Market and Economic VolatilityPrivate credit investments are susceptible to market and economic volatility. Businesses seeking out private credit often have weaker credit profiles, having been denied lending by other financial institutions. This increases the risk of defaulting on the loan. 
  • Regulatory and Legal Risks – The private debt industry has lower underwriting standards than traditional lenders, such as banks and credit unions. These standards are designed to protect lenders, so a lack of lofty standards increases the risk level for investors. It is crucial to ensure that any private debt contract follows all legal and governmental regulations. 

Despite the inherent risks, private credit investing presents a unique opportunity for diversification and potentially higher returns. With careful risk assessment, strategic planning, and the right expertise, investors can navigate these challenges and leverage the promising potential of this dynamic market. 

Mitigating the Risks in Private Credit 

In the dynamic landscape of private credit investing, understanding and mitigating risks is paramount. As we navigate through this section, we will explore some of the best practices that help fund managers manage these risks effectively. 

These strategies range from building a centralized information repository to strengthening internal valuation processes, and from advancing analytics to collaborating with private equity sponsors. Let us delve deeper into these strategies. 

  • Building a Centralized Information Repository – Private credit asset managers are increasingly adopting the practice of a centralized “information repository” to enhance portfolio surveillance and reporting. These repositories store and track key information about each investment, such as financial performance and debt covenants. By maintaining a centralised information repository, asset managers can track key investment metrics constantly, immediately spot potential issues and take appropriate action to mitigate them. 
  • Strengthening Internal Valuation Processes and Advancing Analytics – Private credit asset managers are increasingly turning to domain-led third-party valuation service providers to improve the frequency, accuracy, and scale of valuations. The usage of advanced analytics, machine learning and increasingly generative artificial intelligence, has allowed firms to analyse large data sets and identify trends, thereby boosting the accuracy of their assessments. 
  • Collaborating With Private Equity Sponsors – Private lenders are increasingly looking to finance large private equity takeovers, taking advantage of the withdrawal of investment banks and banking players from the market. This collaboration can also lead to the adoption of innovative practices that improve the due diligence process, as private equity sponsors have access to advanced analytics tools that private credit firms can leverage. 

In conclusion, while private credit investing comes with its share of risks, these can be effectively managed with the right strategies. By adopting best practices such as centralized information repositories, advanced analytics, and collaborations with third-party entities, private credit firms can not only mitigate risks but also optimize performance and gain a competitive edge in the market. 

The Promising Landscape for Investments 

Doing well in private credit is about measuring investment risk correctly, making sure it is priced right, and handling changes in risk throughout the investment’s life. As SafeRE expects more variety in private credit in the future, choosing investments wisely, structuring them carefully, and negotiating terms firmly will be key to making more profit. 

Just like an iPad, private credit has become a must-have tool, finding new uses every year. In today’s market conditions, it has the potential to do well even when faced with new and unique challenges. 

Start your Private Debt Investing Journey with SafeRE 

From this guide, we learned that investment in Private Credit Market can be a valuable addition to a mature portfolio, complementing private equity, as it offers attractive risk-return profiles, diversification benefits, and income-generating abilities with lower volatility. Most returns come from reliable income streams, and investors can benefit from predictable and contractual returns based on the interest rate charged. Moreover, private credit’s floating rates allow investors to capitalize on rising interest rates, delivering higher returns compared to traditional fixed-income and equity markets. 

Foreseeing that, SafeRE has revolutionised direct access to these quality real estate investments by reducing fees and offering a seamless and transparent investment process. SafeRE’s real estate investment platform provides access for investors to funds that exhibit steady performance over the years, with lenders enjoying flexibility in setting preferred lending terms and greater influence in structuring loans with collateral and financial covenants to mitigate risks for their investment. SafeRE introduces more efficient ways to build your wealth. For more information on investment opportunities and innovative financing solutions, feel free to reach out to us or directly access your account on the SafeRE platform.

Disclaimer: This is not an advertisement making an offer or calling attention to an offer or intended offer for the purchase or sale of securities, units in a collective investment scheme or any other financial product. Neither this article nor anything contained herein shall form the basis of any contract or commitment whatsoever and should not form the basis of any investment decision and should not be considered as advice or recommendation by SafeRE Pte. Ltd. (“SafeRE”), its affiliates, representatives, directors, managers officers, employees, agents, to acquire any investment product. 

The information contained herein is for informational purposes only and should not be construed as financial advice or a recommendation or an endorsement of any particular investment or investment portfolio or strategy. Nothing in this material has been independently verified to ensure its accuracy and fairness. Nothing in this material should be relied upon as a representation or warranty on any matter. In considering the suitability of any investment or other product mentioned herein, recipients of this material should bear in mind that past performance is no guarantee of future results, and any forward-looking statements, predictions or projections are subject to market influence and matters outside the control of SafeRE. Recipients should consult their own advisors. This article is confidential and may not be copied, distributed, or reproduced in any form for any purposes without prior consent provided by SafeRE. SafeRE is neither licensed nor regulated by the Monetary Authority of Singapore and does not manage, advise, or distribute any investment product nor provide any financial advice to anyone.