Five reasons to consider alternatives to private credit

Data suggests that at the current rate of deal execution, it will take almost five years to deploy committed capital. This raises concerns for investors and should prompt consideration of other options. For example, structured credit offers a similar risk/return profile to private credit—without some of the disadvantages.

Thinking about an allocation to private credit? Consider these points.

1. Liquidity concerns
   An allocation to a private credit fund and its drawdown model could take years to meet the desired target exposure. Plus, private credit is wholly owned, generally not syndicated, and trades by appointment, if at all. There is no formal secondary market, so unwinding an investment means finding a buyer, paying a transaction fee, and taking a liquidity haircut. Unlike private credit, structured credit trades in a relatively liquid secondary market with minimal latency to achieving target exposure levels. 
2. Transparency
   Private credit tends to lend to smaller companies. Investors are beholden to what the manager chooses to share about the private borrower. Conversely, a structured credit investment offers superior transparency by way of its credit rating and public financials.
3. Underwriting consistency
   There is dispersion in private credit underwriting quality. While the best funds do generally reliable underwriting, underwriting standards and covenants have loosened as more private credit managers compete with banks (on the upper end) and each other for deals. As banks begin to lend again and compete with the slew of new private credit entrants, it could lead to compressed spreads and less investor-friendly terms.
4. Structural risk mitigation
   Private credit managers call capital loan-by-loan. Often, in the upper-middle market, where the multibillion-dollar funds play due to their size, many loans are structured as uni-tranche deals, a hybrid loan structure that combines senior and subordinated debt into one debt instrument. These deals are newer and have not been fully tested by the bankruptcy courts, and may prove to be less investor friendly after the dust settles. Further, a portfolio of directly originated loans has no structural subordination, meaning that if any loan in the private credit portfolio defaults, the investor returns will be negatively impacted. In structured credit, securitization adds a layer of structural risk mitigation.
5. Similar return potential
   We believe the potential returns from an actively managed portfolio of collateralized loan obligation (CLO) debt and equity are on par with those of private credit. Just as yields look similar across these assets, historical returns do as well. 

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There are risks involved with investing, including loss of principal. Collateralized loan obligations (CLOs) and other structured finance securities may present risks similar to those of the other types of debt obligations and, in fact, such risks may be of greater significance in the case of CLO and other structured finance securities. In addition to the general risks associated with investing in debt securities, CLO securities carry additional risks, including: (1) the possibility that distributions from collateral assets will not be adequate to make interest or other payments; (2) the quality of the collateral may decline in value or default; (3) CLO equity and junior debt tranches will likely be subordinate in right of payment to other senior classes of CLO debt; and (4) the complex structure of a particular security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results.

CLOs are subject to liquidity risk. CLOs may invest in securities that are subject to legal or other restrictions on transfer or for which no liquid market exists. The market for certain investments may become illiquid due to specific adverse changes in the conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The market prices, if any, for such securities tend to be volatile and the Fund and CLO managers may not be able to sell them when it desires to do so or to realize what it perceives to be their fair value in the event of a sale. CLO portfolios tend to have a certain amount of overlap across underlying obligors.

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