Rather than a wholesale retreat, a selective approach to private credit may be more appropriate. Private credit remains an attractive investment allocation despite recent headlines that in our view misrepresent the asset class itself.
It’s easy to understand how we got here -- the industry’s success, evidenced by attractive returns from early adopters, led to an abundance of available capital and prompted concerns about looser lending standards, untested risk assumptions, and potential contagion risk, especially in the largest segment, direct lending. Though the two are often equated, the entire private credit market is estimated to be over $20tn versus the sponsor-backed direct lending market of ~$2tn.[1]
Given the scale of the market, its historical default experience, and yield premium that comes from lending against quality assets with strong underwriting and adequate illiquidity premiums, private credit remains compelling.
The $20tn+ private credit market includes lending to both sponsor and non-sponsor backed corporate borrowers, asset-based lending (often called lending to the 'real economy'), real estate lending, and a variety of small, esoteric markets. Within each of those asset classes exist investment managers of differing aptitude, resources, and size all of which play an outsized role in end outcomes to LPs relative to most liquid investments.
The main reason is the gap in market inefficiencies that still exist in many of these markets vs those in the public markets. While news headlines are flashing "warning signs" about private credit, we continue to see some private credit investors have historically achieved illiquid risk-premiums on their investments.
Today, new AI products have brought into question the assumptions backing software business models and the investment industry is reevaluating companies, products, and asset classes that are most exposed. As a go-to lender to PE backed corporations, the direct lending market is highly exposed to software companies that were assumed capable to take on more leverage than seems currently reasonable. Investors and the financial media realized this, leading to attempts to redeem from illiquid assets and heightened fears about further contagion risk to the broader financial markets.
We believe the solution is not to retreat from private credit but to invest differently within it. Just as direct lending is going through a rough patch, so too did real estate lending in 2022, and so will other asset classes, as is the nature of economic cycles. Illiquidity premiums still exist for investors who are willing to lean into private credit and its less trafficked, inefficient opportunities.
Investors that take a proactive approach by rotating into sectors with diversified collateral can, in our opinion, benefit from attractive long-term tailwind (subject to market conditions), such as in real asset debt and specialty finance. Broadening exposure in this way can enhance long‑term yields while reducing concentration risk.
Outsized returns in private credit do not come without risks. Private credit investments often have higher fees, less liquidity, and longer-time horizons to realize potential returns than public credit investments. Additionally, default risk and investment mistakes are still present and sometimes greater in private markets despite the relatively calm mark-to-market changes on portfolio valuations. Utilizing established private market investors experience and insights can help mitigate those risks.
Whether you are investing in private credit for the first time or reassessing existing allocations in this new environment, WTW has the experience to partner with you. Our dedicated team of private debt specialists has supported clients in selecting highly skilled managers, constructing compelling risk‑adjusted return allocations, and investing at scale.
By engaging with WTW’s private debt specialists, investors can identify high‑conviction strategies, negotiate favorable fee structures, and build diversified portfolios designed to meet evolving financial goals.
Footnote
- Apollo Global Management; Preqin Global Private Debt Report, January 2024 Return to article
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