Private credit has become an increasingly popular alternative investment for institutional and high-net-worth investors in recent years. As traditional fixed income investments like bonds offer low yields in a prolonged low interest rate environment, private credit provides the opportunity for higher returns. Investors can gain exposure to private credit through various investment vehicles and strategies. This article provides an overview of the different ways to invest in private credit along with their risks and considerations.
Private credit funds allow access to loans and securities in the private markets
Many institutional investors get exposure to private credit through private credit funds. These funds provide access to loans, bonds and other securities that are originated and issued in the private markets rather than through public exchanges. Private credit funds invest across the spectrum of credit products, including senior secured loans, mezzanine debt, distressed debt and direct lending. They generate income from interest payments and capital gains when holdings are sold. Investors need to consider factors like fund strategy, track record, sector focuses, leverage use and liquidity terms when selecting private credit funds.
Business development companies focus on private debt investments
Business development companies (BDCs) are specialized investment firms that provide investors exposure to private debt investments, predominantly senior secured loans made to small and medium-sized companies. BDCs manage diversified portfolios of private loans and generate income for investors primarily through interest payments on the debt investments. As publicly traded vehicles, BDCs offer the liquidity of equity investments combined with the income of debt instruments. Key factors for investors to evaluate are leverage limits, fee structure, track record and management quality.
Direct lending funds enable customized private credit exposure
For qualified investors seeking more control over their private credit allocation, direct lending funds are an option. These funds provide customized access to private credit markets by working with investors to determine desired sectors, risk tolerances and return objectives. Direct lending funds originate loans alongside banks and other institutions. They offer the potential for higher returns through direct ownership of private debt but also come with lower liquidity than traditional private equity funds. Thorough due diligence is critical when investing in direct lending vehicles.
Co-investing allows participation in specific private deals
Large institutional investors sometimes pursue co-investments in private credit deals. This involves partnering with a private credit fund manager to invest directly in a specific loan or security originated by the fund. It allows greater control over investment selection and potentially better economics since fees are lower than investing solely in the fund. However, it requires significant resources to source and conduct due diligence on co-investment opportunities. And it results in a less diversified private credit portfolio with exposure concentrated in particular deals.
Managed accounts enable customization of private credit exposure
High-net-worth investors and family offices can get tailored private credit exposure through managed accounts run by specialized credit managers. Managed accounts allow investors to customize investment guidelines, reporting requirements and fee structures. The manager oversees the account and makes investment decisions on behalf of the investor in accordance with agreed parameters. While managed accounts have higher minimum investments than funds, they provide control over liquidity options, tax treatment and transparency.
Private credit encompasses a diverse range of debt investments focused outside the traditional banking system. For suitable investors, it offers the potential for portfolio diversification and attractive risk-adjusted returns. Various investment vehicles provide access to private credit markets, from private funds to BDCs and direct lending. Investors must weigh factors like liquidity, risk tolerance, required resources and control preferences when selecting optimal ways to invest in private credit.