Private credit is going through a golden era, according to its fans, but a handful of asset managers are refusing to be dazzled by the biggest part of the booming $1.5 trillion market: direct lending.
Swiss Life’s investment arm and Scotland’s Baillie Gifford are avoiding the direct-lending craze in part because of transparency fears, a lack of liquidity and the good returns on offer elsewhere. Abrdn Plc says it lends to investment-grade borrowers, but not to the riskier companies that make up much of this market. The three firms manage about $1 trillion combined.
Their caution runs counter to other large funds, which are scrambling for a piece of the private-debt action in the hope that high fees will juice their profits and stop investor outflows. Swiss Life Asset Managers and Baillie Gifford say the returns on company loans aren’t hefty enough to make up for the difficulty of trading them compared to other asset classes.
“We don’t think there’s much of an illiquidity premium any more on private assets in general,” says Daniel Holtz, Swiss Life AM’s head of credit, in an interview with Bloomberg. “Especially when you consider what the private equity shops have paid for and the leverage they employ, it’s difficult to see those deals working with a higher cost of capital.”
Torcail Stewart, an investment manager at Baillie Gifford’s Strategic Bond Fund, says there are now “ample opportunities” to buy easily tradeable junk and investment-grade bonds “at low cash prices on very appealing yields.”
“The ‘search for yield’ days are over,” he adds. “So why chase more illiquid instruments like loans?”
Direct-loan funds — which typically lend cash straight to midsize companies that are private equity-owned or have riskier profiles — have proliferated in Europe and the US since the financial crisis, becoming an important financing source. They’ve mushroomed as banks have become wary about lending.
Many stock-and-bond managers, whose fees are under pressure from passive funds, are rushing into the market, attracted by loans that pay a floating rate and a chunky premium on top, pushing yields toward the mid-teens.
Fidelity International has made a raft of hires. T Rowe Price, PGIM and Nuveen have acquired firms. Janus Henderson Group Plc and Deutsche Bank’s asset manager DWS Group are looking to buy. Even BlackRock, the biggest asset manager and ETF provider, has shaken up its alternative assets business and focused more on private credit.
Some banks are also dipping a toe into the market. Societe Generale is launching a €10 billion fund with infrastructure giant Brookfield Asset Management, while Barclays is following JPMorgan Chase & Co. by using balance sheet cash to compete with private-credit funds.
However, the difficulty of selling illiquid loans is a red line for investors wary about locking up capital for five to six years, the average term in direct lending. While a secondary market has evolved, it’s hard to trade out of private-credit portfolios before loans mature. “If a company’s circumstances change, a public bond can be more readily exited,” says Stewart.
Albane Poulin, head of European private placements at Abrdn, says “investment-grade” private credit is more of a fit for firms like her own with lots of insurer clients. Direct lending to riskier companies is “better suited to alternatives managers, wealth, retail investors and pension funds,” she adds. “It’s just on a different part of the risk spectrum.”
Abrdn has £12 billion ($14.9 billion) of private-credit assets split between commercial-property debt, investment-grade placements, fund finance and infrastructure debt. Swiss Life AM has almost €15 billion ($16 billion) in alternative investments, though nothing in direct lending. Baillie Gifford is a growth investor in equities and bonds, but not private credit.
Some critics worry, too, about how private-credit funds will cope with a bankruptcy wave as there’s little historic data on hand. While lenders like floating rates, many loans were inked when rates were low, putting pressure on borrowers. “Every provider of private-debt instruments will tell you they’ve a database and a good track record,” says Holtz. “But that’s a single data point from that investor. It’s not comparable to any other metric.”
The market’s holding up, so far. Proskauer’s Private Credit Default Index, which tracks senior secured and unitranche loans in the US, showed a default rate of 1.64% for the second quarter of 2023, lower than Fitch’s 2.8% rate for US junk defaults. There’s no equivalent European data.
“Deflation of the asset bubble still has to take place,” says Pieter Rommens, Swiss Life AM’s head of senior secured loans. “It’s potentially true for private credit that higher refinancing costs will work their way through over time. The default cycle may be less of a spike and more of a slow burn.”
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