RIAs considering more private credit in portfolios: Study

A recent survey conducted by Crystal Capital Partners, a wealth tech provider and alts platform, found that registered independent advisors are increasing their allocation to private credit funds.

A majority of the advisors surveyed are looking to reallocate some portion of their existing public fixed-income exposure to private credit, in particular direct lending, to take advantage of better risk-adjusted return expectations, diversification benefits, and the potential for higher yields.

In an interview with InvestmentNews, Alan Strauss, senior partner at Crystal Capital, said advisors are starting to see that not all private credit fund managers are created equal.

“The rationale, from an advisor standpoint, is that they’re giving up certain liquidity,” he said. “When you commit to a private credit fund manager, they are underwriting new loans based on capital … and as they underwrite these new loans, it gives the investor fresh new loans that they're exposed to.”

Strauss noted that private credit fund managers historically have always been able to deliver two important things. One is a premium above public fixed income, with the trade-off being illiquidity, “but you're still getting liquidity because they are distributing yield every single quarter, so it acts like a traditional bond,” he said.

“The second thing is when the managers do it with very low default rates. And that second part of the equation requires an assumption of trust, based on their historical track record” Strauss said.

Data from the survey show that more than 60 percent of advisors said they were planning to increase their exposure to private credit this year. Twenty percent said they had significant exposure to private credit within their client portfolios, while more than 45 percent said they had minimal exposure, and almost 30 percent said they had no exposure.

Of the advisors who said they weren’t  looking to increase their exposure, roughly 70 percent cited the perceived higher risk, and more than 45 percent said it was due to client preferences. Forty percent said it was due to lack of familiarity with private credit.

Strauss says one misconception advisors have about private credit is that they seem to put it in a “risk bucket."

“I've had many conversations with advisors that look at private credit, just like public fixed income, which is the softening element of the asset allocation. Why? Because there's predictability in the income. Again, when you find managers that have done it with very, very low default rates, or none, you understand what their process is all about.”

Chuck Failla, founder and CEO of Sovereign Financial Group, says that with interest rates being higher, private credit has become very competitive with equity while being less volatile.

Failla said his firm is also in the process of figuring out how best to deliver private credit to their clients. “We think most of our clients would benefit from exposure to private credit. But we're going to make sure that, wherever we give that exposure, it’s going to be in an account that that particular client doesn't need to touch for at least four or five years.”

He noted that in the past, while advisors have liked the idea of private credit, a lot of them passed on it because it was difficult to get in and out of it.  

“But now, technology has basically come up with ways of allowing advisors to get in and out more easily. That's what's driving a lot of this as well,” Failla added.

For advisors who are looking for more exposure to the world of alternatives and private credit, Strauss highlights three main levers to pull. There’s a liquidity part of alternatives, which at the core is hedge funds, he said. Second is an income component, which is where private credit fits in.

Finally, there's a growth component, in which different strategies, from venture capital to leveraged buy-outs, are placed in the private equity side.

To incorporate these strategies, and to do it effectively and in a scalable manner, Strauss recommends advisors find a partner that can help bring that level of expertise.

“A platform is really the way that things are moving now," he said. "It helps you deliver solutions, not just product, because it's up to the adviser to really be able to dissect everything that's happening in the industry.

“The most successful advisors I see are the ones that are able to manage clients, find expert solutions to surround their practice, be able to pull whatever levers they need to, and ultimately behave like institutions. Institutions have continued to be successful with their investment practices," he said. "We see why, when investors can mimic that, it's to their benefit.”

Strauss believes that the new asset allocation model is no longer 60/40 or 50/30/20, with a 20 percent allocation to alternative investments, but rather, 40/30/30, with a 30 percent allocation to alts. He says it's no longer anecdotal because “the data is there, and it’s proof positive.

“There is a good collection of managers that can bring continuously the streams of income that investors need and are doing it at a premium to risk-free or fed funds rates and are able to do it consistently because they've created amazing sourcing networks, they've done it in a repeatable way for decades and they've created institutions themselves," he said.

“Private credit, has without question, carved a place within client investment portfolios that want to have exposure to alternatives,” Strauss added.

Additional data from the survey highlighted factors that influence advisors’ decision to include private credit strategies in their investment allocations. The three most common answers were high yield potential, better risk-adjusted returns and diversification benefits.

Other reasons for investing in private credit included long-term investment horizons, where illiquidity was not a concern, inflation hedge and client demand.

The specific types of private credit advisors find particularly appealing, according to Crystal Partners’ survey, are direct lending, real estate debt, and mezzanine debt and special situations. Interestingly, more than 40 percent of advisors said they had no preference.