Private credit is an investment strategy where non-bank institutions, such as private equity firms, hedge funds, or specialized private credit funds, lend money to private companies or individuals. Unlike traditional bank loans, private credit offers more flexibility and can be tailored to meet the specific needs of borrowers. This type of financing includes senior secured loans, mezzanine debt, unitranche loans, and distressed debt.

Over the past 10 years, private credit has outperformed four of the main income-generating assets used by investors. In fact, it’s nearly double the returns of real estate, its closest competitor of the group.

Private credit investments are typically made through private credit funds, which pool capital from multiple investors to lend to private companies. These funds are managed by experienced professionals who analyze potential borrowers, structure loans, and monitor the performance of the investments. The goal is to generate attractive risk-adjusted returns for investors while providing essential financing to private entities.

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One example of a private credit fund is the Cliffwater Corporate Lending Fund. This fund offers access to corporate loans with lower minimum investments, allowing investors to participate in high-quality institutional investments without needing to commit a significant amount of capital. Another example is the Apollo Diversified Credit Fund, which provides a diversified portfolio of credit investments, including senior secured loans, mezzanine debt, and distressed debt. These funds offer investors the opportunity to achieve diversification and access unique investment opportunities.

Investing in private credit can offer several benefits, including higher returns compared to traditional fixed-income investments, diversification, and access to unique investment opportunities. Private credit funds can provide attractive risk-adjusted returns by lending to borrowers who may not have access to traditional bank financing. This can include small and medium-sized enterprises (SMEs), real estate projects, and other private entities.

Diversification is another key benefit of private credit. By investing in private credit funds, investors can gain exposure to a different asset class that is not correlated with public equity and bond markets. This can help reduce overall portfolio risk and enhance returns. Additionally, private credit investments can provide access to unique opportunities that may not be available through traditional investments.

Along with annual returns that consistently outperforms other income-generating assets, private credit’s volatility is lower as well. In fact, private credit delivers nearly the same returns as U.S. stocks with 75% less volatility. (Source: T. Rowe Price, 2023)

While private credit can offer attractive returns, it also comes with risks. One of the main risks is the potential for defaults by borrowers. Since private credit is often provided to entities that may not have access to traditional bank financing, there is a higher risk of default. Additionally, private credit investments are less liquid compared to publicly traded securities, meaning they cannot be easily bought or sold. This can make it more difficult for investors to access their capital when needed.

Another risk is the lack of transparency and regulation in the private credit market. Unlike publicly traded securities, private credit investments are not subject to the same level of regulatory oversight. This can make it more challenging for investors to conduct due diligence and assess the quality of the investments.