There has been a lot of noise and data around private credit – part of a wider expansion of non-listed financial activity – and the wealth sector is getting its fair share of sales pitches. The private market sector may have much to commend it. But this isn't a straightforward area, and we talk to wealth managers about the evolving field.

It is rare that a day goes by without a wealth management firm enthusing about private credit, and non-listed market opportunities more generally. 

It is easy to see why. A decade of ultra-low rates (now over) and a structural shift from listed to private markets, have fueled rapid growth. Low rates meant that investors tolerated illiquidity in private markets to grab returns. Tighter capital rules on banks after the 2008 crash pushed money into alternative spaces. Another reason for all this ferment is that fees for private funds can be 1 to 2 per cent for the annual management fee, with an incentive fee of 15 per cent above a certain threshold. It’s not surprising that funds’ general partners are keen to promote their wares, given the revenues on offer.

The sector is still a relatively new one for RIAs, multi-family offices and others, although not as obscure as it once was. According to the International Monetary Fund, assets under the management (deployed and committed) of private credit managers in the US reached $1.6 trillion in June last year, growing at an average annual rate of 20 per cent over the last five years. Private credit now accounts for 7 per cent of the credit to non-financial corporations in North America, comparable with the shares of broadly syndicated loans and high-yield corporate bonds.

As reported here, the IMF is getting nervous about where this strong growth will end up. It thinks trouble may be brewing. However, another concern that the IMF doesn’t address in its Global Financial Stability Report (April 2024) is whether enthusiasm for private credit clashes with clients’ best interests if they don’t understand the asset class’s pros and cons.

“They [private assets] have a really important role and they can add significant value to portfolios, but only if the right behaviors have been set,” Michael Zeuner, managing partner, US-based WE Family Offices told this publication. (Zeuner is also a member of Family Wealth Report’s editorial board.)

"With private market funds, investors should expect a premium, after fees, of 200 to 300 basis points to compensate for illiquidity," he continued. “With the use of feeder funds and other structures, this can add as much as 200 bps in fees over the life of an investment – there goes the illiquidity premium!” Zeuner said.

Unless advisors work through the impact of such fees and other costs with clients, then investors would probably be better off sticking to public markets, Zeuner said. 

“It is a nuanced conversation. Even with diversification [of private market assets], the question is 'do you have tolerance for private market investment and do you have the capacity?'” he said. 

While private credit funds can mature within, say, three to five years, certain sectors, such as venture capital, can take up to 15 years. Such investments come with capital calls. Also, they typically have a “J-curve” pattern – initial negative returns when money is deployed, followed (hopefully) by positive returns when investments are exited, Zeuner said.

Getting in the front door
As this news service heard recently at a funds conference in Luxembourg, investment houses are trying to create structures that don’t hold daunting requirements such as capital calls and are relatively easy to access. 

Examples include “evergreen,” aka “perpetual” funds, which firms such as Blackstone offer (see here). Policymakers in the UK, to give another example, have come up with the idea of the Long-Term Asset Fund. A tricky issue is ensuring that retail/mass-affluent investors’ expectations for liquidity don’t veer from the underlying assets. There have been cases, such as with open-ended real estate UK funds, where demands for rapid cash could not be reconciled. This kind of outcome scares regulators.

That said, market infrastructure is developing fast. Firms such as New York-headquartered iCapital, or CAIS (also in the US) and Moonfare (Germany), provide tech platforms over which alternative funds can be brought to market more efficiently than in the past. There is also an expanding market in secondaries – buying and selling private market stakes. Meanwhile, jurisdictions such as Guernsey, in the Channel Islands, have developed new markets to buy and sell shares in unquoted firms.

Framing expectations
Helping wealthy clients grasp what private markets can – and cannot do – is part of the job description of Alona Gornick, managing director, senior investment strategist, and co-head of the Chicago office of Churchill Asset Management, a US firm. 

In the future, private credit will be “broader, larger and a core part of a private client portfolio. This evolution will mirror what we have seen occur with many larger institutions,” she told FWR. 

On her trips around the US, Gornick said advisors are “curious, engaged and leaning in to learn more about private credit. There is a lot of interest in private credit and from my purview, it’s more positive and intrigued than unsure or uncertain.”

With end clients, some sit back and let advisors manage their investment strategy; other clients are more hands on, she said. 

Wealth managers continue to argue that if they don’t have private market know-how and offerings, this will hobble business growth, and deny clients the necessary exposure to drivers of return. For example, in late March, Robert Picard, managing director and head of alternative investments, Hightower Advisors, told FWR that the shift toward private market investment must happen. “We now know that portfolios with large allocations to alternative assets tend to deliver better risk-adjusted returns,” Picard said. “Clients have to be rewarded with higher risk-adjusted returns in exchange for [taking] accepting that illiquidity.”

The structure of American capitalism, in terms of how firms are owned, has shifted. There are fewer firms listed on US exchanges. In 1976, the US had 4,943 firms listed on exchanges. By 2016, it had only 3,627 firms. From 1976 to 2016, the US population increased from 219 million to 324 million, so the US went from 23 listed firms per million inhabitants to 11. (Source: National Bureau of Economic Research, 2018.) Instead, privately-held firms have become more significant. However, for years investors have had to put up at least $1 million to enter private equity – sometimes far more.

A survey of US advisors found that more than 20 per cent of them had "significant" exposure to private credit within their client portfolios; more than 45 per cent said they had "minimal" exposure. Almost 30 per cent said they had no exposure. And 60 per cent said they were looking to increase exposure to private credit this year, according to the report published yesterday by Crystal Capital Partners. (The business is a wealth-tech provider and turn-key alternative investment platform for financial advisors.)

Low digits
It is widely remarked that for many wealth management clients, exposure to private market assets remains in the low single-digits, percentage-wise. CAM’s Gornick said portfolio exposure is around 2 to 3 per cent. Large institutions often have as much as 20 to 25 per cent allocated to alternatives, with private credit accounting for 5 to 8 per cent of all portfolios.

A word that regularly comes up is “access”
“There has been incredible momentum toward more accommodating fund structures,” Gornick said, talking about registered entities such as perpetual/evergreen structures. “They have been a focus for managers, providing even more optionality and education opportunities to the retail investor community.”

In some of these vehicles, investors can acquire an entry ticket for just $2,500, she said. 

Gornick mentioned the entity known as Business Development Company. BDCs were created by Congress in 1980 as an amendment to the Investment Company Act of 1940, to encourage the flow of capital to private, mid-sized businesses in the US. 

Publicly listed BDCs will have analyst coverage. With private funds, meanwhile, technology platforms for such alternative investments, provide considerable due diligence and scrutiny, she said. 

Asked about fees, Gornick said with BDCs, annual management fees are typically 125 bps, some are as low as 75 bps; incentive/performance fees range from 15 to 20 per cent. Churchill aims to be on the lower side of the fee range, she added.

Gornick said that when talking to advisors, discussions typically focus on default/loss experience and expectations, impact of competition on spreads and yields, key differentiators within segments of private credit and liquidity flexibility. 

Gornick is bullish on the private credit sector’s growth.

“We believe the industry will continue to grow significantly – in many ways due to the influx of capital coming from the retail investor community. Preqin estimates that private credit AuM will hit $2.8 billion by 2028, up from $1.7 billion today. As a result, I think young professionals will continue to be interested in joining and being a part of this burgeoning asset class,” she said.  

Bespoke tailoring
WE Family Offices’ Zeuner said he and his colleagues look at the specific circumstances of each client – liabilities and assets, goals, tolerance for loss and illiquidity – before starting to consider whether private market investments are a good fit or not.

A key issue is a client’s capacity for illiquidity, Zeuner said. A situation to avoid is for a client to be a forced seller of such assets if they fall short of cash, for example. The size of fund commitments must be understood. “We have heard stories of investors forced to sell private funds on the secondary markets for a 20 to 50 per cent per cent discount,” he said. 

Another important question is how much leverage is a client using within a portfolio and generally the more leverage being used the more careful an investor has to be about investing in illiquid assets. And finally, it is important to know how much comfort a client might have in locking capital away for a decade or more, Zeuner said.

Different appetites
Some WE Family Offices clients may have up to 30 per cent of all assets in the private markets space, and others will have far less than that.

Matt Farrell, who leads the alternative investment research efforts at WE Family Offices, said he and his colleagues are “hyper-focused on creating bespoke portfolios for clients” because clients’ circumstances can differ widely, including their likely need for liquidity, age, commitments and other factors. 

Asked about specific sectors, Farrell said areas he likes include real estate debt (with some exceptions) because equity-like returns could be obtained without unduly stretching credit quality. He also uses hedge funds when appropriate for clients. Farrell said enthusiasm for direct investing – bypassing a fund structure completely – has declined somewhat, after challenges in areas such as VC cooled enthusiasm when interest rates rose.