Why RIAs Should Consider Private Credit
After the arrival of fourth-quarter statements, many RIAs are likely addressing client concerns regarding the outlook for fixed income and the role it plays in client portfolios. RIAs are having to explain (yet again) that fixed income may help portfolios withstand a market environment characterized by low yields and rising interest rates.

One possible solution – and a topic for that conversation – may be summed up in two words: Private Credit.

As an asset class, private credit is well-established and projected to reach $1 trillion in global assets under management (AUM) by 2020,1 up from $638 billion in global AUM in June 2017.2

Private credit was, for a long time, the exclusive province of institutional and ultra-high-net-worth investors, who were able to capitalize on the unique market premium of this investment strategy. In recent years, however, private credit has become more accessible to a broader range of investors due to the growing availability of individual investor fund structures such as interval funds.3

Potential Benefits, Risks of Private Credit

Private credit funds offer investors the potential for substantially higher yields and income than what may be available in public corporate debt markets, albeit with heightened risk. Investors may receive little or no return on an investment in private credit funds due to their limited liquidity. Additionally, private credit funds employ a high degree of leverage (otherwise known as borrowing), which may also expose investors to increased risk and volatility.

Returns on direct lending have historically been less sensitive to changes in interest rates and have remained positive even during periods of rising rates, when returns on high-yield bonds and bank loans have turned negative. Exhibit 1

Exhibit 1: Private Credit vs. Public Credit

Private credit funds also offer investors the opportunity to earn an “illiquidity premium.” Unlike long-only open-end mutual funds, which have daily liquidity, private credit funds generally require investors to lock-up their capital for a specified minimum amount of time (e.g., monthly or quarterly redemptions; this time interval is also the derivation of the term “interval fund”). In return, investors may earn an illiquidity premium. Exhibit 2

Exhibit 2: Value of Illiquidity Premium

Advisors seeking opportunities to diversify client portfolios may also find that private credit offers a viable option.4 The yields available to investors in the private credit space have historically been higher than those available from other fixed income sources, including bank loans, high-yield bonds, and emerging market government bonds.5

Private credit provides an opportunity for RIAs to increase clients’ exposure to private markets and seek to further diversify client portfolios. Advisors know that the typical individual investor portfolio is likely to have a far lower allocation to alternatives, including private markets, than what institutional investors allocate to this important diversifying asset class. While industry research shows that the generally recommended allocation to alternatives for individuals ranges from 10% to 20%, the average is 3%. That compares with a 33% allocation to alternatives for the typical endowment portfolio.6

OppenheimerFunds, Carlyle Private Credit Venture

Earlier this year, as you may have heard, affiliates of OppenheimerFunds and The Carlyle Group formed a joint venture entity, OC Private Capital LLC, to focus on bringing private credit opportunities to high-net-worth investors and their advisors. The OFI Carlyle Private Credit Fund7 focuses on the so-called middle market – private companies with annual revenues between $20 million and $1 billion.

If you’re wondering why private companies, the answer is: That’s where we see the best opportunity set for investors. According to the U.S. Census Bureau, more than 99% of the roughly 6 million companies in this country are privately held.8 If these middle-market companies were a country, they would have a GDP of $5.9 trillion, making them the third largest economy in the world, trailing only the United States and China, and ahead of Japan, Germany, and the U.K.9

The Fund originates loans directly to businesses that cannot or do not want to access public markets for their capital needs, and across the major sectors of Carlyle’s credit platform, including:

  • Direct Lending – Loans and subordinated debt;
  • Opportunistic Credit – Opportunities that arise due to market dislocation or special situations;
  • Loans and Structured Credit – Broadly syndicated senior secured bank loans and negotiated tranches of Collateralized Loan Obligations (CLOs) and structured financings;
  • Liquid Credit – Debt, government or corporate, with robust, liquid markets; and
  • Distressed Credit – Debt and equity of operationally sound, financially distressed companies.

The Fund also seeks to meet clients’ needs by offering quarterly share repurchases and simplified Form 1099 tax reporting.

For a more complete overview of the OFI Carlyle Private Credit Fund, as well as an excellent analysis of credit markets and opportunities, I invite you to watch the replay of our recent webcast, “Inside the OFI Carlyle Private Credit Fund.”

I’m sure it will not only answer any questions you may have, but also help you answer your clients’ questions when they call looking for more robust fixed income portfolio strategies in this market environment.

 
  1. ^Source: “Private credit market to hit $1trn by 2020, survey says,” IPE.com, 11/12/18.
  2. ^Source: 2018 Preqin Global Alternatives Report.
  3. ^An interval fund is a type of investment company registered under the Investment Company Act of 1940, as amended, and the Securities Act of 1933, as amended, that periodically offers to repurchase its shares from shareholders. They are classified as closed-end funds, however, they typically do not trade on the secondary market and are permitted to continuously offer their shares at a net asset value (NAV).
  4. ^While this asset class may help provide added diversification for clients, the OFI-Carlyle Private Credit Fund is classified as non-diversified and investments are concentrated.
  5. ^Source: Annualized return from 1/1/05 to 12/31/17 represented by Bank Loan (S&P LSTA Leveraged Loan Index 4.8%), High Yield (Bloomberg Barclays U.S. Corporate High Yield Index 7.4%), and Private Credit (Cliffwater Direct Lending Index 9.7%).
  6. ^Source: Money Management Institute, Dover Financial Research. Endowment excludes marketable alternative strategies (hedge funds, absolute return, market neutral, long/short, 130/30, event-driven and derivatives). Retail allocation excludes liquid alternatives.
  7. ^The OFI Private Credit Fund is advised by OC Private Capital, LLC, and sub-advised by Carlyle Global Credit Investment Management, LLC.
  8. ^Source: U.S. Census Bureau, 2008.
  9. ^Source: U.S. Private Markets Gross Domestic Product (GDP) is as of12/31/17, as provided by the National Center for the Middle Market. Country GDP is as of 2017, provided by the International Monetary Fund.