Private credit investments attractive, say banks, but with caveats
Diversification risks, market bifurcation and interest rates are among the factors to watch
[SINGAPORE] Financial stress may be elevated in some segments of private credit, but returns for the asset class have remained respectable this year.
Private banks maintain that private credit remains attractive, but investors have to be wary of the caveats. These include lower interest rates, which are likely to dampen returns. Private debt is typically floating rate in nature.
Andrew Tan, Muzinich & Co chief executive for the Asia-Pacific and head of private debt, points out other risks in a market that is less regulated and less transparent than public debt.
One is the challenge of diversification, which may not be immediately apparent even when one invests in large and well-known managers. “The bulk of capital raised from retail has been directed towards US upper-middle market or large-cap financial sponsor direct-lending transactions,” he said. “Many general partners (GPs) might be chasing and invested in the same deals.”
He added: “Investors who think they are getting diversification by investing across different managers may be exposed to concentration risk; this is something that may not be evident at the first instance.”
Zain Bukhari, S&P Global associate director in risk and valuations, pointed out a similar concern in a report. “A small cohort of dominant private fund managers controls a significant portion of the market, frequently co-investing in similar deals or across each other’s funds. This concentration limits retail investors’ ability to achieve adequate diversification, increasing portfolio risk.”
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Hartmut Issel, UBS Global Wealth Management’s Asia-Pacific head of equity and credit, said direct lending delivered solid returns in the first half, but increasing market bifurcation and the outlook for interest rates “point to a more balanced risk-reward profile ahead”.
He added that investors should be mindful of factors such as anticipated rate cuts which will weigh on returns. Another factor is tight spreads, as “competition from the broadly syndicated loan market maintains pressure on spreads”.
On defaults, he said: “While industry-level credit metrics remain healthy and risks are broadly contained, market bifurcation is intensifying, with rising stress in the lower-middle market.” He said the upper-middle segment is healthy, but the lower-middle market shows signs of weakness.
Chee Jiun Wen, Bank of Singapore head of alternative investments, said private credit returns “have been punching above their weight in the past few years with the spike in short-term interest rates”. “We anticipate returns will normalise as base rates come down and (we) see increased competition in this space,” he added.
He expects the asset class to continue to grow. “Investor desire for added portfolio diversification, the retrenchment of bank lending, and borrower preferences for more customisable loans likely will continue to drive the expansion of the private credit market in the years to come...
“Manager selection is vital in private credit, as skilled managers have a disciplined approach to underwriting creditworthiness; they have a track record of mitigating non-accruals and workout experience.”
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