As the alternative investment landscape continues its rapid expansion, private credit is emerging as a significant growth story in its own right, often operating in the shadow of its more prominent cousin, private equity. This burgeoning asset class is democratizing access to sophisticated investment strategies, opening doors for individual high-net-worth (HNW) investors and registered investment advisors (RIAs) to capitalize on its unique opportunities. Andy Hagans, host of The Alternative Investment Podcast, recently sat down with Nelson Chu, founder and CEO of Percent, a leading private credit platform, to delve into the intricacies of this dynamic market.
The Shifting Landscape of Income Generation
Hagans opened the discussion by underscoring a fundamental investment principle: "income never goes out of style." This sentiment, he noted, resonates deeply within the current economic climate, where persistent inflation erodes the purchasing power of traditional savings. Nelson Chu wholeheartedly agreed, highlighting that the demand for consistent income streams remains a core driver for investors. In an era where even relatively high yields from Certificates of Deposit (CDs) and Treasuries struggle to outpace inflation, the pursuit of attractive risk-adjusted returns becomes paramount.
Nelson Chu’s Entrepreneurial Journey to Private Credit
Chu’s path to founding Percent is a testament to his entrepreneurial spirit and a nuanced understanding of market evolution. He described a non-traditional upbringing that steered him away from conventional career paths. While his initial foray into traditional finance provided valuable lessons in professionalism and process, it was his subsequent venture into a consulting company focused on helping founders build businesses that ultimately led him back to the financial sector, albeit through the lens of fintech.
"Finance, I just can’t quit you. Right?" Hagans quipped, mirroring Chu’s sentiment. Chu recounted his decision to leave finance in 2013 with a firm resolve never to return, a vow famously broken as he embarked on building Percent, a platform designed to tackle the complexities of private credit.
The Rise of Private Credit: A Post-GFC Phenomenon
The emergence of private credit as a distinct asset class is a relatively recent development, largely catalyzed by the 2008 Global Financial Crisis. In the wake of the crisis, traditional banks significantly curtailed their lending activities to consumers and small businesses. This vacuum created an unprecedented opportunity for non-bank lenders, often backed by venture capital, to step in and provide essential financing.
These non-bank lenders, lacking the balance sheets of traditional banks, rely on asset managers to provide the capital necessary to fund their lending operations. This symbiotic relationship has fueled the growth of private credit, transforming it from an esoteric corner of finance into a crucial engine of economic growth. Chu estimates the asset class has truly hit its stride over the past 12 to 14 years, explaining why many investors may not yet be fully familiar with its potential.
Private Credit’s Role in a Diversified Portfolio
The traditional 60/40 portfolio, once the bedrock of investment strategy, is increasingly being questioned in the current economic environment. Hagans and Chu agreed that the "60/40 model is most definitely dead" for many investors. Real estate has long been considered a primary alternative to stocks and bonds, offering tangible assets and income potential. However, the recent surge in interest rates has presented significant challenges for real estate funds, leading to increased redemptions and market volatility.
In contrast, private credit has demonstrated remarkable resilience. Large institutional players like Blackstone, KKR, and Ares, which manage both real estate and private credit funds, have observed private credit outpacing its real estate counterparts in both inflows and returns. PitchBook data from late 2022 indicated private credit ranked third in asset class demand, underscoring its growing appeal as a source of consistent, asset-backed returns.
Understanding the Two Arms of Private Credit
Chu elaborated on the dual nature of private credit, categorizing it into two primary arms:
- Asset-Backed Securities (ABS): This segment involves securitizing cash flows generated from interest-bearing assets, such as loans. Non-bank lenders, in both consumer and small business sectors, package portfolios of loans, creating structured products where investor principal is protected by advancing a percentage of the total loan value (e.g., 60%). Additional risk mitigation measures are incorporated to address potential defaults. Examples of companies operating in this space include SoFi, Affirm, Capchase, and Wayflyer.
- Corporate Debt: This arm involves lending directly to a single company, introducing single counterparty risk. Investments here can range from venture debt, backing early-stage, high-growth companies, to middle-market lending for established businesses. The risk-return profile can vary significantly, from high-yield opportunities with warrants in venture-backed companies to more stable, investment-grade-like loans for larger corporations.
Chu emphasized that while investors may not directly recognize these structures, they likely interact with private credit in their daily lives through "buy now, pay later" options, consumer loans, and small business financing.
Navigating the Risk-Return Spectrum
The risk and return profiles within private credit span a wide spectrum. On the asset-backed side, the yield can vary from single-digit returns for highly-rated, large-scale securitizations to higher yields for earlier-stage lenders with less established track records. Similarly, corporate debt can range from the riskier end of venture debt, offering potential equity upside through warrants, to more conservative middle-market lending.
"It really just runs a spectrum of high yield all the way to investment grade on both sides of the asset class spectrum of private credit," Chu explained. He noted that investors can typically expect an illiquidity premium compared to public credit products, with the size of this premium varying based on the perceived risk, structure, and borrower sophistication. A typical premium for investment-grade private credit might range from 50 to 150 basis points, widening significantly for higher-yield opportunities.
Institutional vs. Individual Investor Approaches
The investment approach to private credit differs between institutional investors and individual accredited investors. Institutional investors, bound by specific mandates and allocation buckets, tend to invest in larger chunks and often have more defined risk thresholds, typically seeking lower APY expectations on investment-grade opportunities.
Accredited investors, on the other hand, often seek higher yields, with a desire for returns in the mid-teens or higher to supplement their existing equity and alternative investments. However, Chu observed a recent shift towards a "flight to quality" even among retail investors, with an increased demand for lower-yield, hard-asset-backed investments that demonstrate strong risk management and low default rates.
The Percent Platform: Democratizing Private Credit Access
Nelson Chu founded Percent with the explicit goal of making private credit and alternative investments more accessible. The platform addresses several key barriers, including high minimums, short durations, and opaque deal structures.
"The design, the UI, the UX, the copy, all that stuff. They are phenomenal," Hagans remarked, praising Percent’s user-friendly website. The platform aims to simplify the investment process through a straightforward sign-up and accreditation verification, typically completed in under a day.
Percent offers investors several avenues to engage with private credit:
- Direct Deal Investment: Investors can select individual deals based on their preferences for asset class, sub-sector, and risk profile. To facilitate entry, Percent often features deals with low minimums ($500) and short durations (sub-nine months), allowing investors to "try before they buy."
- Blended Notes: For investors seeking a more diversified and hands-off approach, Percent offers "blended notes." These are thematic, diversified baskets of investments that algorithmically allocate capital across various opportunities, simplifying portfolio management and offering a "set-it-and-forget-it" mentality. Themes include total market, U.S. only, short duration only, and high yield only.
Transparency and Due Diligence: The Core of Percent’s Model
A cornerstone of the Percent platform is its unwavering commitment to transparency. Historically, private credit has been an opaque asset class, with limited visibility into underlying deal structures and performance. Percent aims to rectify this by providing investors with granular data and comparative tools, akin to those found in public markets.
"We have learned how to create almost like the market standard for a private credit," Chu stated. The platform offers detailed insights into factors such as advance rates, portfolio expected default rates, currency hedging, and cash control accounts. This level of disclosure empowers investors to make informed decisions at both the deal structure and asset performance levels.
Furthermore, Percent has implemented a public market-style execution process for its deals. Investors are given ample time (two to three weeks) to conduct due diligence and place "limit orders" specifying their minimum investment, maximum interest, and minimum APY requirements. This order book transparency allows underwriters and borrowers to gauge real-time market demand and price deals accordingly, ensuring a fair and efficient execution.
Impact Investing and Emerging Markets
Beyond traditional yield generation, Percent is also facilitating impact investing within private credit. The platform’s diverse range of sectors and geographies allows investors to align their capital with their personal values. Chu highlighted instances where investors have focused exclusively on international deals, particularly in emerging markets, to support the under-banked population and entrepreneurs.
"We have seen groups and individuals who basically say, ‘I only do international deals,’" Chu noted. These investors often prioritize lending to support banking capabilities for underserved populations, demonstrating the potential for private credit to drive positive social and economic change. The platform’s ability to offer exposure to these markets allows individual investors to participate in financing solutions that are a structural necessity, rather than a mere "nice-to-have," in these regions.
Outlook for Private Credit in a Changing Macro Environment
Looking ahead, the outlook for private credit remains robust, even as inflation shows signs of disinflation and interest rates stabilize. Prognosticators widely anticipate another strong year for the asset class, benefiting platforms like Percent that offer market-agnostic options across various sectors.
Chu anticipates continued demand for venture debt as companies navigate a more challenging equity financing environment. The ability to secure venture debt can serve as a crucial bridge to future funding rounds, enabling promising companies to weather economic downturns. On the asset-backed side, both small business and consumer credit are expected to perform, with small business credit potentially showing more stable performance in the current climate. Consumer credit, while facing increased debt levels, is expected to offer higher yields as compensation for the associated risks.
The Inherent Liquidity of Private Credit on Percent
Addressing a common misconception about private credit being inherently illiquid, Chu clarified that the Percent platform is designed to offer "inherent liquidity." This is achieved through shorter refinancing cycles on many of the deals, allowing investors to access their capital periodically. While not a traditional secondary market, this intermittent liquidity, combined with the option to invest in longer-term blended notes, provides a flexible approach for investors to manage their capital allocation.
In conclusion, private credit is no longer a niche investment reserved for the ultra-wealthy or institutional investors. Platforms like Percent are actively dismantling barriers to entry, offering transparency, choice, and accessibility. As the economic landscape continues to evolve, private credit stands poised to play an increasingly vital role in generating income, diversifying portfolios, and driving impactful change.
