As the alternative investment landscape continues its rapid expansion, private credit is emerging as a significant growth story, often overshadowed by the more prominent private equity sector. This burgeoning asset class is attracting increasing attention from sophisticated investors and their advisors seeking yield and diversification in a complex economic environment. Nelson Chu, founder and CEO of Percent, a leading private credit platform, recently joined Andy Hagans on The Alternative Investment Podcast to delve into the opportunities private credit presents for high-net-worth individuals and Registered Investment Advisors (RIAs).
The Growing Appeal of Private Credit
The narrative surrounding private credit’s rise is intrinsically linked to shifts in the traditional financial system, particularly following the 2008 global financial crisis. Banks, constrained by regulatory pressures and a recalibration of risk appetite, significantly reduced their lending to consumers and small to medium-sized businesses. This created a void that non-bank lenders, often financed by venture capital and other private capital sources, began to fill.
"Private credit as a well-understood asset class really hit its stride after the global financial crisis," Chu explained. "When banks really stopped lending to consumers and small businesses, you had this rise of nonbank lending that emerged. These are guys who probably raise VC capital, don’t really have a balance sheet since they’re not a bank, and they’re the ones kind of powering the growth of the broader economy as a whole without a balance sheet to do it."
This evolution has positioned private credit not just as an alternative, but as a critical component of the modern financial ecosystem, providing essential capital for economic growth. Its relative nascency, with its widespread adoption occurring over the past 12-14 years, contributes to why many investors may still be unfamiliar with its nuances, despite potentially interacting with its outcomes through various financial products.
Understanding the Private Credit Landscape
Private credit, at its core, involves lending to companies or assets outside of public markets. This can be broadly categorized into two main areas: asset-backed credit and corporate debt.
Asset-backed credit typically involves securitizing cash flows generated from interest-bearing assets, such as pools of consumer or small business loans. This segment has seen significant growth, fueled by the expansion of non-bank lenders like SoFi and Affirm, as well as newer entrants such as Capchase and Wayflyer. These platforms offer innovative financing solutions to businesses and consumers, and their loan portfolios can be securitized to provide investment opportunities. The structure of these deals often includes mechanisms to protect investor principal, such as advancing a percentage of the total loan value and incorporating risk mitigation strategies for defaults.
Corporate debt, on the other hand, involves lending directly to a single company. This can range from venture debt, where loans are provided to early-stage, often venture-backed companies with less immediate profitability but significant growth potential, to middle-market lending to established businesses. The risk and return profile in corporate debt varies widely, from high-yield scenarios for riskier ventures to more stable, investment-grade-like returns for larger, cash-flow-generating companies.
The spectrum of risk and return within private credit is extensive. While some deals might resemble high-yield bonds, others can offer the security of investment-grade debt, depending on the underlying collateral, the borrower’s financial health, and the deal’s structure. This inherent variability allows for tailored investment strategies to meet diverse investor objectives.
The Impact of the Macroeconomic Environment
The current economic climate, characterized by higher inflation and rising interest rates, has significantly reshaped the investment landscape, making private credit particularly attractive. With traditional fixed-income investments like CDs and Treasuries offering yields that often fail to outpace inflation, investors are compelled to seek alternative avenues for capital preservation and growth.
"Inflation is the silent killer," Hagans remarked, highlighting the erosion of purchasing power for cash holdings. "When inflation is 6%, 7%, 8%, 9%, arguably, it may be higher depending on where you live, you’re not beating inflation."
In this environment, private credit offers the potential for attractive risk-adjusted returns. The illiquidity premium associated with private investments, coupled with the inherent yields of lending to businesses, can translate into higher returns compared to liquid credit markets. While specific premiums vary, investors might expect an additional 50 to 150 basis points for investment-grade private credit, with this gap widening considerably for higher-yield opportunities.
Percent’s Platform: Bridging the Gap for Investors
Nelson Chu’s Percent platform aims to democratize access to private credit for accredited investors and RIAs, offering a transparent and user-friendly experience. The platform distinguishes itself through its emphasis on transparency, data standardization, and a unique execution process.
"Percent as a platform, the smallest deal we ever did was 50 grand," Chu stated, underscoring the platform’s accessibility. "And then we had a deal, the largest one we ever did was $144 million. So naturally, it kind of shakes itself out, from a bell curve standpoint, as to what each one is suitable for."
The Percent platform employs a rigorous underwriting process, with the company acting as the sole underwriter for its initial years to establish market standards. This involves detailed due diligence on each deal, focusing on structural integrity, asset performance, and borrower creditworthiness. Investors can access comprehensive data and comparison tools, allowing them to scrutinize deals down to granular details such as obligor count, portfolio expected default rates, and currency hedging for non-U.S. deals. This level of transparency is a departure from the historical opacity of private credit.
Furthermore, Percent has implemented a public market-style execution process for its deals, offering investors a two to three-week window to conduct due diligence and place orders. This "limit order" system allows investors to specify their minimum investment, maximum investment, and minimum Annual Percentage Yield (APY) they are willing to accept. This transparency in pricing and demand building empowers both investors and borrowers, ensuring that deals are priced appropriately for market conditions.
The platform also offers "blended notes," which function as diversified baskets of investments curated around specific themes, such as "total market," "U.S. only," "short duration only," or "high yield only." These notes provide a "set-it-and-forget-it" approach for investors seeking broad exposure without the need for granular deal selection. This product was developed in response to investor behavior observed on the platform, including one highly active investor who was meticulously selecting each individual deal.
Impact Investing and Global Reach
Beyond yield generation, the Percent platform facilitates impact investing, particularly in emerging markets. Chu highlighted how investors are increasingly drawn to opportunities that offer both financial returns and positive social or economic impact.
"We have seen groups and individuals who basically say, ‘I only do international deals,’ especially in emerging markets. And that’s very important for them," Chu explained. "They focus almost exclusively on consumer and the under-banked population and how they can actually support the lenders for providing capital and access for this population that desperately needs some sort of banking capabilities."
These emerging market ventures often address a fundamental financing gap, providing essential services to entrepreneurs and under-banked populations who are overlooked by traditional banking systems. This creates a compelling opportunity for investors to contribute to economic development while achieving competitive financial returns.
The Outlook for Private Credit
Looking ahead, industry projections suggest a strong year for private credit. As inflation potentially moderates and interest rates remain elevated, the demand for credit solutions is expected to persist.
"Private credit is number three in terms of demand and interest for it as an asset class in the latter half of 2022," Chu noted, citing PitchBook data. "That’s coming from the fact that there is a need to get consistent returns that’s really asset-backed at the end of the day."
In the venture debt space, the current environment, where venture capital funding has tightened, creates an increased need for alternative financing. Companies that can secure venture debt are better positioned to weather economic downturns and bridge to future equity rounds. Similarly, on the asset-backed side, both small business and consumer lending are expected to see continued demand. While consumer credit may present higher risks due to increased credit card debt and potential auto loan challenges, this translates into higher potential yields for investors willing to take on that risk.
The inherent liquidity provided by Percent’s platform, primarily through shorter refinancing cycles rather than a traditional secondary market, further enhances its appeal. This structure allows investors to access their capital more readily than with traditional private credit investments, which often feature long-term maturities.
"Inherent liquidity was really the answer here for us versus traditional private credit," Chu emphasized. "Investors go in and out all the time. Like, they like a deal. They like a sector. Now they fall out of favor with that sector. They back out."
In conclusion, private credit is solidifying its position as a vital asset class for sophisticated investors. With its ability to offer attractive yields, diversification, and increasingly transparent access through platforms like Percent, it is well-poised to continue its growth trajectory, catering to the evolving needs of high-net-worth individuals and RIAs seeking to navigate the complexities of the modern financial landscape.
