The alternative investment industry has experienced a significant surge in assets under management, with private equity often capturing the lion’s share of attention. However, private credit is emerging as a formidable growth story in its own right, offering compelling opportunities for investors seeking income and diversification. Nelson Chu, founder and CEO of Percent, recently sat down with Andy Hagans of AltsDb’s "The Alternative Investment Podcast" to discuss the burgeoning private credit market and how high-net-worth individuals and registered investment advisors (RIAs) can leverage this asset class.
The Growing Appeal of Private Credit
Private credit, broadly defined as debt financing provided by non-bank lenders, has witnessed a dramatic expansion, particularly in the wake of the 2008 global financial crisis. As traditional banks scaled back their lending activities, a new ecosystem of non-bank lenders emerged, fueled by venture capital and institutional investment. These entities now play a crucial role in financing small businesses and consumers, powering economic growth without the constraints of traditional banking balance sheets.
"Income never goes out of style," declared host Andy Hagans, setting the stage for a discussion centered on generating consistent returns. Nelson Chu wholeheartedly agreed, emphasizing that the demand for reliable income streams remains a constant, even amidst evolving market conditions.
Chu’s own journey into private credit is a testament to the often circuitous paths entrepreneurs take. Initially rebelling against a traditional path, he pursued entrepreneurship, founding a consulting company that advised startups. This led him into the fintech space, and despite attempts to steer clear of finance, he found himself repeatedly drawn back. "I quit my last job in finance in 2013 and I was, like, I will never do finance ever again. And those are very, very famous last words," Chu quipped, reflecting on the trajectory that led him to co-found Percent.
The genesis of Percent, Chu explained, was a perceived gap in the market: making private credit and alternative investments more accessible to a broader range of investors. This involved addressing traditional barriers such as high minimum investment thresholds, long lock-up periods, and limited transparency.
Navigating the Current Economic Climate
The current economic environment, characterized by persistent inflation and rising interest rates, has amplified the importance of strategies that can outpace the erosion of purchasing power. While traditional safe havens like Certificates of Deposit (CDs) and Treasuries now offer more attractive yields, they often fall short of matching inflation rates, particularly when considering the impact of taxes on nominal returns.
"Having a lot of dry powder, having a lot of cash, when inflation is 2%, you can kind of squint and round that down to zero, right? But when it’s 6%, 7%, 8%, 9%, arguably, it may be higher depending on where you live," Hagans observed. Chu concurred, noting that even current yields on CDs and Treasuries of 4-6% are insufficient to outpace inflation, necessitating a search for alternative avenues to preserve and grow wealth.
The conversation highlighted the critical role of tax efficiency in wealth management. For high-net-worth individuals and family offices, the net return after taxes is paramount. Investments that offer tax advantages or generate returns that significantly outpace inflation are crucial for maintaining and growing generational wealth.
The Case for Private Credit in a Diversified Portfolio
Despite the growing presence of private credit, a significant portion of high-net-worth investors remain uninvested in this asset class. Hagans questioned whether private credit belongs in every portfolio. Chu responded by contextualizing its recent rise.
"Private credit as a, well-understood asset class that’s really kind of hit its stride, didn’t really happen until after the global financial crisis," Chu explained. The post-2008 banking landscape spurred the growth of non-bank lending, which in turn fueled demand for private credit. This relatively recent development means many investors are still unfamiliar with its intricacies, even though they may have indirectly interacted with it through various financial products.
The traditional 60/40 portfolio model, which allocates 60% to stocks and 40% to bonds, is increasingly being viewed as outdated. Chu suggested that the sheer number of investable asset classes now available necessitates a more diversified approach. Real estate has historically been a popular alternative, but sophisticated investors are increasingly recognizing the dual opportunities in both private equity and private credit.
"More sophisticated managers, I think they’re kind of playing on both the equity side, but also the credit side," Hagans noted. "And I think they look at it almost, like, we want to be flexible. And a certain year might be more of a year where we want to put equity to work. And then there might be other environments where actually we’re more bullish on credit right now."
Chu elaborated on this synergy, stating that the credit side often relies on the equity side, allowing managers to influence investment outcomes by participating in both tranches. This integrated approach offers a robust strategy, particularly in volatile market conditions.
Understanding the Private Credit Spectrum
Private credit is not a monolithic asset class; it encompasses a wide spectrum of investment strategies and risk profiles. Chu outlined two primary arms: asset-backed credit and corporate debt.
Asset-backed credit involves securitizing cash flows from interest-generating assets, such as pools of consumer or small business loans. These structures can offer principal protection by advancing a percentage of the total loan value and incorporating risk mitigation strategies.
Corporate debt, on the other hand, involves lending to a single company, introducing single counterparty risk. This can range from venture debt, backing early-stage, high-growth companies, to middle-market lending for established businesses generating substantial free cash flow.
The risk-return profile varies significantly within each category. Early-stage lenders or venture debt providers might command higher yields due to increased risk, while larger, more established companies seeking securitization for their loan portfolios could secure lower costs of capital, akin to investment-grade public debt.
"There’s always the, call it the triple C’s of the world in the lower middle market range that is in ABS and corporate debt," Chu explained. "Like, you could have a very early-stage lender… Versus a company that is about to go public that has done several billion dollars’ worth, they need a $500 million securitization. They can get it rated by a rating agency. That’s gonna get single-digit cost of capital."
The Illiquidity Premium and Investor Profiles
A key differentiator for private credit compared to liquid credit products like bond funds is its inherent illiquidity. Investors typically expect a premium for this lack of immediate access to their capital. Chu estimates this illiquidity premium can range from 50 to 150 basis points for investment-grade equivalents, widening considerably for higher-yield opportunities.
The investor base for private credit also spans a wide range, from large institutional investors to individual accredited investors. Institutions often deploy substantial capital into specific allocation buckets dictated by their investment mandates, with defined thresholds for high-yield and investment-grade exposure. Their yield expectations tend to be more conservative, driven by LP (limited partner) dictates.
Conversely, accredited investors often seek higher yields, frequently targeting investments in the mid-teens or higher. This pursuit of enhanced returns is often balanced against their other portfolio allocations, which may include equities and other alternative investments.
"Accredited investors, for better or worse, tend to want higher-yielding products," Chu observed. "That is just sort of the nature of what they expect." However, he also noted a recent trend toward "flight to quality" within private credit, even in a higher rate environment. This indicates a growing appreciation for well-structured, lower-risk private credit opportunities, even if they offer yields below 10%.
Percent: A Platform for Transparency and Accessibility
Percent aims to democratize access to private credit by providing a technology-driven platform that emphasizes transparency and offers a range of investment options. The platform features a user-friendly interface, designed to demystify the investment process.
"We try and, to my point earlier around optionality, give as much optionality as possible for investors," Chu stated. Investors begin with a straightforward sign-up and accreditation verification process. Percent offers "try-before-you-buy" opportunities with low minimums ($500) and short-duration investments (under nine months), allowing investors to experience the platform and the asset class with minimal commitment.
For investors seeking a more passive approach, Percent offers "blended notes." These are diversified baskets of investments, themed around specific strategies such as total market exposure, U.S. only, short duration, or high yield. These notes function akin to index funds, algorithmically allocating capital across numerous opportunities, simplifying portfolio management.
A cornerstone of Percent’s offering is its rigorous underwriting and due diligence process. The platform has developed market standards for private credit, a sector historically characterized by opacity. "Private credit, historically, has been a very opaque asset class," Chu noted. "When you invest in a private credit fund, you kind of sort of know what they’re investing into. You get a statement at the end of every month."
Percent provides detailed information on deal structures, underlying asset performance, and pricing mechanisms, empowering investors to make informed decisions. The platform facilitates a public market-style execution process, allowing investors several weeks to conduct due diligence and place orders with defined parameters, including minimum investment amount, maximum investment, and minimum desired Annual Percentage Yield (APY). This transparent, order-book building approach ensures that both borrowers and investors have visibility into market demand and pricing.
Impact Investing and Emerging Markets
Beyond pure financial returns, Percent’s platform also caters to investors with an impact-driven thesis. The diverse range of sectors and geographies available allows individuals to align their investments with their values.
Chu highlighted the growing interest in emerging markets, where a significant financing gap exists for entrepreneurs and under-banked populations. "In emerging markets, there’s so many entrepreneurs, right? But there’s a gap in just basic banking services," he explained. Percent’s platform enables investors to finance these crucial needs, providing capital to lenders who serve these underserved communities.
This focus on emerging markets represents a structural need for alternative financing, rather than a mere "nice-to-have." Companies in these regions often leverage mobile-first, technology-driven solutions to bypass traditional banking limitations, offering a compelling avenue for both impact and financial return.
Outlook for Private Credit
Looking ahead, projections for the private credit market remain robust. Chu anticipates another strong year, driven by continued demand for income-generating assets and the persistent need for credit financing across various sectors.
"They are definitely expecting higher yields. Yeah," Chu stated regarding investor expectations for 2023. He noted that venture debt, in particular, is poised for growth as venture capital funding becomes more constrained. Companies seeking to bridge to the next equity financing round will increasingly turn to venture debt providers.
On the asset-backed side, both small business and consumer lending are expected to perform well, though with differing risk-return profiles. Small business lending is seen as inherently resilient, while consumer credit may offer higher yields to compensate for increased risks associated with rising credit card debt and potential challenges in auto loan portfolios.
The ability of the private credit market to remain liquid, even during periods of stress, is a key differentiator. Unlike equity markets that can seize up, credit markets, both public and private, tend to find a price where investors are willing to deploy capital. Percent’s emphasis on shorter refinancing cycles further enhances liquidity, allowing investors to reinvest or withdraw capital more readily than with traditional long-term private credit instruments.
"There isn’t a secondary market. But part of the thesis when we launched Percent was to give investors inherent liquidity," Chu explained. "So inherent liquidity comes from shorter refinancing cycles." This structure means that while not possessing a formal secondary market, private credit investments on Percent offer a degree of flexibility that surprises many investors accustomed to more rigid structures.
Nelson Chu’s insights underscore the evolution and increasing sophistication of the private credit landscape. As asset managers and investors continue to explore opportunities beyond traditional public markets, private credit stands poised to play an even more significant role in diversified portfolios, offering a compelling blend of income, growth, and impact.
For those interested in learning more about Percent and its offerings, the platform can be accessed at Percent.com.
