The alternative investment industry continues its rapid ascent, with private equity often capturing the lion’s share of attention. However, private credit is emerging as a significant growth story in its own right, presenting compelling opportunities for both individual high-net-worth investors and Registered Investment Advisors (RIAs). Nelson Chu, founder and CEO of Percent, recently joined Andy Hagans on The Alternative Investment Podcast to illuminate the potential of private credit and how investors can leverage platforms like Percent to access this dynamic asset class.
The Evolving Landscape of Alternative Investments
In recent years, the financial world has witnessed a substantial shift away from traditional 60/40 stock and bond portfolios. This trend is driven by a confluence of factors, including persistently low interest rates in the pre-pandemic era, which diminished the appeal of fixed income, and a growing recognition of the diversification and potential return enhancement offered by alternative investments. While private equity has historically been a focal point, private credit has quietly matured into a robust and increasingly accessible asset class.
Chu explained that private credit’s recent surge can be largely attributed to the aftermath of the 2008 Global Financial Crisis. "After ’08, when the banks really stopped lending to consumers, to small businesses, you had this rise of nonbank lending that emerged," he stated. These non-bank lenders, often fueled by venture capital, stepped into the void left by traditional financial institutions, providing crucial capital for economic growth. Asset managers and credit funds subsequently emerged to provide the necessary financing for these non-bank lenders, solidifying private credit’s position.
Despite its growing importance, private credit remains relatively unknown to many individual investors. Chu noted, "It is a very recent phenomenon, call it 12, 14 years, give or take. And so, it makes sense that the average person either hasn’t heard of it or hasn’t really invested in it." However, he emphasized that most people have likely interacted with private credit indirectly, through consumer loans or small business financing, without realizing it.
Understanding the Private Credit Asset Class
Private credit encompasses a broad spectrum of lending activities that occur outside of public markets. It can be broadly categorized into two main arms: asset-backed lending and corporate debt.
Asset-backed lending involves securitizing cash flows generated by interest-bearing assets, such as loans. This can include consumer lending (like buy-now-pay-later services) or small business lending. A key feature of asset-backed credit is its ability to structure investments with principal protection, often by advancing a percentage of the total loan value and incorporating risk mitigation strategies against defaults. Platforms like Percent facilitate access to these opportunities by pooling loans from various non-bank lenders, including emerging players like Capchase and Wayflyer, alongside more established names.
Corporate debt, on the other hand, involves lending directly to a single company. This can range from venture debt, which supports early-stage, venture-backed companies, to middle-market lending to more established businesses. The risk and return profile in corporate debt can vary significantly, with venture debt often carrying higher risk but potentially offering equity-like upside through warrants, while loans to established companies with strong cash flows may offer more predictable, albeit lower, returns.
Chu highlighted the inherent flexibility within private credit, stating, "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. 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." This demonstrates the wide spectrum of risk and return available, from high-yield opportunities to investment-grade-like structures.
The Role of Private Credit in a Diversified Portfolio
In the current economic climate, characterized by higher inflation and interest rates, private credit offers a compelling alternative to traditional fixed-income instruments. While government bonds and certificates of deposit may offer higher yields than in recent years, they often fail to outpace inflation, leading to a decline in real returns.
"CDs and Treasuries these days, yielding 4%, 5%, 6% feels good compared to what it used to be, that’s for sure. But you’re not beating inflation. So you gotta find something else at that point to be able to offset all of that," Chu explained. He further emphasized the tax implications, noting that taxable income from these sources can further erode real returns when inflation is taken into account.
The debate on whether private credit belongs in every portfolio is ongoing. However, its ability to offer attractive yields, often with shorter durations than traditional bonds, and its potential to provide diversification benefits make it a strong contender for inclusion. Many sophisticated investors, including family offices and ultra-high-net-worth individuals, are increasingly allocating capital to private credit, recognizing its potential to generate consistent income and enhance risk-adjusted returns.
Percent: Democratizing Access to Private Credit
Percent, founded by Nelson Chu, aims to bridge the gap between sophisticated private credit opportunities and individual investors and RIAs. The platform distinguishes itself through its commitment to transparency, accessibility, and investor choice.
"We got a lot of users at the outset. And now, that we’re in a higher rate environment where the actual risk of sitting on the sidelines is even higher, we’re coming out to market and peaking at a really good time," Chu commented. The platform’s design prioritizes user experience, offering a clean and intuitive interface that simplifies the often-complex world of private credit.
The process for investors on Percent is designed to be straightforward. After a simple sign-up and accreditation verification, investors can link their bank accounts and begin exploring a diverse range of investment opportunities. Percent offers flexibility through both individual deal investments and "blended notes."
Individual deals allow investors to select specific opportunities based on their risk tolerance, sector preference, and desired yield. For those seeking a more hands-off approach, blended notes offer diversified baskets of investments based on various themes, such as total market, U.S. only, or short-duration strategies. This "set-it-and-forget-it" mentality appeals to investors who want broad exposure without the need for constant monitoring.
Transparency and Due Diligence: Pillars of the Percent Platform
A core tenet of Percent’s offering is its unwavering commitment to transparency, a quality often lacking in the private credit market. "Private credit, historically, has been a very opaque asset class," Chu observed. He detailed how Percent has developed standardized reporting and data standards, allowing investors to compare the performance of underlying assets across different borrowers with unprecedented clarity.
"The underlying asset performance… all that stuff normally is just made super opaque. Like, you would never know that across these borrowers who need debt capital. And we actually have a standardized reporting, so you can compare the asset performance of one borrower with the asset performance of another borrower, and it’s side by side," Chu explained. This level of detail empowers investors to make informed decisions based on a thorough understanding of the risks and potential rewards.
Furthermore, Percent has implemented a public market-style execution process for its private credit deals. Investors are provided with ample time to conduct due diligence and place orders, similar to limit orders in equity markets. This "order book build" process allows underwriters and borrowers to gauge real-time market demand and price deals accordingly, ensuring a more efficient and transparent pricing mechanism.
"This level of transparency around the deal structure, the actual data performance, as well as around how the deal is priced, is designed to give investors as much time, confidence, and comfort in making the investment that’s the right fit for them," Chu emphasized.
Impact Investing and Global Reach
Beyond the pursuit of yield, Percent also caters to investors seeking to make a positive impact. The platform’s diverse range of sectors and geographic focus allows for tailored investment strategies. Chu highlighted instances where investors specifically choose to invest in emerging markets, supporting entrepreneurs and the underbanked population.
"We have seen groups and individuals who basically say, ‘I only do international deals,’ right, especially in emerging markets. And that’s very important for them… But then in the emerging markets, 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," Chu elaborated.
This focus on emerging markets underscores a critical aspect of private credit: in many developing economies, it represents not just an alternative investment but a structural necessity for small and medium-sized businesses and entrepreneurs. The platform’s ability to facilitate capital flow into these underserved markets aligns with a growing investor interest in socially responsible and impactful investments.
Outlook for Private Credit in 2023 and Beyond
Looking ahead, the outlook for private credit remains robust. As inflation gradually recedes and interest rates stabilize, the asset class is expected to continue its growth trajectory. "They’re all expecting private credit to have a very good year," Chu stated regarding market projections.
He noted that the venture debt sector, in particular, is poised for continued activity. With venture capital funding becoming more discerning, companies are increasingly seeking venture debt to bridge the gap to future equity rounds. This creates opportunities for investors to support promising companies while potentially earning attractive yields.
On the asset-backed side, both small business and consumer lending are expected to perform steadily, albeit with varying risk-reward profiles. "Small business in general, that continues to always perform. It takes almost like a complete shock to the system, like COVID, where it fully gets shut down for something to be actually problematic on that side," Chu remarked. While consumer credit may present higher risk in the current environment, this is often compensated by higher yields, allowing investors to align their risk appetite with potential returns.
Crucially, Percent emphasizes inherent liquidity through shorter refinancing cycles rather than a traditional secondary market. This structure allows investors to enter and exit positions with relative ease, mitigating the illiquidity concerns often associated with private markets. "Inherent liquidity was really the answer here for us versus… Investors go in and out all the time," Chu explained.
In conclusion, private credit is no longer a niche segment of the alternative investment landscape but a significant and maturing asset class. Platforms like Percent are instrumental in democratizing access, providing investors with the transparency, choice, and tools needed to navigate this dynamic market and potentially achieve their financial objectives. As the financial world continues to evolve, private credit stands as a testament to innovation and opportunity for those seeking diversified income streams and risk-adjusted returns.
