(Bloomberg) — Three academics have a bold take on the booming $1.7 trillion private credit market: After accounting for additional risks and fees, the asset class generates little additional returns for investors.
In a new study released by the National Bureau of Economic Research, professors argue that, overall, direct lenders generate virtually no alpha, or additional compensation, relative to a broad market benchmark.
That conclusion is sure to be controversial in a market that has more than doubled in size over the past five years, given the appeal of higher, more stable returns compared to publicly traded debt.
read more: Why is private credit booming? How long will it last? :QuickTake
“It’s not a panacea for investors where they can earn 15% risk-free,” said Michael Weisbach, a finance professor at Ohio State University. Research With Isil Herer and Thomas Flanagan. “Once you adjust for risk, they’re basically getting the amount they’re entitled to, but that’s about it.”
There’s complex math behind this study, trying to tease out the alpha portion of returns that depend on skill, and the beta portion that might come from a bull market. While it’s now standard to compare stock pickers to market benchmarks like the S&P 500, the right standard is less clear for private credit funds, which make special and opaque loans to numerous companies.
To be clear, the study covered broad industry returns rather than any specific fund, and Weisbach was quick to add that the asset class could still be a favorite as long as investors can tolerate its lower liquidity. A diverse source of welcome.
The three economists analyzed MSCI data on cash flows from 532 funds, covering their capital inflows and distributions to investors. They compared the sector’s performance to equity and credit portfolios with similar characteristics, whose volatility ultimately explains the majority of private credit returns. The study shows that these private credit funds also carry some equity risk, as about 20% of their investments contain equity-like features such as warrants.
After accounting for these risks, they found that there was still alpha – which only disappeared after deducting the fees paid to these managers.
“To my knowledge, this is really the first attempt to use credit and equity benchmarks to look at private credit,” said Tobias True, a partner at Adams Street Partners who applies data analytics to building private investment portfolios. “There are a variety of loan structures. Diversity, including equity components and varying degrees of leverage. That’s the real challenge for us in differentiating alpha from beta.”
The paper’s conclusions may resonate with some investors or limited partners who are beginning to question the high costs as interest rates rise and competition for the dollar intensifies. At the same time, default risks are rising as tighter monetary policy squeezes corporate borrowers. After several years of rapid growth, fund-raising activity has slowed, and some private credit funds have begun waiving fees for major investors.
read more: Private credit funds offer “free” trading to distinguished investors
As private markets boom, some quants — most notably Cliff Asness of AQR Capital Management — suggestion Investors are misled by returns that mask volatility, and returns may not be as impressive as they appear.
Adams Street Partners did, he was the first document Regarding private credit performance, he warned that it may be difficult to determine true alpha until the sector faces its first recession. But he said the NBER study is an important step in digging deeper into private credit returns.
“It’s not going to give anyone a magic formula that they can go in and say, you haven’t delivered any alpha,” he said. “Perhaps this just raises awareness that there are additional risks and that in some cases overperformance is not worth it.”
trade
- Thryv Holdings Inc. is a software company that owns Yellow Pages. discussed Providing $350 million to private credit institutions to refinance their existing debt
- Private credit funds are making plans Offer up to $2.5 billion to sell U.S. packaging company Trivium Packaging
- BC Partners’ Credit Division agree to provide Pay $400 million to football helmet maker Riddell in deal that will bring long-awaited payout to shareholders including private equity firm Fenway Partners
- Oak Hill Advisors serves as co-lead arranger of private credit financing in support of HGGC’s acquisition of Rimkus Consulting Group
