Private credit funds are pitched as safe and stable, but investors aren’t getting anything special for the high risk and feesI get pitched a lot of financial products. The one that I have been pitched the most in recent years is private credit, and private-credit strategies are being marketed and sold to retail investors, too.
The part of the private credit market that gets pitched most often to retail investors is private credit funds. These are funds that raise money from investors and make direct loans to private companies, typically ones that are unable to get bank loans. Between lending to higher-risk borrowers and containing equity features in the loan contracts, private credit can start to look a lot more equity-like than bond-like. This is where it gets interesting.
Understanding risk in illiquid assets can be complex. One interesting perspective comes from a 2023 paper in the Financial Analysts Journal titled The problem is that investors in BDCs do not earn these returns. Publicly listed BDCs don’t always trade at their net asset value; they tend to trade at a discount, particularly during times of market stress.
The authors find that using both equity and debt benchmarks to measure risk, an investor in a typical private debt fund is not getting anything special for the risk they are taking in these funds - their risk-adjusted excess return is indistinguishable from zero., skilled fund managers will attract assets to their fund up to the point where they are no longer able to generate excess risk-adjusted returns.
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