What role can private credit play in 'higher for longer' environment?

Private credit, or private debt, has continued its rapid growth trajectory. The alternative asset class was worth $250 billion (USD) globally at the end of 2010 and has grown to $1.4 trillion (USD) by 2022, according to data provider Preqin. Blackrock predicts that the global private credit market will be worth $3.5 trillion by 2028, growing at a roughly 15% annualized compound rate. That growth has been mirrored by some of Canada’s ‘smart money.’ According to Ninepoint partners, the Canada Pension Plan Investment Board had $44.4 billion invested in private credit at the end of last year, a 770% increase since 2011.

Joseph Pochodyniak says that the growth we’ve seen in private credit has been driven by two key factors: return and innovation. The portfolio manager, alternative assets at MacNicol & Associates Asset Management Inc. explains that as investors sought higher yields over the past decade, the interest rates available through private credit investments have been more attractive. At the same time, asset managers have developed new ways to access private credit investments, opening up the asset class to more investors and more capital. 

But this asset class — wherein investors lend money to private businesses — comes with risks and challenges that traditional debt investments like bonds do not. Moreover, as interest rates have ratcheted up over the past two years, the fixed income market may start to look more attractive for income seeking investors once again. As the investment landscape shifts, Pochodyniak believes that private credit has a place in investor portfolios provided they are supported by advisors capable of finding the right opportunities.

“There’s a wide range of private credits on the market, so if you’re an investment advisor and you’re speaking to clients about this I think it’s important to be careful and know that not all private credits are created equal,” Pochodyniak says. “We at MacNicol tend to be on the more cautious side in general. We draw the line in the sand at the level of about $20 million in earnings before interest, taxes, depreciation, and amortization (EBITDA). Those are companies with larger established business footprints who are able to renegotiate their debt terms with lenders more effectively.

“Our investors come to us and say, ‘we want the benefits, we want the diversification, we want access to this marketplace.’ We have to remember that it’s unregulated, so for the most part you have to be very careful with whom you’re doing business.”

Pochodyniak says that following the recent spate of central bank rate hikes, we’re already beginning to see some weakness in more marginal private credit borrowers, validating his focus on more established businesses.

Moreover, because private credit investments are typically much less liquid and transparent than bonds, investors need to be as aware as possible of what specifically they’re invested in. Pochodyniak believes advisors need to become industry specialists if they want to manage private credit investments. Without the backing of a ratings agency, knowledge of a business and its industry is key to any level of success.

At MacNicol, Pochodyniak and his team begin their assessment of businesses with financial statements. They then engage management directly in discussions to assess the strength and health of the overall business, and where they see it going over the next few years. Groups like MacNicol, Pochodyniak says, can offer a platform for advisors to access private credit opportunities. Perhaps more importantly they can share some of their research and knowledge about these businesses with advisors, giving them access to crucial information and functioning as that industry specialist.

Pochodyniak is clear-eyed about the potential risks and issues he sees in the space. He thinks that seeking private credit exposure solely to deliver fast returns or even to maximize income is not necessarily the right motivation. Rather he thinks advisors moving into this space should focus on the diversification opportunities that lending money to certain businesses will offer your clients.

“We're very clearly in a more cautionary tone and posture in this area, we do invest in this space, we think it's important that investors consider it but it's far from an easy layup,” Pochodyniak says. “That's the reality of the world you live in when interest rates move higher.”