Private credit is having its moment in the sun—but is it the dawn of a golden age or just another bubble waiting to burst? The debate around this alternative asset class seems to get louder as each additional dollar pours in. Reflecting on the last edition of FCP, two questions lingered in my mind:
- Will this growing pool of assets dilute the quality of the loans made by investment managers?
- What will the private credit market look like 5-10 years from now?
While exploring this, I couldn’t help but think back to my reading of Mary Childs’ The Bond King. It’s the story of how a small division in one of the most boring corners of financial services–the bond portfolio of a life insurance company–became a trillion-dollar behemoth (PIMCO) with a seemingly direct line to the Chair of the Federal Reserve.
The Making of Today’s Bond Market
If we rewind, the public bond market, particularly the over-the-counter (OTC) market, was once highly opaque. For much of the 20th century, investors had little access to the true pricing or trading volume of bonds, and why would they? Pretty much everyone bought bonds and held them to maturity, ideally receiving their investment back plus interest along the way. However, a seismic shift started in the 1970s when Bill Gross and PIMCO began actively trading bonds to increase returns (create alpha). Gross demonstrated that there was money to be made by going beyond the simple buy-and-hold approach to bonds, and like any small corner of financial markets where substantial sums of money are being made, investors took note, which paved the way for more participation and competitiveness in the active trading of bonds.
By the 1990s, the rise of electronic trading platforms, such as TradeWeb and MarketAxess, allowed institutional investors to execute trades in real time. Soon after, a major turning point occurred: the TRACE (Trade Reporting and Compliance Engine) database was introduced in 2002, requiring real-time reporting of bond trades from all market participants. TRACE helped to level the playing field between dealers and investors, and brought transparency to a market once dominated by opaque, off-exchange transactions.
Mark Twain’s “history doesn’t repeat itself, but it often rhymes,” seems apropos here. We very well may be in the throes of a similar transformation within private credit as it continues to gobble up assets. With each passing day, I hear of more advisors allocating client capital to readily available vehicles (most are easy to enter, but precarious on the exit). One glance at the higher yields and perceived lower volatility is enough. But historically, the kicker has always been liquidity. It’s the forbidden fruit: when investors want it most, they can’t have it…and we always want what we can’t have! But PRIV has now entered the liquidity chat. So, is it the real deal or a false start?
Getting PRIVy With It
The launch of PRIV, a part public credit and part private credit ETF from State Street, is a milestone that could begin to usher in a shift similar to Bill Gross in public bond markets around 1975. PRIV will provide fractional access (supposedly 10-35% of the portfolio) to private loans sourced by Apollo in a vehicle that trades throughout the day. While I believe this is a positive development for the maturity of private credit markets, this feels like a watered down access point for retail investors and far from the real deal. In the short term, PRIV seems likely to attract inflows and spark broader interest in the asset class as investors seek higher yields and perceived lower volatility. However, just as the public bond market faced challenges in its nascent days–price inefficiencies, opacity, and questionable trading practices–private credit is likely to encounter its own growing pains as the investor base broadens.
I believe we’ll look back on PRIV’s launch as the kickstarter for a more transparent private credit market. Apollo has hinted at establishing a private credit trading desk, and as others follow suit, increased transparency and evolving reporting requirements seem inevitable. Innovations like blockchain could further enhance accessibility and efficiency. The dominoes are beginning to fall.
Two Years Away from Being Two Years Away?
While the launch of PRIV might well be looked at as a groundbreaking moment, it bears noting that private credit markets are not without their risks. As more money pours into the space, investors will be chasing deal flow, and some of these deals may not deliver the returns that have historically attracted investors to the asset class. My suspicion is that many private credit investors are beholden to private equity sponsors offering them deals–“say no, and you might not get another look!” Even if we aren’t there yet, evidence of suboptimal deal flow and underwriting slippage won’t become apparent until the tide goes out and markets sour—precisely when that evidence is largely useless.
Is PRIV’s launch an important milestone? Absolutely. But rest assured, this is no panacea for investors seeking high, consistent returns. The path to a more liquid, transparent private credit market resembles the incremental development of public bond markets. 5 years from now, is a TRACE for private credit out of the question? Will Apollo, KKR, Blackstone, Carlyle, and PIMCO all have private credit trade desks actively trading portfolios of private loans? It all seems quite likely.
Yet, this meaningful step is part of the larger maturation of private credit. A maturation that has taken and will continue to take years. When that transformation finally materializes, it may feel less dramatic than many anticipate—more a gradual evolution than a sudden revolution.
CONSIDER:
In many ways, it is the best time in history to be an investor. Boundless access to information, incredibly low transaction costs, and professional asset management for 5/100ths of 1%…all the tools are there for an outstanding investment experience.
In other ways, it is the worst time in history to be an investor. The ease of access and shockingly low costs work like financial leverage: you can use them to exponentially increase your wealth at a faster rate than ever before, but you can also use them to disintegrate your wealth faster than ever before.
The tools that create seemingly immediate financial catastrophe are the same tools used to create long-term investment success, and they are right at our fingertips.
That’s where the right financial advisor can make all the difference.
Brooks
Sources:
Morningstar
State Street Global Advisors
Brooks Palmer, CFP® is Head of Investments at Root where he helps identify, evaluate, and implement the best investment solutions tailored to clients’ needs. In Full-Court Press, he breaks down what’s happening in the markets—cutting through the noise and jargon—while connecting it to Root’s core investment tenets so you can make the most of your money and your life!