Hard to Ignore: Risk/Return Profiles of Private Credit and Senior Private Credit

March 03, 2023 | 4 Min Read

What you should know

  • Private credit strategies, including senior private credit, are loans, bonds or other credit instruments that are privately issued by companies or through private offerings.
  • Private credit strategies offer a range of benefits, including diversification, potentially higher yields, downside protection and, for senior private credit specifically, historically strong recovery rates.
  • Senior private credit sits higher in the capital structure than other private credit instruments – which translates to more protections for investors.

The size of the private debt market currently stands at an estimated $1.2 trillion. And with private credit AUM increasing over 10% annually for the past decade, we believe that the opportunity for future investment remains robust.1

But there’s more than the size of the private credit markets that has captured investors’ attention. The increase in the number of private credit strategies means there are more options than ever to help investors balance the tradeoffs between risk and return. These are strategies that offer potentially higher yields versus traditional credit vehicles, downside protection, attractive covenant protections (i.e., senior credit) and more.

With the growing interest in private credit, many investors are asking, “What can private credit do for my portfolio?” To answer this question, we’ve outlined the key characteristics that make senior private credit unique relative to other private credit strategies, along with the importance of market data when building portfolios.

Senior credit and private credit: what's the difference?

Broadly speaking, private credit, including senior private credit, can be either loans, bonds or other credit instruments that are privately issued by companies or through private offerings. They are referred to as “private” because they are not listed on security exchanges nor available through public markets. Instead, private credit assets are held in a fund.

In instances where private credit is tied to a corporate asset, repayment is derived from cash flows that are generated by an actual operating company, in the form of principal payment and distribution yield. Meanwhile, if the private credit exposure comes from a different type of company asset, repayment is typically derived from a physical asset or a complex, esoteric asset such as securitized debt or mortgage-backed securities.

When thinking about incorporating private credit, or specifically senior private credit, as part of an overall investment strategy, you should know that they can offer opportunities across the risk/return spectrum, including capital preservation or return maximization. Capital preservation strategies, such as traditional sponsor-focused mezzanine and senior debt funds, aim to provide predictable returns while protecting against losses. Return-maximizing strategies, on the other hand, include distressed corporate credit funds and funds that focus on capital appreciation and may offer the potential to generate equity-like returns, albeit at greater levels of risk.

Private credit risk profile

So, what makes senior private credit different? These loans tend to be the senior-most debt in a private company’s capital structure. This affords senior private credit investors a first- or second-lien claim on those assets that were used as collateral. Senior private credit can also include unitranche loans, which package both senior and subordinated debt into one hybrid debt instrument.

Senior private credit sits at the top of the capital structure

The opportunity for you today

One of the most significant drivers of growth in the private credit markets is the change taking place across the banking industry. With changes in regulations and an increasing number of banks deleveraging, the net result is that the major banks are retreating from the credit space. This has created an opportunity for private debt to step in to fill that void.

Increasing demand for private credit financing

When people talk about the private credit market opportunity, you often hear that there are no more opportunities or there’s too much money flowing into private markets. Those statements are generally driven by anecdote versus actual data. We have the data. And we’re more convinced than ever that there’s still room to grow. For example, if you look at growth in private markets year over year, the numbers are compelling. But on a macro basis, private credit continues to represent a very small segment of the overall credit market.

Data is key to understanding the role private credit can play as part of a broader investment strategy. For example, investors who are interested in private markets often focus on how private credit has historically been resilient in the face of market volatility and has consistently performed through both up and down markets. But historical performance is only one part of the overall story.

Our business is built around customization for clients and the idea that data can be a critical tool in creating a great performing portfolio. While the idea of choice for investors is good, investors inevitably need the data to make great decisions.

Because we have invested so heavily in the infrastructure and the resources to collect and interpret the data, today. We're able to see how private credit has performed both on an absolute basis and on a risk-adjusted basis. Private market investors today have better access to due diligence information and can structure and negotiate deals, while actively managing their investments – which ultimately translates to a compelling risk/return profile that’s hard to ignore.

1Source: Preqin as of September 2021

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