As more inflation data rolls in, it’s clear that we could see as many as four rate hikes in 2022. U.S. consumer prices rose a massive 7% in December 2021, compared with the same period the prior year, up from 6.8% in November Source amid persistent supply chain issues, strong consumer demand and nearly two years of aggressive fiscal stimulus.
Whether the Fed raises interest rates three or four times to try to stamp down soaring inflation, in 2022, the new, tighter rate environment may steer institutional investors away from high-yield public fixed income. Instead, institutional investors may seek out private direct lending opportunities where they can gain access to variable-rate, shorter-duration investments to mitigate risk.
What may make this market cycle different from previous periods of rising rates is that the efficiency gap between public and private investing is closing. More deals may get done thanks to digital marketplaces that allow institutional investors to quickly source deals, as well as conduct due diligence, score, match, price and close transactions, significantly accelerating the number of deals that get done.
Here are 6 reasons why investors may look to private credit moving forward.
1. Potentially less interest-rate risk
Variable rate structures ensure that as rates rise, debt investors benefit from the added yield. At the same time, shorter duration loans reduce sensitivity to interest-rate changes. Just compare the risk profile of a two-year maturity floating-rate private credit investment to the high-yield bond index, where all rates are fixed and weighted average duration is 5-7 years.
2. Potentially lower volatility than public markets
Private loans offer relatively low historical volatility while still maintaining attractive returns when compared with public securitiesSource . As a non-correlated investment, direct lending may add diversification to a portfolio in volatile and uncertain markets.
3. Credit quality is improving as the economy recovers
The credit quality of borrowers tends to improve as the economy improves, providing more opportunities for investors to gain risk-adjusted returns from direct lending transactions.
4. Investors have greater discretion and choice
Human-centric deal sourcing is waning as new online digital marketplaces allow investors to selectively access a wide number of deals, benefitting from machine learning algorithms and predictive models that match them with appropriate borrowers at fair market terms quickly and efficiently.
5. Investors can explore new asset classes
Private debt investing spans a wide range of asset classes and structures, including litigation financing, art lending, real estate lending, SME lending, auto lending, ABL lending and consumer unsecured lending, potentially providing both yield and diversification.
6. Private credit deals are happening digitally, faster than before
Investors using private credit marketplaces can set extensive parameters such as investment focus, desired yield and duration; borrowers input their desired cost of capital and key financial data. This allows investors to match with borrowers faster, potentially increasing deal flow for investors.
As institutions seek out yield, private debt, with its combination of higher starting yields and shorter maturities, has the potential to capture a larger portion of institutional allocations. On the Finitive platform, the loans we facilitate have a weighted average maturity of about two years, and over 80% are variable rate.
By the end of 2026, Preqin expects money dedicated to private debt to hit $2.69 trillion, which will be attributable not only to the higher rate environment, but also to advanced deal-matching technologySource. Finitive anticipates accelerated deal flow on the platform as lenders allocate capital quicker and more efficiently than before, and borrowers gain access to financing with less friction and more price transparency.
All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid, speculative and are not suitable for all investors. Investments can lose their entire value. Securities on the Finitive technology platform are offered through North Capital Private Securities Corporation, member FINRA/SIPC.