Rich investors are buying risky credit that banks won’t touch

Trader Talk

The higher risk, higher reward world of private credit is targeting the wealthy.

Blackstone Group, Carlyle Group, Apollo Global Management and other large firms have started offering products for individuals to invest in loans to midsized companies that banks won’t touch. The lure is a potential annual return at times surpassing 8%, when corporate bond return indexes are negative, plus a relatively low initial investment.

Their push coincides with a broader democratization in financial markets, with apps such as Robinhood Markets helping people find their way into everything from SPACs to Dogecoin. The meme-stock phenomenon in the U.S. this year showed the potential return for retail investors in distressed companies such as AMC Entertainment Holdings, up more than 1,500%.

Unlike in publicly traded stock and bond markets, the risk in private credit is a relative lack of liquidity. In a public market, traders have the ability to sell almost instantly, even if at lower prices. In private credit, lenders typically hold loans until they mature, making it more difficult for someone to pull their money out in a pinch.

“My concern is if a client is looking for yield, there is a reason you’re getting a much higher yield than a Treasury, and that’s an increase in risk,” said Paul Auslander, director of financial planning at ProVise Management Group.

For banks, it’s not just that the loans are risky, but that capital requirements put in place by regulators make it hard to hold certain investments.

There’s reason to believe the new products will attract retail demand: Yields on fixed-income investments are near historic lows as central banks suppress rates to support the post-pandemic economy. And private equity firms — whose client lists typically include pension funds, endowments, insurance companies and sovereign wealth funds — are now gaining traction with affluent individuals.

Blackstone, for example, opened up hedge fund products, private real estate investment trusts and longer-term drawdown funds to individual investors — asset classes historically limited to institutions.

Now the firm is offering its Blackstone Private Credit Fund (BCRED), investing mainly in direct loans to U.S. middle-market companies, including senior secured and unitranche loans, as well as subordinated debt. Unitranche loans include elements of conventional loans and unsecured debt. According to its website, BCRED Class I shares, for higher earners, delivered a 7.34% return as of June 30.

Some classes of the Blackstone fund may reach even the merely affluent. Eligible investors in the fund must have a net worth of at least $250,000 or a gross annual income of at least $70,000 and a net worth of at least $70,000, according to its website. The minimum initial investment in the Blackstone fund’s common shares is $2,500, per its prospectus.

“We see the investment opportunity and we believe the investor demand is there,” said Joan Solotar, global head of private wealth solutions at Blackstone. The environment today “makes it challenging for a traditional fixed income portfolio to deliver the necessary yield.”

Individuals targeted

The offerings from the private equity firms illustrate how they’re increasingly chasing retail money alongside firms such as BlackRock and Macquarie Asset Management.

“If you look at the future of asset management, it is closely intertwined with private wealth,” said Stephanie Drescher, chief client and product development officer at Apollo. “This is a strategic decision to lean in and amplify our commitment and create significant momentum and access for those buyers.”

Individual investors account for almost 20% of the assets Blackstone manages as of the second quarter. The firm expects that figure to eventually reach 50%. KKR & Co. co-president Scott Nuttall said in April that about 10% to 20% of capital raised over the past several quarters came from individual investors.

Faced with criticism that the products could prove too risky for rookie traders, private equity managers are quick to point out their products cater to higher net worth, more sophisticated investors — not the day trader crowd.

The Carlyle Tactical Private Credit Fund (CTAC) has a $10,000 initial required investment for most classes of its shares, according to the prospectus. The fund, unlike some of its peers, pools money from investors and allocates it across deals from the same private debt strategies institutions have access to. CTAC has delivered to investors a quarterly net yield between 7%-8.74% on an annualized basis since the start of 2020.

More on the way

The push for retail investment in private credit is still growing. Apollo said on its Aug. 4 earnings call that the firm is looking into a semi-liquid private credit fund that would be accessible for high-net worth individuals.

Some firms, in line with U.S. Securities and Exchange Commission rules, offer ultra-wealthy investors, or so-called qualified purchasers, the chance to put their money in private credit funds, but barriers to entry are high — typically owning $5 million or more in investments.

BlackRock allows wealthy individuals to invest through its BlackRock Credit Strategies Fund (CREDX). Macquarie, in partnership with Wilshire Advisors LLC, recently jumped into the retail space with the Delaware Wilshire Private Markets Fund, also aimed at high-net worth investors.

“In the past, there wasn’t much available to individual investors and we’re trying to fix that,” said Justin Plouffe, deputy chief investment officer for Carlyle Global Credit. “We see tremendous demand for it to be part of any diversified portfolio.”

Due diligence

To be sure, the risk of defaults at midsized U.S. companies has receded as the post-pandemic economy is bolstered by government stimulus spending and the Federal Reserve’s highly accommodative monetary policy. Chicago-based Lincoln International says such companies violated their lending terms just 3.1% of the time in the second quarter, the lowest level in three years and down from 9.4% at the peak of the pandemic.

Still, Auslander of ProVise advises caution to any individual who invests in a private credit fund. “I would go with the big companies that are well-known with big reputations, like Blackstone or Carlyle,” he said.

Private equity and alternative asset managers say they’ve put safeguards in place and make sure people understand what they are getting into. Funds typically offer investors the ability to pull money out at fixed times during the year.

“We dedicate a significant amount of time and resources towards educating advisers,” said Blackstone’s Solotar. “We provide education and transparency around the structure and types of investments we make.”

— With assistance from Pierre Paulden and Pratish Narayanan.

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