The Private Credit Debate Isn't Going Away. Here's What Investors Should Know.

There has been a lot of debate about private credit over the past year. Proponents will contend that these investments can generate above-average fixed-income returns over the long run. However, detractors have argued that the sector poses systemic risk to the global economy and could result in significant capital losses for investors.

Here's a closer look at what investors should know about the private credit debate.

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The private credit market has risen in prominence over the past decade for two reasons. The capital needs of industry have grown as the economy has expanded. However, traditional lenders such as banks and credit unions have retrenched due to increased regulation and more burdensome capital requirements. That has created a large funding gap that alternative capital providers, such as global alternative investment firms and business development companies (BDCs), are filling.

"At its core, private credit is simply credit," wrote Brookfield Corporation (NYSE: BN) CEO Bruce Flatt in the global investment firm's first-quarter letter to shareholders. Flatt stated that companies like Brookfield are "providing senior capital to asset owners and businesses, in return for a prioritized fixed return." He noted that while structures slightly differ from those in the public markets, "the underlying principles of underwriting, collateral, and discipline remain unchanged. Credit outcomes have always been driven by what you lend against, how you structure transactions, and the discipline applied, particularly when capital is abundant."

Separating fact from fiction

Leading providers of private credit, including Brookfield and fellow giant alternative asset manager Blackstone (NYSE: BX), both defended the asset class during their first-quarter earnings reports. Blackstone CEO Steve Schwarzman spent some time on the company's first-quarter conference call separating the facts from fiction. One falsehood he addressed head-on was the question of whether the asset class posed systemic risk. Schwarzman stated that "the Treasury Secretary, leaders of the Federal Reserve and the SEC, and the heads of numerous financial institutions have now acknowledged they do not see systemic risk from private credit."

Blackstone's CEO also addressed the unfounded concerns about widespread losses across the private credit sector. He started by highlighting that Blackstone has "generated 9.4% net returns annually in our non-investment-grade private credit strategies since inception nearly twenty years ago -- roughly double the return of the leveraged loan market." He noted that, "This track record crosses market and economic cycles, periods of high and low interest rates, and multiple credit default cycles." While he admitted that we're moving into a period of lower base rates and higher expected defaults from historic lows, Blackstone has "designed our funds with these cycles in mind, with low fund leverage, high current income generation, and the equivalent of meaningful reserves for future potential losses." That drives Blackstone's high confidence in its private credit strategy.