What investors need to know about private credit

Private credit has become a hot investment on Wall Street as institutional investors seek out alternative investments with attractive dividends. Individual investors may want to proceed with caution. It’s an asset largely bought by professionals at hedge funds, pensions or insurance companies, but accessibility has lately been growing for Main Street buyers. For instance, SoFi announced in January it was adding Franklin BSP Private Credit Fund (FBSPX) to its platform as part of a move to include alternative investment funds. SoFi, a digital banking and personal finance company, said it wanted to provide investors with an opportunity to diversify their portfolios while also potentially enhancing returns. “Given its unique risk-return profile, private credit can complement traditional investments by offering potential for higher yields and diversification benefits,” a SoFi spokesperson wrote in an email to CNBC. “Investors might consider allocating a portion of their portfolio to private credit, depending on their individual risk tolerance, investment horizon and financial goals.” The company is providing educational tools on its websites so investors can make informed decisions. Opportunity or bubble? SoFi’s announcement comes amid increasing interest on private credit on Wall Street, with some cautioning it is in a bubble and others touting the opportunities available as the market expands. Data firm Preqin forecasts that private debt assets under management will reach an all-time high of $2.8 trillion in 2028, nearly doubling the $1.5 trillion in assets in 2022. In fact, BlackRock expects global private market debt to reach $3.5 trillion in assets under management by the end of 2028. That has presented an opportunity for institutional investors with a time horizon of 10 years or longer, said Vivek Paul, BlackRock’s Global Head of Portfolio Research. “In the overall fixed income complex, we think direct lending looks comparatively attractive from the sense of the spreads that are on offer,” he said. “Public credit spreads are quite tight.” He also said the fact that the assets have floating rates is attractive. Private credit funds have yields generally in the low-teens, although it can vary, he said. “We do have a view that long-dated yields actually are going to go higher from here,” Paul said. “So anything that is of that more sort of floating-rate nature, isn’t going to have a valuation drag when rates go higher.” Meanwhile, Goldman Sachs Asset Management believes private credit should remain attractive this year thanks to higher base lending rates, continued capital inflows and attractive spreads. “It’s a particularly interesting moment,” said Greg Olafson, Goldman’s global head of private credit. For one, yields are higher and, although they will decrease, they should still remain higher than the past decade, he said. “It’s a yield product, first and foremost,” he said. “There’s more yield in the world and we think that will endure at attractive levels.” Investors also pick up excess spread per unit of risk, he added. Goldman has $130 billion in private credit assets, and CEO David Solomon said at a conference Tuesday he sees an “enormous opportunity” for the firm to increase those assets. UBS, on the other hand, reportedly warned in November that risks are building up in private credit, which it said was seeing an asset bubble. In a February report on U.S. life insurance ratings, Fitch Ratings said, “elevated private credit borrower leverage and a relative deterioration in private credit terms and conditions during more competitive lending environments are adding to pressures in the credit quality of private credit assets.” “Most private credit lenders have yet to experience an observable stress event to test their acumen, as much of their growth occurred in benign economic periods,” the report continued. How individuals can get access Private credit funds are largely used by institutional investors, although individual investors can get some access through their financial advisor or, in SoFi’s case, its website. Yet investors need to be aware that there is a lack of liquidity in the closed-end funds. There are also interval funds where investors may get small redemptions on their investments after a certain period of time, like three years, said Lisa Kwasnowski, senior vice president in DBRS Morningstar’s U.S. structured credit team. “These are popping up more often because it is a way for retail investors to come into these funds and begin to redeem their investment after three years,” she said. Blackstone, for instance, has the Blackstone Private Credit Fund (BCRED), which has a 9.5% annualized distribution yield. The majority of the portfolio is in direct lending private credit, but a portion is also in publicly-traded securities of larger corporate issuers. However, investors need to be aware that funds have the option to halt redemptions, Kwasnowski noted. Certified financial planner Chuck Failla, founder of Sovereign Financial Group, likes private credit for his clients, but only for accredited investors. To qualify as an accredited investor, households must meet wealth requirements, including a net worth above $1 million, excluding the primary residence, according to the Securities and Exchange Commission. “Private credit tends to have a higher yield. … It tends to have lower volatility,” he said. “But it is harder to get in and out of.” For those with less than a $1 million net worth, Failla would stick with a more traditional portfolio of stocks and bonds. “Once you get over a million you’re looking for, ‘Okay, I’ve already diversified into stocks and bonds, what else can I diversify into?'” he said. That said, there are firms that are making it easier for smaller investors to get involved in private funds, he said. That’s good news and bad, he said. “If you really don’t understand what you’re doing, it’s getting to be a little too simple to get in over your head,” Failla said. Investing in BDCs The main way retail investors have gained access to private credit is through the stocks of business development companies, or BDCs. This way, there aren’t liquidity issues. Instead, they are investing in the companies that lend money to businesses. About 80% of public BDCs are owned by retail investors, said Oppenheimer analyst Mitchel Penn. “BDCs are, in my opinion, a really good investment, if you are looking for income,” he said. “They’re investing in securities that are floating rate. So if interest rates go up, your income goes up. If interest rates go down, your income goes down, but it’s in line with the market.” However, they are riskier companies, Penn noted. He focuses on return on equity, not the dividend when evaluating a BDC. “Some of the BDCs will just raise their dividends without getting the earnings to support it, and you see their NAV [net asset value] just shrink,” he said. Right now, Penn likes defensive names that have generated a strong return on equity and have done so with small credit losses. That includes companies such as Blue Owl Capital , Golub Capital , Oaktree Specialty Lending , Ares Capital and Sixth Street Specialty Lending . “Those names have a longer track record. They’ve got good credit analysis. They’re [return on equity] is stable,” he said. For those who want broader diversification, there is the VanEck BDC Income ETF (BIZD). The fund has $926 million in net assets, as of Feb. 28 and a 30-day SEC yield of 10.33%. But that yield comes at the other end of the fund’s total expense ratio , which stands at a whopping 11.17%.