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A Wiser Retirement®
282. Is Private Credit Right for You? Pros, Cons & Considerations
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Join us for this episode of A Wiser Retirement® Podcast as we explore private credit, a unique investment option offering potentially higher yields by lending to non-public companies. While it can generate attractive returns, it comes with risks such as illiquidity, higher fees, and limited transparency, making it best suited for high-net-worth individuals with significant liquid assets. Tune in to learn more about the pros, cons, and key considerations of this investment opportunity.
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Introduction to Private Credit
Speaker 1the businesses really like private credit because it provides, unlike traditional finance and banking, it provides them really just surety of capital flexibility.
Speaker 2Welcome to a Rise of Retirement podcast. Are you curious about private credit? Is it right for you? I'm Casey Smith and joined today with our very own investment manager, the king of data, andrew Pratt. Hey, andrew Morning, casey. Each week we bring you practical advice on retirement, investing and planning for your financial future. Don't forget to subscribe to the podcast wherever you're listening. Let's get started. All right, so private credit. I think people are like what is private credit exactly? I think we should back it up to a little higher level. Everyone's heard of private equity. They think this is something super exclusive that only the wealthy get access to. But there's private credit, there's private equity, there's real estate. Which kind of lives in both worlds?
Speaker 2And then you have hedge funds, which people probably don't know the difference between hedge funds and private. So let's break that down a second. What is all this word? Jumble of private? Yeah.
Understanding Private Investment Types
Speaker 1I mean there's a lot of different structures out there, but essentially you know private investing, whether it's private equity or private credit. You're investing in private companies. Private equities typically.
Speaker 1You know you're taking an ownership stake in a company that's for long term value, non publicly traded non publicly traded and it's more for a long term value appreciation, and that's either done through restructuring or, you know, a sale from IPO or an exit. Private credit's a little bit different. It's more about lending money to non-publicly traded companies, private companies, for a shorter period of time and you're getting interest payments on that. So those are really the main differences there. And then hedge fund, and so I guess we'll back it up to private real estate. Private real estate can actually have both structures there's. You know, you could be an equity investor or you could be a credit investor, and that's where you're participating in the loan structure, lending out, you know to private real estate or, you know, have an ownership stake in private real estate but then go into hedge funds.
Speaker 1Hedge funds, I would say it's a little bit unique and different animal. Hedge funds you're typically investing in a manager. There's lots of different strategies. I think the most common strategy is a long short fund where the manager is trying to, you know, maybe have a market neutral or have a zero exposure. Market exposure you know where the portfolio is sort of just kind of moving, you know, sideways to the market, so it doesn't really fully participate in up markets but also protects you on the downside. The hedge funds are different. There's no sort of income stream tied to hedge funds and they're just sort of unique structure there.
Speaker 2Hedge funds have always been strange to me, Cause like why would you take millions of dollars to put into a fund that's supposed to do nothing?
Speaker 1Yeah.
Speaker 2When you could just buy short-term treasuries and it hedges perfectly well. You know, that's the part I've never understood.
Speaker 1My previous firm, we actually had an internal hedge fund and that was a common objection and criticism with investors is you know there's a lot of investors especially, you know, in the retirement stage that like yield and income and you know they're invested in this hedge fund product and there's no yield that's being spit off.
Speaker 2It's like buying commodities Right.
Speaker 1The main selling point is it's actually a very good fund. But the main selling point is it's very uncorrelated and really helps with diversification benefits in the portfolio. So that's the main selling point, but that's just really kind of hard thing to kind of communicate to clients or investors.
Private Credit Characteristics & Yield
Speaker 2So today we want to focus on private credit specifically, so let's kind of start diving into all the private investments. This is probably the most conservative approach to private investing right.
Speaker 1Yeah, I would say the most conservative. You know it is fixed income, like you're. Again you're investing in loans. It's, you know, I'd say it's a little bit, you know, obviously riskier than traditional fixed income, but again it's, you know the risk profile is very similar. You're getting a yield, the portfolio is getting a yield, consistent stream of dividends or coupons payments. And again it's more conservatively positioned.
Speaker 2So let's talk about yield. So right now, a 10-year treasury yields 4.22% as of today, what kind of yield should I expect in a private credit investment?
Speaker 1Yeah, I would say obviously that that changes over time with where the Fed funds rate is, but private credit they're actually.
Speaker 1The yield is based on the the swap overnight fixed rate and there's really a spread between each contract that a manager will make with a business you know depends um, you know it also depends on, it depends on the structure of the contract, so, but usually there's a spread between this uh, it's called SOFR, this SOFR rate, and, um, there there's a premium there. So, uh, right now the manager that we've decided to partner with the portfolio is yielding around um, about you know, two and a half times that. You know about 10% you know, 10 and a half to 11%.
Speaker 1So there should be, you know, excess premium for it being a private investment, you know a little bit of a liquidity there, and then also it's just a little bit riskier with the type of companies it's investing in.
Speaker 2So when we, when we think about private credit, what is? Um, what well, we'll start with the positives what, what, what, why? Why would we invest in private credit? Because when we, when we do private credit, we are actually pulling a little bit from equities and a little bit from bonds in the portfolio. So it's not a complete bond replacement. We it has some risks to it, so we we we take away a little bit from the equity allocation.
Speaker 1Yeah, and, and so I think benchmarking is key here and just with any private alternative investment you really should think about where are you taking it from in the portfolio? You know private equity, I would say for you know you'd want at least 4% above, like where the SBI 100 returns, if you're investing in private equity. You know you'd want at least 4% above, like where the SBI 100 returns, if you're investing in private equity. You know private credit.
Benefits and Business Appeal
Speaker 1Again, we want at least, I would say you know at a minimum, you know 300, or you know 3%, 300 bps is what I was gonna say. But we want to be a little bit more conservative where we're pulling it from, Because we just don't want to be a little bit more conservative where we're pulling it from, because we just don't want to say it's all coming from fixed income, because that's just not an apples to apples comparison. Right, you know it's investing in, yeah, I will say sub investment grade, but it's invested again, just in companies that are not like the large cap. You know the highest quality, like the large cap, you know the highest quality, but it's you know they. They have robust teams doing underwriting and due diligence, so they are vetting all these concerns with these companies. So how we're benchmarking it at Wiser is, you know, 70%. You know a private credit allocation would be coming from traditional fixed income and 30%.
Speaker 1Just again, to be conservative, 30% is coming from your equity bucket and that's, you know, us equities and international equities.
Speaker 2All right. So when we, when they're private credit funds doing its thing, how many? There's lots of different options out there to invest in, but typically how many holdings does it have? Like, how many companies are you lending?
Speaker 1to.
Speaker 2What's the? What's the company risk?
Speaker 1Yeah, so there's again depends on the manager and the portfolio. You know, I believe the fund we've partnered with and I guess we'll go and say it's Goldman Sachs GS Credit Fund you know there's, I think, 50 underlying investments and then, but it's also, it's diversified and this is the thing with, you know, real estate. You know, if you decide to go with private real estate, you're just in that one asset class and maybe even one. You know, subsector real estate, private credit they're lending to everyone. That could be real estate, it could be to. You know, technology companies they spread it out amongst different industries. Right, it's, it's very diversified in that regard.
Speaker 2So, but right now, yeah, our our fund, I think it's about 50 underlying investments or underlying loans, and what's the cap size that they normally focus on. So what meaning are these Fortune 500 companies? Probably not. These are probably what.
Speaker 1Yeah, small to mid-size. I think it's around, you know, a hundred million. You know EBITDA around that target threshold. But you know, obviously it can range. But I think the lowest they might go is like 10 to 20 million operating cashflow.
Speaker 2Okay, so small business, but not super small.
Speaker 1Not super small, no, not speculative. It's definitely has a track record for sure.
Speaker 2So do you think private credit has become so popular because of the low interest environment that we had for so long, and if so, do you think it will continue?
Speaker 1Um, well, so I mean, I would say, you know, private credit is definitely, uh, gained a lot of traction lately, Um, you know, I'd say the past five years, especially past five to 10 years. Um, and in the past couple of years, you know, especially where interest rates, you know, given to the level that they had risen, I would say that that could, should, be a headwind to private credit, because there's, um, you know, as you said, you can buy a 10-year treasury around 4%. That's pretty good, but so, no, that hasn't caused private credit to lose steam by any regard, because, again, they are getting that, you know, premium to that spread.
Speaker 2Yeah, so if just rates were to keep rising or inflation continues to increase, then you would hope that your private credit would just keep having that three percent spread, meaning that it would be three percent higher than the standard.
Speaker 1Yeah, and that was one risk you know I was concerned with is. You know we are. You know the Fed hasn't cut rates in a while now but it's presumed that they will cut eventually. Rates in a while now, but it's presumed that they will cut eventually. You know what is that. How is that going to impact the spread? Because these are floating rate loans. You know, again, the contract, the negotiated terms are different but for the most part they're adjusting every couple of months or you know even maybe even less than that. So how will that impact the portfolio?
Speaker 1And you know, going back to kind of the benefits the businesses really like private credit because it provides, unlike traditional finance and banking, it provides them. You know really just surety of capital. You know flexibility, the speed. You know there's so many regulations with banks and just kind of the ability. I think you know maybe in the new administration they might try to loosen some of these regulations, but it's really hard for these businesses to get capital when they need it and a lot of times these investment opportunities are very quick.
Speaker 1They need someone they can partner with. You know that again can be very nimble and they like the bespoke nature of these contracts, very custom. And then also with these asset managers that are doing private credit, unlike a bank that does a broadly syndicated loan, they can sometimes, you know, work these just say they got in trouble. The manager can partner with these companies and say, hey, well, you know you missed a covenant, you tripped a covenant on your contract. You know we're going to take over ownership and you know you missed a covenant, you tripped a covenant on your contract. You know we're going to take over ownership and you know, help, work this thing out. Whereas if you're with a partner, with a bank, you might, they might just go ahead and default and send you to bank or up to court. So that's one positive and that's why all these businesses like private credit. The managers are willing to work with them.
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Speaker 2now let's get back to the episode so it's a good hedge for inflation, because if rates are going up, these rates will be going up as well. The good portfolio diversifier is what I'm hearing from you, and obviously a higher yield, which is what everyone's looking for when you have your own cost increasing. But with everything comes risk. So let's talk about the first thing that comes to my mind. When you think private anything is liquidity like?
Speaker 3how long does?
Speaker 2your. How long does your money get locked up?
Speaker 1yeah, and again it. It all depends, but there are a lot of uh they call it evergreen structures, which is just a structure that's not permanently closed. So there's a lot of these evergreen structures out there and this is something that I think really makes sense in the private credit space, um, because it's, you know, usually there's like an initial lockup, maybe like one year um. You could redeem uh your investment if necessary, but it might be like a slight discount. I think goldman's fund it's like a 98 discount if you redeem in less than one year um, but typically it's quarterly liquidity um and there's monthly investment subscription process.
Speaker 1So, yes, there's reduced liquidity, like you know, typical ETF mutual fund. But I would also kind of argue that this is a positive in a sense. You know, I mean not from a liquidity perspective but from a return standpoint, because that's one of the, you know, with private investing. That's one of the positive attributes is this illiquidity premium is because, you know, just say, in recent weeks we've had this huge drawdown on the market. A lot of these, just say, mutual fund managers have had to sell assets at an opportune times because they had to raise cash for redemptions. You know, this liquidity, illiquidity provides a little bit of a buffer, you know, to where the managers don't have to sell assets, they can, they can sort of manage this. You know, if there are a flood of redemption requests, they can kind of manage that process better. Where they don't have to, you know, be forced to liquidate these assets.
Speaker 1So, but yes, reduce liquidity. That's something that investors definitely be aware of and need to plan for if they're going to invest in privates. Also, I'm sure it's widely known private investments come with higher fees. There's the typical management fee. Everybody's heard the term, probably two and 20. That's like a standard hedge fund fee, but private credit it's a little bit better. You know, I believe our funds are like one and a quarter.
Speaker 1There's a 12% you know preferred return fee or incentive fee, that where they share in the profit. So there's usually a profit. But these are all kind of standard terms in the industry.
Speaker 2You still get that net 10 to 12, 10 to 11% yield after those fees. Yeah.
Speaker 1So the total return on the portfolio, it's primarily all yield and that's all net. So yeah, so those are net numbers.
Speaker 1Net numbers and that's obviously very important, right, and they have. And one thing I'll say is, with those performance fees there's usually like a hurdle rate and that's like a minimum return for investors. So you know, commonly it's like a hurdle rate for private credits about five percent. So there's at least guaranteeing. Hey, at a minimum you're going to. You know I shouldn't say guarantee, but we're not going to start taking a profit. You know incentive fee until you guys at least get 5%. Yeah, so at least there's that kind of buffer there. But you know, moving on to other risks, there's you know, limited portfolio transparency.
Speaker 1You know.
Speaker 2unlike investing in SBI, you don't know exactly what's in it.
Speaker 1Yeah, you don't know. I mean they produce monthly fact sheets and you you know they do a good job giving some transparency, but you don't know exactly. You know you can't and they have case studies on different. You know loans that they make but you don't know exactly what's in the portfolio. It's usually lagged reporting, obviously because of the valuations aren't as liquid and you know it takes time to work with the auditor to you know, to get a like a true valuation. So you know there's lag valuations and then also use of leverage. Unlike you know, investing in just public equities, there's, you know, leverage to these funds that they can use, I will say private credits.
Speaker 2I would say that's one of my biggest fears is you put in a dollar and that dollar becomes $2, 100% leverage would be horrible because if it all falls apart, you lose everything. In the Goldman Sachs fund there is some leverage, but not that much actually.
Speaker 1Yeah, and the structure that we're investing in it's a BDC, so there are caps on leverage. I think the maximum cap is 2%, Only 2% can be levered Is oh well two's like I guess two times.
Speaker 2Sorry, two times. Oh, okay, okay.
Speaker 1But you know most funds won't go. The max will go is one and a half times.
Speaker 3Yeah.
Speaker 1And I believe the Goldman fund is, you know, around 50%, you know max.
Speaker 3And they did.
Speaker 1I was kind of, you know, question them just like, would you guys dial up the leverage a little bit if yields were to come down? Just to, kind of you know, I hate to say juice the return, but just kind of get that return back up. And they were like, yeah, we, we would look to do that maybe a little bit if we had to. But they're very averse again. They're there, this is fun, is more conservative than other private credit funds and they're really against using leverage unless they, unless they need to.
Risk Considerations and Manager Selection
Speaker 2And I just talked to our listeners. The reason why we're talking about this one fund is just we've searched the world, our world and what was offered to us, and this is really. We look at a lot of crappy stuff honestly and this is one that kind of filtered to the top is like okay, this is a conservative fund, has a high yield, You're not going to do 2X your money to leverage. It seems to be a more conservative approach, had a long track record and, just for the record, we have access to everything at Goldman Sachs. So anything at Goldman Sachs Advisor can provide, we can provide through our relationship with them and Charles Schwab, and it's probably a good time to enter this in as well. These are type of investments we deploy with people with assets greater than $5 million.
Speaker 2So liquid assets at our firm greater than $5 million. And the reason why we do that is for all the cons that we're just explaining is illiquid investment. Even though you can get out quarterly, they'll only liquidate 5% of the fund's net asset value. So if there's a mad dash to the door you may not be able to get in that quarter. We want it to be focused on the longer term.
Speaker 2There is some leverage, which means there is some risk. There's also risk manager risk. What if this manager just picks 50 really bad companies and they all default for whatever reason, then then your money can go to zero, yeah, where we have a lot less issues with that, with US treasuries and more traditional approaches that we use in a normal portfolio, right.
Speaker 1Yeah, I would say. I mean there's a few reasons why I really like partner with Goldman. Obviously they have a established team. This fund is fairly new, but they've had different types, structures of this version of the fund for over eight years and the team has been together, I think you know, almost 20 years and so obviously Goldman's established as an asset manager. But they've also have a very experienced private credit team as well and you know, I think, their historical default rate across all but they also have a very experienced private credit team as well and you know, I think their historical default rate across all their private credit type funds is around like 0.5 or 0.5 percent. So it's very low, you know, not to say like defaults could maybe take up if we do do enter into a um contractionary period. But still, overall the manager's done very well.
Speaker 1They have us, you know, against established team. Their investor base is very sticky. It's institutional, uh investors, it's rias. We like that um. So those are the main reasons. And the portfolio again is more conservative versus other private credit funds. It's 98 um senior secured loans, um. Some other funds go a little bit down the credit stack and they'll invest in mezzanine debt or subordinated debt and we didn't like that. We wanted something that is a more conservative position in the credit stack, and that's a good segue, actually.
Speaker 2So considerations before investing in any product like this. First of all, I would stay away from the ones that you see on your Facebook feed and your Instagram feed. Yes, place Meaning if you lose all your money and that there's not a whole lot you can do in that scenario and you really have don't have a good way of vetting them other than through their own advertisements, which is going to be very biased. So those are, those are not the best places to be investing and their team is probably.
Speaker 1I'm sure there's some qualified people there, but they're it's not a deep bench. They probably don't have a ton of experience and it's probably very concentrated in the type of investments that they are making.
Speaker 2Um, if there's a, a hurricane in Florida, well, they also had California assets. They had Montana assets. Right, so it it. It diversifies the risk more. But what are some of the key um considerations? You've touched on most of these, but what are the key considerations before? You should be investing in this?
Speaker 1Yeah, you know, I think. Uh again, manager selection is paramount. Um, you know you want to partner with a team that has a deep underwriting bench there. I can't remember. I think it's four percent of all the loans that Goldman's team looks at will actually make it to the portfolio and they look at.
Speaker 1I think it was like maybe 700 loans with maybe it was 2023. They looked at 700 loans. Four percent of those ended up making into the portfolio, so that they look at a lot. I mean, these managers are inundated with opportunities and just being able to adequately sort of sift through those opportunities and identify the best ones and properly vet them. You know I asked Goldman about you know, Trump's tariffs and does that really impact in the new administration policies? And they're, like you know, for the most part, no, they're insulated from that and they also take that into consideration in their underwriting. So they do account for that kind of stuff economic, macro, economic risk.
Speaker 2So that goes back to some of the objectives and criticisms. So would lower rates adversely impact the portfolio? So if the rates went the opposite direction?
Speaker 1Yeah, yeah, we, we talked about it a little bit. So, lower rates, yeah, the yield might compress a little bit, but you know, for the most part, no, that actually might be a good thing. That means that the credit quality, you know, could be getting better for these underlying companies as well.
Who Private Credit is Right For
Speaker 2So that could could be a positive, but yield might compress a little bit um, we talked about tariffs that the only way you would affect a business is if that business was affected by tariffs and then couldn't pay their note right in this case, um, what about? Uh, there's so many private credit opportunities. Is this space over overcrowded?
Speaker 1Yeah, again, that comes back to being manager. Selection is paramount. You want to partner with someone that you know has a good team and track record. But no, I would say you know, right now, private credit, the market capitalization is around 2 trillion For a frame of reference. Private equity is around 11 trillion and I think, like, the high yield space is about 2 trillion as well. So no, I mean, yes, there's been a a rush in this space, but there's, you know, it's very scalable and there's a lot of room to grow.
Speaker 2Uh, what about um the risk? You think about cyclical risk over different asset classes. Where would you place this? Um, maybe even like financial crisis type stuff, credit credit risk type crises?
Speaker 1Yeah, so I think you know there's a. There's a common misconception out there. You know people are getting cyclical and systematic risk kind of mix up. Yeah, I think you know, like a lot of asset classes, there's cyclical risk. You know companies, earnings can contract and so yeah, there's a little bit risks there that they're not able to pay their notes. But systematic risk I would like to push back a little bit. I think there's actually very little systematic risks like 08 and 09. You know the main issues there were. You know banks were over levered. They had asset liability mismatches. Asset managers that are doing private credit, they don't have these issues. I mean, yes, they can do 2X, but they're not significantly over levered like the banks were back then.
Speaker 1And then you just saw, in 2023, there were some bank failures that happened then. So I think private credit kind of acted as a line of defense.
Speaker 2Kind of saved the day.
Speaker 1Yeah, from that credit crunch.
Speaker 2All right. So who is this? Right for? Certainly high net worth individuals. As we said, we have a $5 million asset minimum before we deploy these type of investments. People who want to have ample liquidity, meaning that you would never have to sell this, it can live in the portfolio as long as it needs to Right, and obviously understand that privates are long-term investments. So you know, I think that's important, probably not talking to our entire client base with us, I think it's always important to learn more about this, right, but the reason why you don't have access to it if you have less than 5 million, in our opinion, is if you ever have to liquidate at an inappropriate time for the fund.
Speaker 2You could really get hurt. So it's much better just to be in like short-term treasuries and the aggregate things of normal investments.
Speaker 2But anyway, thanks for listening to the episode. Thank you, andrew, for bringing this and talking about this as a subject expert. If you'd like to learn more about Weiser Wealth Management, I want to schedule a consultation meet with one of our fiduciary financial advisors. You can do so by going to wiserinvestorcom. Don't forget, you can watch this on YouTube on A Wiser Retirement, and we also have in our show notes videos and other episodes you might be interested in. Thanks for watching. We'll see you guys again next week.
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