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Extra Credit

  • Writer: ACosgrove
    ACosgrove
  • Jul 21
  • 5 min read
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An incredible amount of money has flowed into "private strategies" over the last 5 years. And that growth continues…take a look at private lending, for example:

 

Pitchbook pegged total global private debt (institutional and retail) at $1.75T at the end of 2022; that number had grown to $2.2T at the end of 2024 – up 25% in just two years.1 And Cliffwater’s Corporate Lending Fund (CCLFX – which is something of a bellwether for wealth channel allocations to private credit) has seen its assets increase from $11B on 3/31/2023 to $28B on 3/31/2025 – up 2.5x over two years.2

 

And now private equity and private lending and all the other “alternative assets” are all but certain to come to a retirement plan near you.3 Which means its all but certain that the numbers cited above will be going up. For some, that’s all they need to know to be “bullish” on private everything. For us, not so much.

 

Let’s narrow the field down to private lending again to illustrate how we think about these markets. 

 

First, the defining features of private lending strategies are:

 

  • They cannot be turned into cash readily (i.e., they are not liquid) though some strategies are less liquid than others

  • The key part of their return profile is a yield that is comprised of a base interest rate and a spread; so the loans made by the fund might have a base rate of SOFR (4.34% as of this writing)4 which changes, typically quarterly, plus an additional rate of interest, say 4%, equating to a total loan interest rate of 8.34%

  • They have higher expenses5 – typical management fee 1 – 1.5% and fund expenses 0.5 – 1% but often funds borrow some money so they can lend out even more money and the fund has to pay interest on the borrowed funds so that’s an expense too

 

Next is why…why do people want to use these vehicles that are not liquid and have higher fees to make loans to (mostly) corporations? Here are a few (not exhaustive) reasons:

 

  • The success of the “endowment model” (David Swensen, the late CIO of the Yale University endowment, had enormous success with private assets and became the envy of the institutional finance world)

  • Diversification – sometimes these funds invest in markets that really cannot be reached any other way

  • Alternative "alpha" – this gets thrown around a lot but it basically means the ability to earn returns that are in excess of what is otherwise available when lending money to corporations

  • And therefore it is possible to achieve higher returns with far less price volatility (the way private equity has since the GFC and private credit has since Covid)

 

Now, when we look at where we are in mid-2025 versus where we were just 18 months ago here is what we see:

 

  • Massive increases in the supply of capital (see examples cited at the start of this post) with almost no questioning of whether this makes sense or not – seems to be pretty much one way traffic

  • Lending terms that may still be OK but are quietly moving in the direction of more borrower friendly

  • Base interest rates are lower

  • And spreads are modestly lower

 

Absent a sharp recession it's hard to see these trends changing any time soon.

 

As always, the ultimate question is…does the reward on offer adequately compensate for the risk assumed? 18 months ago our answer to that question was “yes” (with a few caveats).  Today our answer is “maybe” - so it's important to understand terms on a deal-by-deal basis.

 

IF - after all fees, expenses, and an allowance for losses; and adjusting for potential base interest rate and spread changes - a private credit strategy is expected to generate an annualized return of 9% over the next 5 years…which translates into 5-5.5% after-tax when held by an individual or in a taxable brokerage account (since most of the return is taxable ordinary income)…is that enough additional return, versus say, a high quality muni bond portfolio yielding 3.5 - 3.75% after-tax? Or cash at 2 - 2.25% after-tax?

 

Let's just say that we'd prefer to see the difference be a point or 2 higher.

 

We worry (perhaps more than we should) about capital flows + deteriorating loan terms + market structure changes (increasing need for lender size so as to get a seat at the table in a restructuring – due to more flexible loan documents that potentially open the door to lender prioritization vis-a-vis other lenders) + default rates (inclusive of “liability management exercises”) being higher than understood + low spreads in some market segments…

 

Therefore – for now - we’ve gravitated toward niche markets and opportunities.

 

Turns out we’re in good company. Here’s Armen Panossian from famed credit investor Oaktree Capital Management speaking recently:

 

“We have a tremendous amount of dry powder at Oak Tree across all of our strategies, and we're ready for the right opportunities that are structured appropriately. We tend to like to invest more when there is a dislocation, and we don't see very much by way of dislocation anywhere right now. So we're going to proceed cautiously and looking for just kind of our steps as they present themselves rather than make a big market call and push in all at one time”6

 

Some dislocation wouldn’t be a bad thing: it might shake up investors, reduce complacency, and create better opportunities. Until then – we are happy to stay niche.






This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.


The projections are based on current market conditions and historical data, which are subject to change.


Diversification and asset allocation do not ensure a profit or guarantee against loss.


Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website.www.adviserinfo.sec.gov   Past performance is not a guarantee of future results.

 
 
 

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