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Public vs Private Credit: Golden Age, or Fool’s Gold?
One of the most widely debated investment topics in recent years is the rise of private credit, in particular the growth of the sponsored direct lending sector. We discussed our team’s view on this topic at our recent 2024 Artisan Investment Forum, diving into the drivers of growth across public and private credit along with key considerations that investors should bear in mind when allocating to credit markets in today’s investing environment.
Since 2021, the high yield bond market has shrunk by approximately 12%. Upgrades of companies from below investment grade to investment grade (so called “rising stars”) have removed some of this supply from the market. However, companies have also made decisions to substitute high yield borrowing with issuance in competing markets. While traditionally the primary competitor to high yield was the leveraged loan market, the private credit market has grown in recent years to become a significant force, bidding away public assets.
Source: Artisan Partners/ICE BofA/Preqin, data through 30 Sep 2023. High Yield and Leveraged Loan market size represents face value outstanding of each market according to ICE BofA. Private Debt market size according to Preqin.
Over the past five years, data from Preqin estimates that the global private credit market has grown over $1 trillion in size, increasing by an astounding 175% from 2017. However, volumes for the traditional source of sponsored direct lending deals – leveraged buyouts – have decreased materially from their peak in 2021, while private credit fundraising continues to be well above pre-pandemic levels. This lack of traditional supply has created a significant “need to invest” for private credit managers sitting on record amounts of dry-powder.
Source: Artisan Partners/Preqin/LCD, a part of PitchBook. Leveraged Buyouts (LBOs) are transactions used to take a public corporation private that are financed through debt such as bank loans and bonds.
We believe this dynamic is beginning to drive convergence across public and private credit markets. Ultimately, borrowers in any market – whether you are a prospective home buyer looking for a mortgage or a corporation looking to fund your ongoing business – don’t necessarily care which lender loans them money. They care about pricing (e.g. interest rate) and terms (e.g. covenants). In 2024, all three “wrappers” of the corporate credit market – high yield bond, leveraged loan, and private credit – are approaching companies with their best offers, putting downward pressure on pricing.
Source: Artisan Partners/JP Morgan/Bloomberg. Article titles are for illustrative purposes only.
In our view, when market pricing and terms converge, so too should return potential. The historical illiquidity premium that direct lending has offered investors over public markets should continue to decline as these markets effectively become one source of financing. Unlike allocators, companies won’t think of these markets as distinctly different buckets – they will simply choose the best “wrapper” that fits their needs.
Going forward, we believe this has material implications for those who invest in private direct lending strategies. In our view, declining illiquidity premiums and a convergence of terms should prompt a re-think of the asset class and its role in allocator’s portfolios. After all, if you don’t get paid much to lock up capital, why would you?
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