Private credit experts slam claims that sector does not offer higher returns
Private credit professionals have hit back at a recent report which claimed that private credit does not offer higher returns once fees and risks have been taken into account.
The claim was based on an analysis of the risk-adjusted returns of private debt funds originated between 1992 and 2015, using the Burgiss-MSCI database.
However, industry professionals have slammed the research, calling it outdated and incorrect.
One private credit fund manager, who requested anonymity, told Alternative Credit Investor that the 1992-2014 sample set “does not reflect the dramatic changes to the private credit market over the last 10 years.”
Read more: Private debt diversifies from direct lending
“Private funds today are much more focused on senior secured debt with lower fees,” the fund manager said. “They also discounted risk using public equity returns.
“In particular, the Cliffwater analysis – which uses a much more recent sample set (2004 to 2024) and a more conventional risk measurement tool – shows approximately 600 basis points of annual excess return after fees.”
Cliffwater is an alternative investment adviser and fund manager which also conducts its own research. The firm’s chief executive Stephen Nesbitt published a response to the NBER analysis, claiming that the paper suffers “at least four weaknesses”.
These include the outdated time period, a lack of transparency in data collation, and an “inconsistent” approach to risk management.
Read more: Emerging ‘bifurcation’ of quality in middle market private credit
Nesbitt added that “with a few exceptions, those managing private debt portfolios today are very different from pre-financial crisis managers, who often included public high yield and distressed debt into their private debt funds,” rendering the NBER data inaccurate.
Cliffwater concluded that “fees and expenses for unlevered private debt typically average no more than two per cent, giving a net, risk-adjusted excess return equal to approximately four per cent.
“While most private debt funds use leverage to increase return, leverage will generally not change risk-adjusted excess return.”
Claire Madden, managing partner at Connection Capital, agreed that the 1992-2014 funds sample is “a bit before the maturity of the market”.
“In times of a fully functioning banking system, it may well have been the case that only sub-prime lends were available to private funds,” she added. “That is absolutely not the case now.”
Other experts criticised the study’s risk-adjustment calculations, stating that private credit is a diverse market which cannot be generalised en masse.
The term private debt covers a range of finance solutions including direct lending, sponsor lending and mezzanine lending, each of which comes with its own unique set of risks and returns. Furthermore, in the decade since 2014, major innovations have shaped the private credit market, making it more liquid, diverse and transparent than ever before.
Read more: Fitch: Competition in private debt is intensifying
“From the global financial crisis to date the industry has matured and lending by private credit funds is much more mainstream,” added Madden.
“The study seemed to suggest that the credits were of lower quality because the debt funds were writing business that banks wouldn’t do.
“Private credit today operates in the same markets as banks – the creditworthiness of the borrower may be strong but the borrower requires something different from the lender such as more flexible amortisation, or a lighter covenant regime.
“Private debt funds are set up to provide this flexibility, banks are not.”
According to the Cliffwater Direct Lending Index, private debt earned 6.19 per cent in annual excess returns, risk-adjusted and gross-of-fee between 30 September 2004 and 31 December 2023.
Read this article and more in the latest issue of Alternative Credit Investor, out now.
