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The private credit market has risen dramatically in the past decade, with upward trends pointing to new areas of growth for investment teams that are willing to explore further.
Given volatile macroeconomic conditions, underperforming public markets, and heightened geopolitical tension, increased allocation toward private markets offers investors stability and yield when they need it most.
In 2023, private credit is one of the fastest growing segments in the lending landscape. Calling this growth “the private credit boom”, Moody’s recently estimated that the market would reach at least $2 trillion by 2027.
Assets under management (AUM) in private debt has now surpassed $812 billion, said research from Preqin, with the number of active investors in the industry currently numbering more than 4,000. For reference, private debt AUM came in at $412 billion at the end of 2020, and has since almost doubled in size.
Also colloquially known as private debt, private credit is non-bank lending to companies that aren’t publicly traded or issued. Pluses associated with this asset class include attractive returns, speedy executions, and new opportunities.
It is seen as increasingly competitive, with new inflows and interest. A December 2022 paper from Wellington Management, titled “Private credit in 2023: The benefits of a bear market?”, said that the organisation continued to see new entrants amongst US and non-US insurers.
For the former group, “investment-grade private credit represents a long-standing core asset class”, said the analysis. However, the report noted that the newest entrants included increasingly varied insurer types – such as health, property and casualty, and reinsurance – as well as pension funds.
There were “ongoing opportunities”, the report said, similarly noting that private credit issuance volumes were at historic highs going into 2023.
Alternative investments have been gaining steam recently – given volatile macro conditions and investors’ desire to seek more uncorrelated returns. Private markets are one way to do so.
The adoption of private credit strategies, in particular, is a relatively new trend, with the rise in AUM often attributed to fallout from the Global Financial Crisis. Banks and more traditional lenders were often nervous to fulfil riskier loans, which meant that direct lenders – private lenders – took their spot.
With this trend continuing today, private credit could become a mainstay in an insurance investor’s portfolio. According to the Q2 2023 Europe edition of Cerulli’s quarterly report, “The Cerulli Edge”, research indicated that direct lending and private placement would be the most sought-after sub-asset class in the private debt space going forward.
“Around 25% of private bank and wealth manager respondents on average plan to increase their allocations to these strategies over the next 12 to 24 months,” the report continued.
“The opportunity set for investors is orders of magnitude greater than those
offered by public markets.”
Compared with other alternatives, private credit is relatively low-risk, which for insurance investment teams means it’s often a viable tool for fixed income diversification. The potential for higher yield is also a plus, as is the closer relationship between lenders and borrowers.
CEO and Founder of the private markets solutions provider PM Alpha, Tom Douie, said that he believed private markets were the ideal stage for executing on targeted investment strategies. “The fact that the vast majority of economic activity and commercial revenues are generated by private companies means the opportunity set for investors is orders of magnitude greater than those offered by public markets,” he added.
Nevertheless, the ‘new frontier’ nature of the asset class has some investors worried, and those with unpredictable, short-term liabilities should be more cautious than their longer-term counterparts.
Whilst this growth trend has many causes, investors cannot ignore the significance of volatile macroeconomic conditions and wallowing public markets.
The Wellington report also noted an increase in cross-border activity as market dislocations persist, which it especially attributed to the Russia/Ukraine war in Europe and resultant fallout.
“Challenging times may offer even better opportunities for
private credit.”
Historically, private credit has stood in opposition to more liquid public alternatives, offering a pricing premium, better asset/liability matching (ALM) characteristics, enhanced diversification and returns. The possibility of uncorrelated returns is particularly appealing in tough market conditions, with Wellington writing that, “we think challenging times may offer even better opportunities for private credit”.
However, there are still macro risks that insurance investment teams must consider. The report pointed to the likelihood of a longer and deeper recession, which, it said, could impact corporate earnings and therefore affect a company’s ability to repay its debt.
Ultimately, though, the asset class’s hot streak was expected to continue through 2023; “we expect private credit investors to see greater diversification and the ability to negotiate favourable pricing,” the analysis concluded.
This means that investment teams would be wise to consider the risks and opportunities this asset class has to offer – even if only to stay alert on current trends.
The promises of better yield and operational efficiency in private markets have been alluring to insurance investment teams globally.
“Many institutions are showing interest in private credit,” said Cerulli's analysis. “Managers can improve the structural protection on the bonds and loans they invest in, and therefore are in a better position if there is a credit issue to deal with than if they were in public high yield.”
A recent Goldman Sachs survey back up these sentiments, reporting that that the shiny promise of higher yield was luring insurers back to fixed income, whilst appetite for private markets remained strong.
The survey, which consulted 343 insurance company Chief Investment Officers (CIOs) and Chief Financial Officers (CFOs) representing over $13 trillion AUM, showed that insurers were leaving into fixed income and seeking to increase duration and credit risk.
“Insurers are looking to take advantage of higher rates while
managing their market risk.”
This appetite was remaining strong despite the deterioration of credit quality and predictions of a greater upcoming recession in the US. The survey analysis added that, for the first time, insurers ranked increasing yield opportunities in the current environment as the most important factor driving asset allocation decisions.
“With high inflation, rising geopolitical tensions, and the effects of tightening monetary policy, insurers are looking to take advantage of higher rates while managing their market risk,” said Matt Armas, Global Head of Insurance Asset Management at Goldman Sachs.
He added that the “journey to rebuilding yield” for insurers will require a balance of duration and high-quality credit opportunities.
The general consensus seems to be that with banks scaling back on lending in the current risk-adverse environment, direct lending funds could have new roles to play in an investor’s portfolio. For small and mid-sized insurers, especially, they could offer alternative sources of financing – a reprieve amidst the storm.
“This expansion could lead to volatile flows of money into
and out of the market.”
The trend remains constant: investment teams are reallocating assets in response to difficult market conditions, searching for fixed income yield and seeking to play to market cycles.
However, considering risks is always key.
An S&P Global report on private debt as a lesser-known corner of finance report finally finding its spotlight noted that with expansion comes heightened risk. “This expansion could lead to volatile flows of money into and out of the market,” it said.
The asset class’s lack of transparency and significant illiquidity are other key risks that investment teams must take into account.
The more nuanced version of this picture is that insurance investment teams – particularly those on the non-life side of the aisle – will need to be picky about private credit and ensure any investment decision is hedged correctly and backed by thorough due diligence.
