Rise of Private Private Credit
Traditional fixed income has faced challenges over the past few years, while equities or stocks have thrived in contrast. This shift has paved the way for the rise in popularity of alternative investments such as private credit, as investors seek to strengthen the fixed income segment of their portfolios.
In our latest webinar, our Chief Investment Officer, Chris Carsley, together with Richard Hillson of Hillson Consulting, delved into the topic of the "Rise of Private Credit." The discussion revolved around the factors that have fueled the expansion of private credit and the anticipated trajectory of this asset class in the foreseeable future, among other things.
Video Highlights:
Is the 60-40 Dead?
Traditional Fixed Income Investments
Rise of Private Credit
Private Credit in Real Estate
“The 60-40 is not dead. It is an allocation that may fit some investors. But it may not be for everyone. Maybe a 70-30 or an 80-20 fits you better. So, I don’t think the 60-40 can really die.”
“A lot of alternative investments are more conservative than some of the equity plays in a lot of portfolios.”
“There’s still a lot of global macro uncertainty in the market. But there are a number of alternative asset classes that are less volatile and have less correlation to some of those global macro decisions.”
Watch the full video below.
Transcript
Richard: Sorry for the late start, everyone. Um, technology has its pros and cons as, uh, as always. Thanks for joining us today. We're going to be talking about 2024, the rise of private credit. Private credit is a Uh, very topical at the moment and is one of the asset classes which is pretty much on everyone's lips at the moment.
A couple of housekeeping items. If you're here for credit, uh, I believe that we are, um, Investments and Wealth Institute, CIMA and CFP, uh, accredited. So if you're here for credit, please do stay on the whole time because we need to log the minutes and report that back to the board. Um, there's nothing worse than someone dropping off after 36 minutes and we saying, sorry, guys, we can't give you the credit.
So please do stick around. Hopefully you'll be enthralled anyway. So you'll want to stay until the very end. And as far as questions, um, you don't need to wait to the end, just ping questions in the Q and A bar, please. And, um, we'll answer those as we go along. We'll save them to the end, depending on whether it's going to be covered later on in the, uh, in the presentation.
So let's just move on. So the next one will be disclosures, disclaimers. I'm not going to read all of that out. Otherwise my voice will be burnt out before we even get started. But I'll pause for a moment to let you flick through that. And, uh, the important thing is that this is not any kind of offer nor solicitation This is, um, uh, educational and, uh, non-sponsor or product specific.
So, uh, no offer nor any kind of solicitation there. Next slide, the disclosures for CFP. accepted for one CE credit hour. And like I said, please do stay on the full amount of time. When this is over, whomever invited you, uh, please email them your details, and we can log the credit for you at that point. And then we are also, uh, in fact, we don't have the, um, CIMA slide, but that's fine.
Uh, we're also approved for Investments and Wealth Institute, CIMA, and the other accreditations there. So, again, let us know as far as that's concerned, um, with, um, the, um, So that we can log your credit for you. Okay. Housekeeping out of the way. Uh, we can get started. My name's Richard Hillson from Hillson Consulting.
And essentially we believe that alternative investments are misunderstood, underrepresented, need to form a part of every portfolio. How do we fix that? One advisor, one client at a time. Um, so, um, It takes a while, but we're trying to change the world one person at a time. Um, I, in my previous life, when I ran an investment bank and an RIA, I was getting very frustrated with having conversations the whole time with advisors who were running decent amounts of money and investors who were supposedly sophisticated.
And as soon as you said the dreaded A word, Alternatives, you saw shoulders tense up and this visceral reaction. as people think that alternatives have to mean Bobby Axelrod from "Billions" or crypto or other high octane, um, strategies. And in fact, a lot of alternative investments are more conservative than some of the equity plays in a lot of portfolios.
So we'll be. anything that promotes alternatives and makes them easier to access, easier to understand is in my wheelhouse. Sometimes work on the advisor, the client, the broker side, and sometimes work with quality, um, alternative sponsors like Chris to help them educate and connect with their audience.
Um, Chris, do you want to give your, um, uh, quick intro here about yourself and, uh, about Kirkland?
Chris: Yeah, sure. No, I'm, myself, I started off as a money manager. I ran, um, high net worth and small family office from a discretionary account standpoint for a number of years. Went to work for a, uh, hedge fund, uh, trading a variety of different, uh, arbitrage trades and dealing with securities finance.
Then had an opportunity to join a fund to fund where, you know, my role changed where I wasn't the one pulling the trade, I was the one reviewing the trade and really tearing funds apart. Um, and doing extensive due diligence to create a series of portfolios, uh, for, um, large endowments, pensions, institutional class investors, and then, you know, got involved in, um, venture, worked, uh, here in Seattle.
There was a booming, uh, Venture and startup community, um, got, uh, pulled into that for a variety of different reasons, worked in that sector for a while, ran a small seed angel fund, and then, um, most recently, uh, teamed up with my partner now, uh, Brock Freeman to build the, uh, Kirkland Capital Group and the Kirkland Income Fund, which is, you know, private debt in, uh, with specific focus on, you know, real estate.
So we'll cover some of that later. But Richard, I, I laugh, you, you talk about hedge funds. I often will talk to students at various colleges in the area, and I always ask them to give me a definition of a hedge fund, and of course everyone thinks they know what it is, and I answer with, well, none of you are wrong, and none of you are right.
Unfortunately, the word hedge has been bastardized, and yes, everyone thinks, you know, high octane speculative funds, but there are many, many, I mean, we're not going to talk about this, but there's many alternatives that are meant and built as far more conservative instruments and a true hedge, uh, and low correlation to, you know, traditional markets.
So, it's a fascinating time. No, most people haven't cared about alts for about 12 years, but It's exciting to be back in where, where, where people want to talk to you.
Richard: Yeah, absolutely. And we'll cover that, why the last 12 years has been kind of interesting, but then also back on the radar now. Um, just in terms of terminology, um, you said private debt.
Um, do you consider private debt and private credit to be interchangeable as terminology?
Chris: I do at a certain level, I will, I, I just had that question from an investor the other day and I said, well, there are ways to trade just the credit worthiness. Um, there are instruments that exist, uh, in the derivative world to trade just the credit worthiness and perhaps credit spread between a variety of different aspects.
But for most people who are looking at what now is private debt, private credit, you, you are, they can be used synonymously. You know, it's, it's, it's the same term in a, in a lot of ways, unless you're really one of the big institutional players that's saying, Hey, I want to go out and really take, you know, dedicated credit bets.
I'm not looking at somebody who's a direct lender in venture or a direct lender in real estate or a direct lender to, you know, corporations or something like that.
Richard: Yeah, sounds, sounds good. Okay. So let's look at what we're going to cover today. Uh, so is the 60 40 dead? Uh, talk about, um, somewhat of a provocative statement there, but we'll dig into that.
We'll then look at traditional fixed income investments, the rise of private credit. I think I've seen, um, a number of, uh, reports and surveys saying that private credit has overtaken real estate as the, um, as the fastest growing area of the marketplace. I don't know if that's in terms of actual number of allocations, but certainly in terms of the, the speed of the trajectory, it's certainly the darling of this space at the, at the moment.
Um, then we talk about, What I think is really interesting is private credit in real estate because sometimes private credit that's maybe lending to small, medium sized businesses might be a bit of a step too far for some conservative and less adventurous investors. But if they're comfortable with real estate, it's only a baby step to actually look at private credit while staying within that potential comfort zone of real estate.
Um, micro balance bridge loans, And then we'll move into some case studies where Chris is going to talk through, um, some real world scenarios here and then leading up to Q& A at the end if we haven't answered all the questions as we, uh, as we go along. So let's get started with that provocative statement.
Is the 60 40 dead? And Chris, actually to tee this up and then I'll talk you, uh, and I'll let you talk through this. I, um, it was, um, a really interesting article that I read and I actually incorporated in a previous presentation, which looked at, um, a set few years, and this was going up to, um, this was going up to 2022, so we can fill in the blanks there, but I found it really interesting, is 1978 to 2008, the There was a huge positive carry on bond and complete negative correlation between stocks and bonds and downside protection because the yield and the duration on the aggregate bond index.
So the 60 40 worked in that window because of that negative correlation. 2008 to 2020, modest principal protection, uh, barely positive carry, uh, because the Bloomberg Aggregate Bond Index, and if I'm looking off here because I'm reading this because I couldn't memorize it, um, uh, yielded 0. 7 percent more than the S& P and near zero correlation.
So again, 60 40 worked for a number of reasons. Um, that 22, uh, 20 to 22 minimal principal protection, um, where the aggregate bond index, average yield of 1.5% and a duration of 6.4 years, negative carry and positive correlation between, um, stocks and, uh, and FI. So that was the two years where it really became.
Um, challenging after a really good run for the 6040, uh, where they really started to open eyes. And I know the last couple of years have been a different story, but I think that was the tipping point where people said, okay, one way or another, we need to add alternatives for diversification and other types of correlation here.
Because we've seen in that two year period, that model, which was supposed to work no matter what the environment was doing, simply did not. So I found that really interesting, uh, looking at those three buckets. But I'll let you elaborate on that and perhaps talk a little bit about the last two years, uh, to get us where we are now.
Chris: Yeah, no, I, that's great. I mean, and you're, and you're right. Um, you know, What to really to kind of go off with the slide saying here is, and I laugh when people are like, Oh, is the 6040 dead? I mean, I mean, there's a number of papers of, you know, where Markowitz came up with the efficient frontier and it found that the majority of investors were finding their most effective investment profile was that 6040.
And so it became a very popular allocation, but that's all it is. It's an allocation. The 6040 is not dead. That is an allocation that may fit some investors. It may not be for you. Maybe you're a 70 30. Maybe, you know, you're an 80 20. You're a 100 0. Um, it's just an allocation. So, I don't think the 60 40 can really die.
And what you really were alluding to is the nature of return that carry plus the diversification that fixed income is expected to add to a portfolio. And that clearly in actually a record level failed in, in, in 2022, um, and people are still crawling out of that hole. And this is one of the reasons you're seeing a lot of people gravitate and look at private credit.
So it's not like, okay, do we need to, let's just stick with our 60 40. The 60 didn't really break. Um, you can look at the chart on this, uh, on this slide here and, you know, the S& P 500 from an equity standpoint, or if we're going to use that as the, the 60%, obviously, most people are far more complicated than that.
They're just not in one thing, but let's just make it simple. That didn't break. I mean, for the last four years, you know, your annualized return was 20, just over 20%. Um, so that, that in my mind is not what people are now eventually coming back into the water and realizing is, Oh, I need to drastically fix my equity.
No, it's actually, I need to fix my fixed income. And I'll be honest. I mean, even when I was managing people's money, You talked a lot about the equity side of the portfolio, and then you kind of glanced over the fixed income because for most people, it was incredibly boring. Um, it was not something that you got excited about and there was no bragging to your neighbor about your fixed income portfolio.
It was just there as a risk offset and maybe you needed some kind of liquidity component in your portfolio, depending on your individual investor profile. Um, that was needed. But now that that's broken, And people are still looking at a situation of where, how am I going to fix that? And the increase of information of private alternatives in fixed income has really opened this door.
And that's the important thing that we're, that people need to address and think about. It's really hunkering down and saying, wait, I need to really look at equity and fixed income separately and really look at my options in that fixed income section to say, okay, what's really working. Now let's look at some of the other data points that are on this slide.
You look at a lot of your traditional investments, your aggregate bond, you would, you were said it's now Bloomberg. I, I still get caught calling it the Lehman Ag, um, that dates me, um, but it's now the Bloomberg Ag, um, and you look at government bonds and corporate bonds. For the last four years, they're still in a hole, but here we're using sort of the MSTR levered loan index, which is, you know, it's not really a great fit for everything that's in private credit.
And we'll walk through some of that later, but it is a very common index used by many people as some level of sort of a representation of private credit. Well, okay. You've obviously seen a very positive return in this space of private credit, you know, for volatility, that's actually been less than you've seen in traditional markets, which is a little bit odd.
And you know, that's obviously driven a lot by 2022. Um, but it has got to get your attention of, Hey, maybe we should start looking at some allocation of our 40 percent and thinking about adding something in the private credit space because there is value to be added there. There is that return that can be captured and you are also capturing diversification that is just not prevalent in traditional investments currently.
Richard: Uh, agree. And so that obviously ties in well to the next slide, which is what is fixed income at the moment. And like you said is It's not something that people really talk about with their friends at the golf club while they're talking about their new AI startup equity investment or whatever. Um, and most people don't want it to be particularly sexy, but I guess most of this is ETFs or mutual fund is where they get most of their exposure.
Um, I mean, if you're paying your advisor to manage your FI, I mean, is that kind of just passing the buck or, um, are there better ways to do that? Well, where is it at the moment?
Chris: Yeah. I mean, and I'll have to admit, even like I said, when I was managing money, it was something you got a general idea of, well, what type of Mitigation do I need to understand? Do I want to be on the long side of the curve? Do I want to be on the short? Do I want it blended? You know, am I running a barbell or a laddered structure? I mean, but that was about it. That was about as far as you took fixed income. And I think to a large extent, because of the last 12 years being so equity focused.
Um, and it, and it has taken a few years for financial advisors to realize, wait, there is an opportunity to add value and come in and recognize, like, I'm not saying you get rid of all your public instruments and fixed income by no means, but you've got to look and say, What value am I adding on the fixed income side that really is diversifying my, my client's accounts and also really offering quite a boost to return even with, you know, interest rates where they're at.
Um, there's a number of different private credit investments that, you know, are in high or even low double digit, you know, net returns to investors, um, in a variety of different formats. Um, so, I mean, it's, it's something that I always laugh. You said it's not sexy. I mean, I've been working for the last couple of years to try and bring the sexy back into fixed income because if you can earn an equity like return in your fixed income and take, you know, debt level risk and even a debt level risk that has lower low correlation to your other fixed income investments, that's got to be an opportunity that piques your interest.
Richard: So you're the, you're the Justin Timberlake of fixed income bringing sexy back, right?
Chris: Yeah, well, I'm trying. It's, it's, it's hard to do. And I admit, I mean, uh, cause we even tell investors, it's like, well, fixed income is supposed to be kind of boring. And if it gets exciting, that's well, not a, not necessarily a good thing.
There is one other thing I want, I do want to mention. Um, and some people, I see a lot of people throwing in the, in the alternative investment class, you know, they'll throw BDCs and we talk about, uh, REITs. Um, It's personal preference. I don't tend to view them as alternatives. Yes, the base investment that they're in CLOs or something of that nature, um, uh, or, you know, direct investments in, in income producing real estate.
It sounds alternative, but once you put it in a wrapper of a C Corp and publicly list it, what you'll End up seeing more than not and we'll see some of these numbers later when we walk through some correlation numbers It ends up just acting and looking very similar to all your other public investments So, um, I believe yes, the underlying investment is alternative, but you put it in the wrong wrapper It starts to look a lot like a traditional investment in fixed income.
So yeah, just that's why I put those two on the slide there
Richard: Yeah, completely agree.
Um, okay, next few slides I'm talking about the current state and this is really new so, um, you jump around as need be and I'll ask any questions or comment as things come up here.
Chris: Yeah, I mean there is opportunities more so than, I mean, I think anyone realizes if you're So there is definitely an opportunity for return in traditional fixed income. And you can see, you know, the chart on the left there, you know, there is now credit spread depending on where you want to be. I mean, things were very, very tight for a very long time because it wasn't really considered much risk between one or another.
Um, and you are starting to see that occur. Um, You know, the other chart there is obviously just simply the yield curve. Um, there's a number of people who are very excited about staying on the short end, uh, and saying, well, why do I really need to think about 10, 20, 30 years? Uh, I can, I can actually hold cash, beat inflation, uh, currently, and be opportunistic about my investment, uh, deployment.
Um, but, with that said, If you're willing to go and step in and make 5%, well, are you really treating cash as a fixed income? And it kind of goes back to Richard's earlier statement. It's like, well, you should really be charging a fee. I don't know how much holding onto cash is, uh, is of value for a long term plan.
Um, and with the idea of what, you know, the statement there is, you know, private debt. In an efficient spaces can capture, you know, really large excess returns in the hundreds of basis points, you know, above even traditional investments. So, yeah, there's an opportunity to maybe, you know, play in that short to intermediate capture this yield curve, have that as a piece of your portfolio, But there again, you know, you, you've got to look at saying if it's suitable for your client, you've got to be moving forward and thinking about how do I access things in the fixed income world and build a diversified portfolio, uh, to really juice this side of my, my client's accounts where I can capture this interest rate in the traditional and then add diversification and increased return.
Um, I mean, there's, there's, and here's the one thing is, you know, some of the risks that are going on, that inflation, that interest rate risk, uh, central bank policies, it's still very uncertain, um, are they going to, you know, ease, are they not going to ease, is there going to be a political statement, uh, instead of an economic statement in this year, um, there's still a lot of uncertainty.
There's uncertainty in there and there's a number of classes also in the alternative investment space and fixed income that are just less volatile and they'll have less correlation to some of those global macro decisions. So that's another consideration.
Yeah, I think next slide is carrying on that trend of the current state. Yeah, um, this is where we're, you know, we're walking through some of the correlations, I think, and this goes back to Richard's statement is, you know, you're looking at, this is covering the last four years, but there again, you had a pinnacle of this impact of increased correlation driven, you know, by 22, and I would expect these, you know, correlations to hang in this level or becomes slightly less correlated over time, depending on, um, current, you know, global macro events and Fed's moves, but you can see here at this current time, you know, adding the aggregate bond index.
Yeah, it has some diversification capabilities, but you're really looking at, you know, a majority of the movements in your, you know, REITs. You know, your equities, your levered loan index have pretty high correlations, you know, to the Bloomberg aggregate bond index. Um, and then we, you know, we go through and compare the rest.
I mean, and as I said earlier, why I consider, you know, REITs and BDCs to be in that traditional bucket, as you can see, the MSCI REITs correlation to the S& P 500 is 88. Um, that's actually lower than it has been. I mean, it's only in the last. I think last year that started to drop out of the 90s from some of the data that I was collecting.
So I, there again, I just reiterate, you know, you might be adding a different risk factor and you're getting a return from a different risk factor. But when things become volatile, or we run into another event where you know, the old hey correlations go to one, you know, these guys are already pretty close.
They're going to move in lockstep and you're going to have another event where clients might experience pain and suffering on both sides of their allocations, both equity and fixed income. And so. You know, I think if we, you know, go to the next slide, you'll see, I think we are talking about now, these are some numbers, you know, pulled in from private debt.
There are multiple indicators that it's private debt really is a diversification factor in fixed income, even on comparison to other fixed income. You can see, I mean, you know, it's a lower negative correlation, but I mean, anyone who's ever done portfolio theory, being negative is rare. Now, some people might argue, oh, it's the illiquidity nature of, uh, of private debt that's creating these correlations.
Um, and the answer to that is yes, certainly. I mean, there's, that's a component of it. But, as we learned in, you know, 0 9, 0 9 and 10, for many, many people, being subject to the emotional whims and the behavioral finance impacts of major left tail events can create massive loss. And so, to some degree, having a level of illiquidity to dampen emotional reactions and knee jerk reactions from people all trying to get out of the same door at the same time actually was a boon for many, many investors in those time periods.
And I think that's, uh, you know, there's, there's a number of papers that have been written recently about that. Uh, you know, is illiquidity really a bad thing? Um, and I don't, I don't think it is, as long as it's under control and you're meeting your client's liquidity needs, you can definitely have a component of both equity and fixed income that can really be an offset to, you know, emotional volatility created by, you know, rapid moves, uh, you know created by market events that, you know, create panic and fear. But you can see here, uh, you're clearly capturing your diversification within the portfolio by adding a component of private debt. And, and this one is, uh, these numbers are related to a private debt in real estate, but I know for a fact that private debt in venture and a variety of others have also negative correlations.
So, I mean, it's, it's not, not one particular class, but you're seeing this diversification impact across a number of different aspects of, you know, private debt.
Richard: So, let's talk about the rise of private credit is, this is, it's not come kind of out of the blue, but it's meteoric rise to be one of the most talked about things at pretty much every conference I go to nowadays.
Um, and the, um, the most, uh, it's the buzzword at the moment is, so it's, it's, it's, come pretty quickly into more mainstream is perhaps talk us through what has happened and why you think that is, what have been the tailwinds that have really pushed Private credit to the fore here.
Chris: Oh, yeah, most definitely.
I mean, there's one that's um, I think, you know, the first adrenaline shot in the arm was the Dodd Frank rule in 2010 where you had increased regulations on banks. It opened up a huge door for private credit across a number of different avenues and then what through that, um, you know, banks lending less to certain aspects or being restricted has, you know, opened up a market space for private credit to grow.
But now you're looking at Just in the last couple of years, you've had another adrenaline shot really out of COVID and then back to back with the Fed's move in interest rates and changing regulations that still, I mean, Basel III, there's a number of different things that are even yet to fully unfold in the private credit space that is just going to continue to open opportunity for investors to come in and participate where banks are being forced out of it.
Um, I mean, that's one of them biggest moves that, you know, we've seen, we've, we've seen, um, you know, private loans that we, we basically consider bankable, um, and I guarantee, you know, two, three years ago, they probably would have been bankable, but now, your, your larger banks, uh, are increasing DSCR levels, they're, they're making it harder to get long term financing, it's not that they're not lending, it's just they're moving the marker.
I mean, they're making it harder. You've got to stabilize your property or have a company that has greater amount of, you know, revenues to get those loans done. Um, and banks are just not going to step in and do it. So now, You've seen, you know, I think I lose track of the number of news announcements of how many people, even on Wall Street, are creating, you know, private debt funds.
You know, you're also looking at a situation of where, with the rise in interest rates, we can, you know, in the private debt world, you can now charge even more. You have an amazing amount of pricing power. And you know, and contract power, because people still need to get deals done. They still need to borrow money to, you know, keep their wheels running.
I mean, we've always needed debt. You know, if you look at where even companies are financed, I mean, especially if you're in real estate, you can see this. A small amount of these operations are financed by equity. A majority of everything is financed by debt. And if that's being squeezed, someone's got to step into that space. And which they are in, in, in droves. I mean, there's, you know, I don't think there's a major shop on wall street that's not creating some multi-billion dollar private debt, you know, instrument that they're trying to take to market, you know, and that's, that's going to be the driver and it's going to continue to drive.
And you can see from this chart, you know, we're already at the 1. 5 trillion. Now that's not a big number in the scale of things, but as Richard said, it's, it's, it's, It's not the overall total dollar size that we're looking at, but the growth rate of what's happened just in, you know, since 2010 has been one of the fastest asset classes.
And you can see the projected growth for, you know, the next, you know, four years. It's, It's steep. I mean, I don't think anyone thinks that the banks are going to, you know, come back in a major way. You know, this, the cat is out of the bag, genie's out of the bottle. I mean, there are people taking this and they're not going to give it up easy.
And I think the government has, you know, really opened the door, um, for a great opportunity that's going to carry on for years.
Richard: We've got a few more slides on, uh, on this. So, uh.
Chris: Yeah, I talked a little bit about this. I mean, so you can see this chart is, you know, kind of covers where it all kind of started. Um, you know, one thing I didn't really mention there, but it came, it was a, was a, was a cause of many things, you know, having bank failures.
Um, you know, has only added more fuel, uh, for people to step in and take business, especially where you saw First Republic and Silicon Valley Bank step out. I mean, I don't think there was a, uh, private debt in venture guy that wasn't happy to see that. Uh, you know, the king and queen were, were dead and the land was open and people were trying to get market share and some of the more agile and capable venture debt lenders, you know, they were stepping in and seeing their business grow, you know, immensely. So that's, that's a different private debt area than I'm in, but I know people in the space and, you know, this, all these events we've talked about is what created this opportunity. And, you know, the one thing that people always say, Oh, well, when is it all going to end?
Well, that, that's the interesting part is there's regulations that haven't even come into play that are actually going to fuel this industry for a while. So, define end. Um, will you have market saturation at a certain point? Um, we'll talk a little bit about that. I think these mega funds that everyone's trying to build.
That's definitely a form of saturation in the space, but, um, there's a lot of places to play that's not in the big, you know, 10 billion, 20 billion fund, uh, in private debt. And, you know, and you can see there that on the right hand side of that slide, um, you know, loan issuances from 94, you know, to 2020, you know, this is Oaktree Capital's information.
It's been absolutely amazing to see. you know, uh, catastrophic, uh, fall in, you know, loan issuance on, you know, in primary markets for, you know, corporate loans.
Richard: When you say catastrophic is, do they want to be in that business though, or is there enough business that from a risk profile keeps them within their very thin lane?
Do they even want to be in it anymore though? Do they, do they view it as lost opportunities or are they happy to stick in their very narrow lane now?
Chris: It depends on who you talk to. Um, you talk to the actual guy doing the loans, um, he hears what we're able to charge and the money we're making and he's, he's pretty upset about the difference in rates.
So he's, he's, he's upset. But do I think from a broad entity standpoint, I think what you're seeing is a certain class of loans being, it's kind of a daisy chain. So the big banks are unable to lend to a certain class. Well, the, the lenders right below that pick that up. And then they run out of money and they have limitations on what they can lend.
So, you get these tranches that maybe are not regulatory available to some of the bigger lenders. It's just moving to another lender, but you can see if you follow that chain down, well, now there's this bigger share that falls out for private debt. And so they're, they're going to step in and pick up that piece.
So, yeah, I don't think the banks are like, Oh my God, we're all going out of business and they're upset about it. Maybe they're happy because they get to be even more conservative and still find a way to make their spread. Um, the actual guy on the front line getting the job done. Most of them I've talked to are, you know, they're doing their job, but it, you know, it's, it's frustrating when you're like, why can't we do these loans?
You know, we have this money to lend. Um, and there's money out there to lend. I mean, it's not like banks don't have money to lend. Um, even though they've had, you know, increased reserve requirements. Um, you know, a lot of banks I talked to that they're, they're eager to lend. They just have to find this new bucket.
And that's where. You know, where they're, they're old hunting grounds. Well, that's not allowed anymore. So they got to go crowd in on the other spaces. And, you know, it has to be frustrating when you see people just come in and taking the business you were doing yesterday and there's not much you can do about it.
Richard: Yeah. Well, on the, on the next slide, we're actually talking a little bit about, we've already mentioned some of the bank failures, but JP Morgan, That looks like they're moving it from their Chase, their retail side to the investment banking side to actually be able to, to do that, which might be the smart move here.
Chris: Yeah, well, I mean, you can go back to the early days of moving things to the investment banking side and how many Chinese walls are actually in play. Do people actually abide by, you know, Wall Street's been known to, I mean, To go back in time, you know, the, all the, Hey, we're going to move all these activities and, uh, investment banking relation aspects are somehow going to be merged with analysts.
Um, you're like, well, I, I mean, you look back on it, hindsight's 2020, but, um. Yeah. Sometimes when you're merging operations across, uh, you know, Wall Street finds a way to invent new ways to make money. I don't know if it's going to be better for investors, but, um, it'll definitely accelerate, uh, you know, the expansion of some of these people's, uh, you know, business into private credit.
And like I said, this is just, some names that have launched. I mean, I think everyone is looking at how do I get into this so that I can still capture a piece of this market, even though my traditional banking arm can't.
Richard: Okay. Um, and then next gives, uh, another graph here, uh, just about the returns, which is why returns drive an interest in the sector typically.
Chris: Yeah. And one of the key things is it's, this chart is, uh, I don't want to dive into any of the math here because we just don't, don't have the time nor have it right in front of us, but the real key aspect is, you know, you looking at direct lending, you know, you've got very high returns given volatility.
So there's your risk adjusted components. Then you're looking at, you know, how did they actually perform in, uh, higher interest rate environments. And, you know, and there again, you know, they're performing quite well. Um, now that'll obviously dependent on variable fixed or term of loan and a variety of different things.
So people don't get, you know, stuck, um, in one rate for too long. And then, you know, you know, how did direct lending, you know, fare during, you know, COVID. Um, and so even when there's a sudden shock of uncertainty, that's a little bit of a gap event, um, you're looking at a situation where. It's still very defensive.
And some of that might actually be due to, you know, some of the illiquidity that we were talking about earlier is, you know, so let's say it's people always view that as a, as a bad word. Um, but from a portfolio standpoint, you know, there is a place for it.
Richard: And the next slide actually talks about the expected returns..
Chris: Yeah, no, this is a very interesting.
This is, um, this from BlackRock. Um, you can, people can access this on BlackRock's, you know, website. This is nothing special, that I get, um, but I found it very, very interesting. When I look at it, this is, this was their five year outlook from, you know, like about a, um, month or so ago, um, when I pulled this up.
And it's very interesting because this chart actually goes through and obviously it puts direct lending, which is, you know, private debt credit is that, that same bucket. And, but it also supplies their view of dispersion. Like, well, what's going to be the potential high and low? And interestingly enough, you're looking at, you know, the highest expected return is private lending.
You know, they're sort of pegging it right around that, uh, you know, 12 percent expected annualized return. which is definitely achievable, um, given the risk parameters you want to take. But I also found it was pretty interesting as the, the overall dispersion was relatively tight compared to a number of different asset classes as well, um, both internationally, uh, between equity, you know, and debt.
Now, obviously, when you start getting into U. S. government bonds, it gets pretty tight. Pretty tight, you know, you're not going to have a lot of variance in your return. Um, but, so this is a really interesting chart and you guys can access that on BlackRock's site. But, um, it's, it, you've got to realize, you know, they've got more numbers than me, Richard, and probably everyone on this phone call combined.
And they're actually saying, listen, there's a real opportunity if you haven't added private debt to your portfolio yet, or your allocation is low, it's something you might want to think about, you know, increasing or adding, um, because the forward looking aspect is, is, is definitely there.
Richard: Um, and then the next slide then talks about the volatility expectation as well.
Chris: Yeah, and this is where we go back to where we were talking a little bit about risk and return. Um, this is a chart that pretty much everyone's probably familiar with these axes, but now you're looking at saying, well, hey, where's private debt from not only an expected return standpoint, but from an expected volatility standpoint land?
And, you know, as you could expect, you know, I don't think anything jumps out here in the other asset classes as being in the wrong place. You know, U. S. equities are always right around 17 percent on, you know, a volatility standpoint, but you can see that, you know, they think that there's going to, I don't know, it'd be interesting.
I hear, I hear so many stories of what people think equities are going to be like this year, and they think the broadening of the market and not having seven names drive it is going to be a negative. And just the other day I had someone say, well, that actually might be a plus positive. And I'm like, okay, but according to BlackRock's numbers, you know, they're looking at, you know, let's say roughly estimated 5 percent return.
But the important part is you look at, you know, if you're going to draw an efficient frontier through this or a regression line through this, you know, direct lending is definitely off the line. Um, and there again, I, I always like to think of things in a risk adjusted basis because that is one of the core aspects of fixed income, and we're talking about adding, you know, alternative fixed income to a portfolio, and here again, you know, it's like, wait a second, I can capture an outsized return here.
and I can be off the curve from a risk standpoint. And you, there again, you've, you know, this is a great, if it's not screaming you in the face, I'm not sure what I need to show you next of like, hey, what, what should you be adding? Or if you have none, or, you know, if your allocation's right, I'm not saying load the boat on private debt.
That's, you know, don't, don't ever, Put too much in one place given your, your client's needs. But you know, if the client's got a small piece of it, it's like, well, okay, let's find that different opportunity or increase an opportunity that we've, we've already taken.
Richard: Yeah, yeah. Agree. Um, we are, um, we want to just jump through the next couple of slides, which we've, we've, we've kind of covered most of these anyway, but in the, in the spirit of time remaining, but some pretty compelling numbers here.
90% of investors said that. Private debt performance has met or exceeded expectations. 51 percent of investors intend to increase commitment. 40 percent intend to keep the same amount of capital in play. Um, we, we've talked about the reasons why these numbers shouldn't surprise anyone there based on what we've kind of looked at beforehand.
Um, and then finally, uh, the last slide here on the rise of private credit. is a few of the different, um, sub asset classes, uh, within private credit here. Um, and that leads well into the real estate side of things because, um, um, like I mentioned earlier, some of these can be a little bit, they shouldn't be in my opinion, but can be a little bit exotic for someone who's not particularly alt savvy and wants to stick within real estate.
Um, anything to add to this slide, Chris, before we kind of,
Chris: I would, I would just say that, I mean, just like hedge funds come in 50 different flavors, private credit is not that simple. There's a lot of ways to express private credit and debt in your portfolio. And, you know, obviously I agree with Richard, you know, a lot of the people that I work with are in real estate.
So it was very easy for them to understand, Oh, wait a second. I, I'm actually just I'm not the equity owner. I'm now the lender to this real estate. Um, so that's made an easy step for a lot of, uh, investors to feel comfortable. Um, there's different risk factors. I mean, all these different classifications can be further broken down into pieces.
Um, and you know, they're, they're, you definitely need to educate yourself on what risks are driving the return and how those risks can be mitigated or come back and, and bite you. Cause even, even though it's all in private credit, they're all taking. Slightly different risk profiles that you need, you definitely need to understand.
Richard: Understood. So, uh, moving on to the private credit in real estate and I'll, I'll kind of reiterate this one more time because I think it's important is we actually, Chris, when was the presentation we did? Maybe it was October, um, on Blue Vault. I think it was September, but maybe. And, um, they'd asked us, Um, to talk about kind of what else is out there because at that time there's a lot of investors and advisors and brokers who, um, have maybe been fairly conservative with their allocations and maybe they just, maybe they moved away from their 60 40 model between 20 and 22 and just did some baby steps and the baby steps are always real estate because people will, know it to some degree and most people are, however much I'm a fan of venture debt, most people aren't going to go in there to a client who's moving from 614 say new thing for you.
Venture debt is we take a while to get that. So, um, the, the gateway drug is quite often a multifamily REIT or something like that into the alternatives world. Um, so I, part of the conversation topic that we had was how when people who have just done equity in real estate and are now saying slightly concerned about different classes within real estate on the equity side of things.
What else is out there? If you took them mid small cap company lending, they might say, yeah, a bit too much, but private credit real estate, if there's a Venn diagram with that kind of forming the middle circle overlap, then that feels like a. Uh, an obvious next step. So I think that this area is a great place. for those who want to be a bit more adventurous with their alts allocation, want to get into private credit, but again, take it one step at a time. So this is the area where you have that overlap. So let's talk about that for a, for a moment.
Chris: Yeah, no, definitely. I mean, One of the key aspects, I laugh because I even know venture people that are uneasy about venture debt.
Um, and that's their space. Um, but there is a lot of opportunities there. Um, but no, in real estate, you're correct. One of the key factors that I know, a lot of people are looking for a yield component. Um, maybe they need the income. The other side of the investors are like, listen, I'm looking to add this as a diversifying aspect to my portfolio.
Um, and those are sort of the two categories. But. Everyone sort of gels on the idea of, yeah, we can create this excess yield. That's great. But I like the idea of the principal preservation aspect of I'm backed by a real asset. And from a familiarity standpoint, as you're talking to clients, most people have a mortgage.
They actually understand the idea of what it takes to have debt on real estate, at least even from a single family residential standpoint, you know, and then that's an easy bridge to say fix and flips or, um, you know, what we do is on the commercial lending side where you're lending to commercial buildings and, but it's a tangibility.
You're able to say, hey, here's a touch and feel. Here's a real building backing every single move you make with your money. So we can actually capture this return. And if everything goes smooth, we can, you know, collect our interest and we can roll out of that loan and do another one, depending on the structure of, you know, how you're investing.
Some people do loan to loan. Some people are part of a fund. Um, But, you know, the other side is even if something goes wrong, there is a clear and understandable path. Now, it can take time to deal with, you know, defaults and leading to a foreclosure, but you are looking at, there is an asset to where you're just not at a zero.
You're able to go out and if the underwriting was done correctly and they were conservative in their valuations, even in this kind of market, you're looking at a situation where, hey, if I've built enough equity cushion, I'm doing low enough LTV on a conservative valuation, the probability of you know, capturing, you know, your principal, if not principal in accrued, you know, interest that hasn't been collected is relatively high.
Um, you know, there are occasions where, you know, you, you know, there might be write offs and some people are definitely experiencing that. And most of what you've seen, you know, you can pick up the news and some of your large private credit lenders dealing with, you know, large aspects of real estate are struggling on, you know, gateway city office.
Um, so there are pockets that are always, you know, Going to have more risk than not, but you also need to find or build a portfolio for yourself that's gonna be fairly diversified so that, you know, you don't have, like anytime, you're not gonna have everything in any portfolio go up, uh, you know, a hundred percent.
Um, you just gotta make sure whatever, you know, fails or falls is not. you know, too detrimental and you're not too concentrated, uh, especially if a client's going into something new. But yeah, I mean, it is, it has been, um, a much easier conversation, um, to have because it's very easy to link this, you know, to a tangible asset.
Richard: Yeah. Yeah. We're, uh, we're coming up to question time shortly. So if anyone's got any questions, put them in the bar while we just finish off on, um, uh, the micro balance bridge and then into some case studies. Um, if we don't get any questions, we'll, uh, we'll spend a bit more time on the case studies for the last few minutes.
If we do, we'll, uh, we'll pick those up, uh, where appropriate there.
Chris: Um, well, we do have one question and I'll address it quickly. Um, it's, um, that's a, that's a, it's a complicated question. The question was, you know, what are the thoughts on non-listed infrastructure debt in, in the private credit space? Um, Two things going on there that can be, you know, positives.
Um, infrastructure is a positive, a place where, you know, the government has a dedicated, uh, effort to really subsidize and push forward and make infrastructure happen. Uh, non-listed, at least the way I'm reading your question. Well, okay, if you receive an email from somebody pushing a project, well, it's, Definitely you and about 20, 000 other people have seen that project, um, and so, you know, being non listed implies you're part of a network that is, hey, I can be, um, you know, I can be part of a smaller group looking at a project that hasn't been, you know, blasted out to the world, and maybe there's still some opportunity to capture an excess return there.
Um, so. Now, infrastructure of late, it was extremely popular early on, and you, it's getting a little crowded, um, and you're seeing some of the same stuff, I, you know, I love infrastructure, I love storage, but you talk to your infrastructure guys and your storage guys, and they're like, uh, it's, it's a little harder now, um, because of popularity and crowding in, and one of the things with infrastructure debt is anytime, they're usually big projects, they're usually requiring Um, very large amount of, uh, money to finance, which means, as an individual investor, you're walking amongst giants.
So, majority of that financing and everything else will be done from, you know, major funds. And so one of the things I would always understand is, well, how are my terms on comparison to somebody else who's, uh, high in capital. Involved in the deal. Um, and you know, am I sitting second fiddle if something goes wrong or there's just a lot of components you need to understand in any kind of private debt.
But if you can be, you know. In a network and get access to deals, whether it's an infrastructure storage, even things that are crowded, uh, there still might be a number of different opportunities there. Um, it doesn't mean it's a bad trade. I mean, you'll hear me say a million times over and over again, be able to identify the inefficiencies that are being captured there and how they're going to create their excess return on a, on a consistent, repeatable basis.
And if they can explain that, and then you can assess the team who's bringing the deal, what's their particular edge and how does that team, you know, how does the say in the do match of what they're bringing and why that team, why are they going to get access to it? And why are they going to be the ones to take it over to the finish line?
You've probably answered a number of different questions and it warrants, um, a deeper look, um, but, um, yeah, and speaking of inefficiencies and everything else, I mean, you know, even in a private debt of, uh, you know, real estate, you know, one of the things that we chose is, you know, I was an ex hedge fund trader and I had a boss that said, you know, don't create anything that's not inefficient if it's too crowded and you got too many big dollars flowing in your trades going to wax and wane and probably disappear, you know, faster, uh, than you would like.
Um, cause most things in arbitrage are at zero sum. So some big guy's going to take your trade. which usually would happen, but if you can find an inefficient niche space, and that's one that, you know, we identified, you know, we're not doing anything different in the private debt space of we're still originating loans, and they're very similar to someone who may be rating a 10, 20, 30 million dollar loan.
We just chose a particular spot that was saying, wait, where are, where is it not crowded? Where do I have that contract power? Where is it fragmented? Where is there a supply and demand imbalance? And where you find that is, you know, where big money just doesn't travel. And when we say microbalance, you know, you're looking at loans as small as 200, 000 to upwards of, you know, 1.2 to 1.3 million. Um, and that's, that's one inefficiency that can be recognized in a subsector. of, you know, private credit within real estate. And that's why I go back to that other slide is, you know, we might mention all these different forms of private credit. There's a fair number of subsectors that are extremely interesting in each one of those, you know, subsectors.
And this is why I'm just sort of bringing this up. You know, it's, it's sometimes if you have the willingness and you have clients that are like, Hey, I do want to create an excess return. I don't want to bundle up with. You know, the big money, um, that might go create, you know, x return. I want, you know, x plus 100, 200 kind of basis points.
You know, you'll have to do that extra step and find a way to do the due diligence, become comfortable with some of your smaller players, um, because there, there is an amazing opportunity in private credit in some of these Odd little niches. Um,
Richard: we, um, we started a couple of minutes late because of the technology.
So we have got about five minutes max left. Um, Chris, do you want to just pick out, um, a couple of the case studies just to finish up here so that we actually look at? Oh,
Chris: sure. Um, yeah, let's go to the next slide. Um, Um, I kind of talked about that. That's kind of, um, you know, you know, a little bit about us, about the inefficiency, but yeah, here's some of the case studies.
Um, you know, in commercial real estate, so let's back up and deal with some definitions, um, because I get this question a lot. Uh, legally there's a breakdown. If you are one to four doors, you are classified as a residential property, um, and that requires a certain licensing and classifications. Anything outside of one to four doors.
So, if you have a quadplex, that's still considered residential. If you actually go to five plus doors in multifamily, or you're dealing with some of the things that you're seeing here, an office building, a restaurant, or a bar, or mixed use, I mean, I know everyone's seen this, you drive downtown, you see like office or retail on the bottom floor and apartments above it.
It's becoming extremely popular in a variety of areas here in Seattle. Those are the things that all fall into sort of the commercial real estate, uh, bucket. Um, and, you know, here, you know, We come in and you've got a, you know, you can't see it from this picture, but it's a multifamily five plus, uh, you know, it's actually about 12 units, I believe, where, you know, the person is coming in and some of the loan types that you'll see is, you know, they're either buying it, So, you know, let's just say, you know, let's move over here to Columbus, Ohio.
They bought that building that's one block away from the college. It was originally a restaurant. They have the experience in running the restaurant and they're going to come in, um, and do a number of different just renovations internally, but the base skeleton of the building is perfect. So we assisted in a purchase of a building to turn into a commercial business.
Um, they had, they were well financed. The building is in great shape from a skeletal standpoint. It's conveniently located, but the other one is you can have someone like the Wellston, Ohio, they actually already own the property and they need financing to expand something out or, um, you know, Do something on the property to increase, you know, net operating income, you know, to help stabilize and get better financing.
But here's the, here's the catch and this is what bridge financing is all about as well. Where do you get the money to then get the money for the long term financing? Uh, so, What we will do is, and this is one form where you can come in and actually do a financing loan. Um, usually they're about 12 months in duration and you can actually lend against an existing income property and they use that money for a series of betterments.
Maybe it's an expansion or they're going to roll a few and make the internal betterments to the property. Um, we don't do any construction or major rehab, but if it's relatively light, Um, then we know that they can get to the level that a community bank or a credit union will come in and definitely finance them.
So, um, uh, you've got, you know, Saginaw's, you know, uh, you know, similar, similar type trade. They already owned the building. So you can see there's, there's a fair amount of demand for this repeatable of like, I need financing to get to the next step of expansion of my property, or I need financing to actually purchase and get into the trade. Um, and so when you're looking at, you know, and that's, that's the big one is where, you know, people usually need money relatively quickly and they need to get into it cause it's a competitive market. You know, some of that competition is dropping now. Um, but you go back two or three years, you know, we had people that you know, a major bank was going to finance them, but they weren't going to get their loan done in time.
And the, and the owner needed, you know, the, to close in, you know, a month. And so we would have people come in and say, Hey, I need to borrow money for three or four months. And that just gets me in the trade. And you ask like, wow, why would someone come in and pay 11, 12, 13 percent for that? Well, one, it's usually short term.
It gets you into a trade where, you know, these buildings and these people that they're not coming in at three or four caps. I mean, a lot of the trades that we look at, You know, these people, you know, 12 caps. I mean, they've got 13 caps. They've got a huge return on investment potential spread that they're looking at, you know, for this property.
So, you know, It doesn't really hurt their numbers much when you see the rates of saying, Oh my God, how would you possibly pay 13 and survive? Well, when you look at the entire project as a whole, it actually makes pretty good sense.
Richard: Can we, can we just flick to the final slide now? We've, um, we've answered the questions that came through and the final slide just gives our details here.
Um, so that's the email addresses to contact us. Um, if there's any follow up for myself or for Chris to dig in more. Um, we rushed a little bit at the end, so there might be a few questions, um, uh, there. Happy to answer any of those. Thank you all for joining us today. Thanks, Chris. Always a pleasure. Um,
Chris: Thank you Richard
Richard: With you and happy to answer any questions or follow up with anyone afterwards.
And, uh, if you do need credit, please ping us your details and we can log your, uh, CE credit for you as well. But thank you very much everyone, and uh, uh, we will, we will hear from some of you soon. Thank you.
Chris: Thank you everybody.
