Private Credit: Unlocking Profitable Investment Opportunities
Private credit, a form of credit extended by asset managers to corporate and individual borrowers, has emerged as a high-performing alternative investment in recent years. Preqin estimates that the private credit market has grown from $250 billion in 2010 to $1.4 trillion in 2023. J.P. Morgan recently published an article entitled, “Can Private Credit Continue to Perform?”. It's worth taking a closer look at the key points in this article and see how they connect with our strategy at Kirkland Capital Group (KCG).
The Persistence of Direct Lending
Direct lending, although perceived as a new asset class, has a long history in corporate borrowing. In recent years, it has represented a shift from traditional bank lending to asset managers. This allows borrowers to access capital more quickly and efficiently, while investors can benefit from potentially higher returns compared to other fixed-income investments. As a result, direct lending has become a well-established option for companies or individuals seeking financing.
The Spectrum of Corporate Debt
Borrowers today have various sources for raising debt, including banks, syndicated loans, the bond market, and direct lending. Each source caters to different types of borrowers based on their size, need and creditworthiness. Direct lending, specifically targeting small or medium-sized businesses, fills a crucial gap in the market. KCG’s micro-balance loans cater to a specific niche in this market gap which validates our focus on this strategy.
The Shift from Banks to Direct Lenders
Regulatory changes (Dodd-Frank Act of 2010) following the global financial crisis has required banks to limit the amount of lending and restricted them from lending on many types of loans, creating an opportunity for direct lenders to gain market share. Additionally, the bespoke nature of direct loans, offering confidentiality and speed, has made them attractive to borrowers who need to close a deal quickly. Investors, on the other hand, benefit from higher yields and more protective underwriting terms. At KCG, meticulous due diligence and underwriting process has consistently prioritized the preservation of principal above all else to safeguard the capital of our investors. Our use of technology enables us to take advantage of the fragmented and inefficient space of micro-balance loans.
Putting Private Credit Growth in Context
Contrary to concerns that rapid growth in private credit assets under management (AUM) would lead to excessive corporate leverage, this has not materialized. Private credit has primarily taken market share from other loan sources, particularly from banks, rather than adding leverage to the economy. The actual size of the private credit market is often misunderstood, with AUM figures including “dry powder” or uninvested capital. When compared to high yield and leveraged loan markets, estimated to be over $3 trillion according to FitchRatings, private credit remains a smaller segment.
“Private credit, specifically direct lending, has demonstrated strong performance over the past decade.”
Strong Performance and Future Prospects
Private credit, specifically direct lending, has demonstrated strong performance over the past decade. The Cliffwater Direct Lending Index has outperformed the J.P. Morgan Leveraged Loan Index and high yield bonds. Current direct lending yields are higher than leveraged loans due to the bespoke nature of the loans, the market's skew towards riskier borrowers, and the illiquidity of direct loans. At Kirkland Capital Group, we approve only a small fraction of the loan applications that pass our thorough due diligence process. This has translated into the performance of Kirkland Income Fund, in over three years of operation, exceeding the returns of conventional bonds with few defaults and no losses.
“Considering the risk mitigation measures in place and the improving credit quality of borrowers, direct lending presents a favorable risk-reward opportunity.”
Opportunity for Investors
Considering the risk mitigation measures in place and the improving credit quality of borrowers, direct lending presents a favorable risk-reward opportunity. The J.P. Morgan Financing Team's proprietary data shows that direct lending yields have increased while risk measures have declined. Leverage in new direct lending deals has also decreased, indicating a safer lending environment. Protections for lenders in the private credit market are robust, providing an added layer of security. For the Kirkland Income Fund, we currently do not utilize leverage. We only lend on first lien and full recourse loans that ensure we have protection in the event of foreclosure. We've recently penned an article discussing options for lenders like us in states that use judicial foreclosure.
Private credit, especially direct lending, has proven to be a high-performing asset class that offers investors attractive risk-adjusted returns. At Kirkland Capital Group, we believe in the sustainability of private credit's strong performance. Several factors contribute to this performance. The market is growing. Borrowers are shifting their demand from banks to asset managers, such as us. Future regulation is on the horizon. Plus, we have strong risk management strategies in place. We're dedicated to using these private credit opportunities to provide value to our investors and help them build and fortify their wealth.
If you want to learn more about the Kirkland Income Fund, you can access our investor library here.
