Are you familiar with the types of Private Credit that may have the greatest potential to enhance your client portfolios?
Private Credit as an asset class may be an attractive option for sophisticated investors who are looking to add diversification while also protecting their principal in volatile markets. However, there are many different kinds of private credit, and not all of them may meet your clients’ investment goals.
In order to help you navigate the different strategies within the Private Credit space, the TIFIN Private Markets Research Team explains some of the common Private Credit strategies, including return profiles and risk exposure.
Private Credit Strategies in Summary
Senior debt often refers to first lien debt, however, it can also mean any other preferred debt in the capital stack. This means that investors could be investing in any combination of second lien, split lien, or uni-tranche debt. Some private credit funds add these forms of debt to a portfolio in order to increase the fund’s return profile since risk and return increase the further down you go in the capital stack or the structure of all capital that is invested into a company.
Senior debt can add steady cashflow from credit-worthy borrowers, primarily in the lower middle-market. These loans are often shorter in term and have floating rates, making them an attractive asset class in periods of rising interest rates. Funds also use leverage to increase the amount of loans they can originate, which increases the returns while exposing the investor to additional interest rate risk.
Mezzanine Debt (Target IRR 15-25%)
This form of debt, a type of financing that bridges the gap between senior debt and equity, is not backed by underlying assets and typically has higher coupon payments when compared to collateralized debt. These loans often come with warrants to lower the interest rate paid by the borrower. Warrants can significantly increase Total Return of the fund if exercised.
Mezzanine debt funds can add high yield cashflow to a portfolio while also providing exposure to rapidly growing middle market companies through the use of warrants.
Bridge Lending (Target IRR 10-15%)
When businesses are waiting to secure long-term financing, whether through a government program or another lender, they may turn to bridge lenders to cover expenses in the interim. These are short-term loans that charge higher interest rates and often have fees for prepayment that help drive fund returns.
Adding bridge lending to a portfolio may bring short term, rate-adjusted cashflow as the short-term duration protects investors against rising interest rates. There is also less reinvestment risk due to the short maturities of these loans. We believe it can be a great way to access long duration markets like real estate without the traditional lockups.
Distressed Debt (Target IRR 10-15+%)
Distressed debt can come in the form of either public or private debt, regardless of the source of the debt, the fundamental strategy remains the same. The fund looks to acquire debt of companies that are either; in default, approaching default, or undergoing some sort of negative pressure that is lowering the acquisition cost of their debt. The goal is to acquire this debt at a significant discount to par, then work with the borrower to repay the loan, or depending on the situation, take control of the company and fix it themselves.
Allocating a portion of a portfolio to distressed debt can potentially add non-correlated returns and also may serve as a way to take advantage of a falling market. As interest rates continue to rise, we expect to see an increase in the number of defaults, which will provide ample opportunities for distressed managers to deploy capital. In our view, this strategy is best deployed in bear markets and the return profile of each fund can vary significantly based on risk.
Getting Started with Private Credit
TIFIN Private Markets offers a collection of curated alternative investments spanning private credit, hedge funds, private equity, real estate and more. To learn more about accessing private credit through TIFIN Private Markets, we invite you to schedule time with our team.