As the private equity industry has grown and matured, so have the operational, regulatory and reporting demands on the asset class. This has been particularly challenging for those managers with leaner back-office teams, who have had to focus resources on the core business of finding and backing great businesses and management teams. This model, which has served managers so well for so long, is now pushing against its limits.

On the regulatory front, US managers are bracing for the implementation of new SEC rules that will oblige managers to produce audit and quarterly performance reports and provide more detailed disclosure on fund expenses. In Europe, meanwhile, managers are readying for the rollout of the next version of the AIFMD II in 2026, which will add to compliance disclosure and reporting requirements. In addition to a higher volume of regulatory disclosure, managers are also navigating the complexities of working with an increasingly international and diverse investor base and the accompanying increase in requests for bespoke, tailored investor reporting. For managers with the scale to invest in large back-office infrastructure adapting to higher disclosure and reporting volumes has been manageable. For other managers, however, existing operating models simply cannot ramp in the same way.

Fund administrators: key partners for long-term success
As private equity evolves, regulation increases and investors become more sophisticated, certain fund services providers are emerging as key partners in the midmarket and will have a crucial role to play in the sector’s long-term success. Rather than facing a scenario where €10-15m of capital expenditure has to be ploughed into upgrading the back-office capacity – at the expense of the core front-office functions of deal sourcing and execution – smaller managers can turn to fund administration partners to support their back-office obligations and free-up resources to focus on transactions and value creation.

Fund administrators, working with hundreds of managers across multiple jurisdictions, have the economies of scale and operational synergies to invest in fund accounting and reporting, regulatory expertise and technology platforms at levels that would be impossible for a single manager trying to carry the load in isolation. Outsourcing back-office functions to regulatory and reporting experts, who have the technology and human capital to handle more complex and intense workflows, gives managers the comfort that their obligations to investors and regulators are being addressed by expert service providers that know the market and have the muscle to scale-up capacity to meet intensifying back-office demands.

Enhancing technology capability is an example of how fund administrators are adding value for clients. In addition to opening access to best-of-breed industry software offerings and realistic price points, fund services partners also have the size and resources to build and maintain proprietary technology that can help clients to operate more efficiently. Alter Domus’ Digital Workflows Application, which uses AI and automation technology to handle the increasing volume and complexity of reporting and transaction flow, for example, is available to clients and can help managers to secure significant operational efficiencies.

Opportunities emerge from challenges
Partnering with a fund services provider to boost back-office bandwidth is not only a defensive play for managers. Harnessing a fund administrator’s service capability can help to unlock new sources of liquidity and new investor bases.

With liquidity for example, a slowdown in exit volumes in the face of higher interest rates has seen managers explore continuation fund vehicles as an alternative exit route to secondary buyouts, as well as trade sales and IPOs, to realize distributions for investors. Fund administrators can help managers to undertake continuation fund deals more frequently and in higher volumes. In addition to complex deal execution and organization, continuation fund vehicles also require ongoing administration and reporting.

Fund administrators can scale-up support to assist managers, as continuation fund deals are secured without placing the additional demand of back-offices. The back-office heft of a fund services partner also opens up pathways into non-institutional investor bases. The administrative demands of raising capital from individual investors – typically through private wealth feeder funds, or semi-liquid funds and open-ended structures, such as Europe’s emerging ELTIF regime – can be a non-starter for managers with small back-office teams. These structures require more regular reporting of portfolio NAV and the capacity to provide liquidity for capped redemptions during fixed windows. Client onboarding and compliance volumes also ramp up significantly when capital is raised from large numbers of non-institutional clients rather than the limited groups of institutional investors that are the norm in closed-ended private equity funds.

Managers can turn to fund administrators that are already operating at scale to digest the additional know-your-client, cashflow monitoring and reporting workflows that come with raising capital from
non-institutional channels.

Partners for the long-term
Shifts in what investors and regulators expect from private equity managers, the types of investors
managers are raising capital from, and the exit pathways available in a more sophisticated market, are reshaping how the asset class is thinking about its back-office requirements. This transformation is particularly challenging for smaller players, but through long-term partnerships with fund administration experts, managers can share the administrative load of operating in a more mature industry and stay focused on what they do best.

Mike Janiszewski, Chief Operating Officer, spoke to PEI Fund Services report about the value of outsourcing administrative functions to respond to the increased market demand from individual investors. With about half of global assets under management (AUM) held by individuals, private fund managers are keen to tap into this vast potential. Large asset managers, like Blackstone, have ambitious goals for increasing their retail capital offer. However, accommodating individual investors in alternatives, presents significant complexity- complicated structures, dealing with varying regulations, individual tax burdens and increasing back-office administration.

Mike opined that “Taking on investment from private wealth investors will require a step-change in middle- and back-office infrastructure” Private markets have responded to this already and multiple investment structures are being adopted to accommodate the differing needs of individual investors, as well as new distribution channels and digital platforms. At AD, we have been specializing in this for the past 20 years; delivering for our clients via a combination of jurisdictional, technological and administrative expertise.

Ultimately, leveraging technology for automation and data streamlining must come alongside partnership with third-party providers who can harness new tools for great success. Reach out to to find out more.

Interview

Q You have recently joined Alter Domus as chief technology officer. What background do you bring to the role, and how is that perspective useful for Alter Domus and its clients?

Most recently, I was a chief technology officer at Wells Fargo bank. Before that I was the CTO of the financial data and software company FactSet, which was my final role there over a 20-year period. In these positions I’ve been in­volved with a vast array of initiatives, from developing mobile capabilities and addressing challenges such as iden­tity protection and fraud prevention to developing and executing artificial in­telligence strategies and implementing generative AI.

Alter Domus is my first experience in a private equity-owned company. The mandate of the senior team here is clear: how do we use technology to make our services more efficient, more intuitive, and more impactful for our clients?

At Alter Domus, my team owns all the technology and app development efforts for the business, as well as the data analytics and engineering and some of the product strategy from a technology perspective. The goal is to help continue to scale an already rap­idly growing business and drive sever­al transformative initiatives, with one area of focus being the data and ana­lytics business, where we see a lot of potential.

Q What is your perspective on AI and its adoption in private markets?

AI has been fundamental to many com­panies and products for a number of years. Companies such as Tesla have been working on self-driving vehicles for more than 10 years, and those are in­herently AI-enabled. So, AI is not new.

What has changed is that last year saw probably one of the most suc­cessful marketing campaigns ever launched when Open AI unveiled its initial version of ChatGPT. We all started talking about generative AI and what ChatGPT would mean for us. Adoption of that tool went from zero to 100 million active users in just two months, making it the fastest growing consumer application in history. That showed the art of the possible with generative AI, and immediately drove that conversation in boardrooms.

Right now, what is important for business is to thoughtfully manage the gap between AI hype and practical business applications. Businesses need to prioritize opportunities in order of obtainability and then manage commu­nications with stakeholders to create meaningful outcomes. Too often, com­panies become focused on what’s new, rather than what’s best, or more to the point in Alter Domus’s case, what’s best for our customers.

Q What steps are service providers like Alter Domus taking in AI?

We believe that before any concrete actions are taken in AI development, governance issues have to be addressed. Protecting both our clients’ data and business at large as well as our own is of the utmost importance.

It’s best practice to have a formal and mature intake process for AI ap­plications and a multidisciplinary panel that considers and prioritizes oppor­tunities for the business, as well as any implementation guardrails and cy­ber-security considerations. That panel should include representatives of tech­nology, business, regulatory compliance and HR. Putting that disciplined collec­tive effort into mitigating risks like data leaks or data breaches is essential.

The other element of this is the technology itself. The way a company like Alter Domus approaches that is with a platform construct. Instead of focusing on underlying infrastructure (such as GPUs), we chose to partner with cloud providers that offer robust ‘out of the box’ solutions that enable us to experiment, validate, and deploy AI solutions with little friction. Leverag­ing our partners that have robust end-to-end services that aggregate versus trained or partially trained algorithms is a smarter method for us.

For example, we have a relationship set up with AWS using some of their services, such as SageMaker and Bed­rock, which deliver pre-packaged plat­forms of large language models. That is central to our strategy because we get immediate access to enhanced technol­ogy and capabilities.

One of the ways we approach AI gov­ernance is to consider use cases in three buckets: ready-made solutions we can buy (such as co-pilots that can be easily integrated into our workspace produc­tivity tools); capabilities and tools, built by Alter Domus, that enhance the effi­cacy of our employees’ service delivery to clients; and AI capabilities embedded into products, delivering sophisticated analytical capabilities and meaningful insights to our clients.

Q Why is private credit a particular area of focus, and what advances are being made there?

We feel the private credit space really lends itself to the last two of those three categories. There are tens of millions of unstructured documents and data sources in private credit, with many in PDF, Excel or even fax format.

We have a product called Digitize that processes 30 million documents, extracting, classifying, and incorporat­ing content into client-facing products. Then it becomes easier to use genera­tive AI and the analysis of that data re­quires less human input, leading to bet­ter outcomes, faster turnaround times and cost savings for clients.

Q Is AI replacing humans in the use cases you see?

I think for the foreseeable future, AI is about creating substantially better tools for humans to use, but we still need hu­mans. Instead of using manual tools to deliver outputs, you can speed up processes and get more reliable results using AI, and that is more rewarding work for the humans involved.

For now, we still need humans to oversee those processes, to check that AI is working properly, which means there is an upskilling opportunity and AI is simply taking away the more mundane elements of tasks. In the longer-term, AI will free our teams to focus on more strategic areas of work.

Q What do you expect to be the most exciting developments in this area in the near future?

We are focused on building out our data and analytics business as a com­prehensive data platform making use of AI capabilities. That will take data from various siloes and make it available in a very secure and compliant way for our clients. We plan to employ AI to enable the data platform to deliver actionable insights and new analytical capabilities for our clients.

The key element in all of this is that you have to ‘feed the machine’: AI needs data to really learn and operate in the most effective way, and we sit on a treasure trove of data. We make cer­tain to prioritize the use cases that will have a beneficial impact on our clients. We want to give them more visibility into their funds than they have ever had before, allowing them to make faster and better formed decisions.

Interview

Q To what extent do the SEC’s private fund rules impact the secondaries industry and how have these changes

been received?

Tim Toska: The US Securities and Exchange Commission’s new private fund adviser rules are certainly far reaching and there are significant changes involved. But, as it relates to the secondaries industry, it is the mandatory requirement for a fairness opinion or valuation in every GP-led secondaries deal that is the most directly relevant. There are also new disclosure requirements around material business relationships and activities, which must be formally documented and posted to a portal. In many instances, both are already happening, but the rules mean there is now a regulatory requirement to take these extra steps in what might well be a time sensitive transaction. That can always be a cause for concern. Managers want to be able to proceed with  deals in as frictionless a way as possible. That said, compared to some other aspects of the rules, these provisions are unlikely to keep many awake at night.

Q Could a clearer regulatory framework around GP-led  secondaries be welcomed, particularly when it comes to ensuring LPs are comfortable with these deals?

TT: Absolutely. This is a fast-growing market, and it has been exciting to see GP-led secondaries emerge as a valid avenue for generating liquidity, alongside traditional M&A and IPOs. But there are clearly some inherent conflicts of interest that need to be carefully managed because the last thing anyone wants is for questions to be asked in hindsight, should a deal not turn out as planned. These are not arms length transactions and so they lend themselves to being second guessed. Increasing the regulatory framework helps eliminate any of that doubt and so from the perspective of the ongoing growth and maturity of the sector, I think it is largely to be welcomed.

Emily Ergang Pappas: It also goes long way towards ensuring all investors are in the same situation. Yes, there were many funds that were already including fairness opinions in their deals and going the extra mile in terms of transparency, but now investors in every fund will be afforded that same level of protection from potential conflicts of interest. The codification of best practice means all investors are now in the same boat.

Q What modifications have we seen since the initial rules were proposed and where are we now in terms of when the rules will be enacted?

EEP: We are in a unique position as fund administrators in that these rules don’t technically apply to us, but they will apply to most of our clients and will affect the services we provide. We are therefore keeping a close eye on how things develop. There are a number of lawsuits that are ongoing, and no-one is entirely sure what the timelines are likely to be, but we are certainly paying close attention. I would agree with Tim though that this rule is not as controversial as some of the others. We have been heavily focused on the quarterly statement rule, for example, because there is a lack of clarity there and because it impacts our role as administrators particularly. There have already been some modifications made between the proposed rules and final rules when it comes to secondaries, with greater flexibility to choose between either a fairness opinion or a valuation. Beyond that we are in a wait and watch holding pattern, considering what the eventual outcomes are going to mean for clients.

Q Given the GP-led market’s growth, is it reasonable to expect it will be subject to greater regulatory scrutiny going forward, beyond these specific rules?

EEP: The short answer is yes, absolutely. Anytime something grows in size and popularity to this extent, particularly when it involves readily identifiable conflicts of interest, it is inevitable that the SEC and other regulators around the world are going to want to put some parameters in place to ensure investors are adequately protected.

Q Against this regulatory backdrop, how are you seeing the GP-led secondaries market evolve?

TT: I would say that the GP-led secondaries market has now reached a stage in its maturation journey where it sits side by side with other strategies. Certainly, in terms of deal volumes, GP-leds have been at or about 50 percent of the overall secondaries market for the past few years. In fact, there has been insufficient capital available to meet demand from GPs, who now view this as a viable exit route and means to generate liquidity in an environment where liquidity has been in short supply.

Q Will that growth trajectory continue unabated as and when M&A markets return?

TT: I believe that it will. There will always be reasons for GPs to pursue this type of deal, regardless of what is happening in the broader macroeconomic environment. It is true that a revival in M&A will lessen the need for GPs to turn to continuation vehicles to generate distributions for investors. However, there will always be sectors, or segments of the market, that are facing structural or economic hardships and where secondaries capital is required.

Furthermore, there will always be situations where the timing just isn’t right for a GP to exit, despite the fact it is running up against the limits of a fund’s life. Due to the intense growth in volume and awareness over the past few years, GPs know these GP-led deals are something they will always have in their back pocket.

Q The GP-led market is widely believed to be one of the most undercapitalized corners of private markets. How do you see the buyside evolving going forward?

TT: The secondaries market, and GP-led secondaries in particular, are undercapitalized relative to the supply of transactions in the market. But I don’t necessarily view that as a negative. In fact, in many ways it can be viewed as a positive, because it ensures buyers are able to originate and diligence opportunities in a disciplined manner rather than feeling any pressure to put money to work. Of course, we don’t want to see that undercapitalization continue forever. But it is no bad thing for supply to outpace demand as the asset class matures. That will help ensure everyone concerned has positive experiences, including LPs that decide to roll and the new investors that come in. The more of these win-win situations that we see come to fruition, ultimately leading to successful realizations over time, the better it is for the asset class in the long term.

Interview

Q How far has private equity come in terms of its willingness to leverage technology to support middle-and back-office functions?

The industry has certainly come a long way, particularly over the past few years. The ability to leverage technol­ogy to support operations has moved from a nice-to-have to a must-have. A lot of that movement has been driven by investors in terms of the timeliness and granularity of the data that they are demanding, and that has placed an unprecedented emphasis on efficiency. Technology has inevitably been part of the solution, but this isn’t something that investors have foisted onto man­agers. It doesn’t work that way – it is something that needs to be embraced and we have undoubtedly seen a marked shift in managers’ willingness to do just that.

Q How is technology being used in the investor onboarding process?

Onboarding is a fantastic use case for technology because it is an area in which the private markets desperately need to become more efficient. Historically, onboarding has involved a huge amount of back and forth across paper trails, e-mail communication and calls. The ability to digitalise subscription docs and streamline AML and KYC processes using tech tools that weren’t available just a few short years ago, is proving transformative for the industry.

It is also incredible to see how far we have come in terms of LP portal devel­opment within a relatively short period of time. Just 15 years ago – which isn’t all that long ago, in the grand scheme of things – investors were receiving call notices by fax machine or even mail.

These investor portals have greatly improved, and continue to greatly im­prove, communication with LPs, while also creating significant cost and time efficiencies both for the manager and the underlying investor.

Q In light of the US Securities and Exchange Commission’s new private fund rules, how important is technology going to be in meeting regulatory demands?

Reporting requirements are intensify­ing as a result of regulation, including the new SEC rules, but they are inten­sifying in re sponse to investor demands in any case. It is therefore critical to have timely and accurate data at your fingertips as a private equity firm or administrator, which is exceedingly difficult without the use of technology. Technology can help with the sourcing of data and with moving that data across channels, which is what needs to hap­pen with any reporting process. Again, technology has really become a must-have in meeting the additional demands that fund managers face today.

Q What are the foundational steps that firms need to take to maximise the potential of the data that they hold?

Small firms can probably handle data requests and analysis in Microsoft Ex­cel. That becomes increasingly difficult to manage, however, as the business scales. It is therefore crucial that firms have a regimented plan around data from the outset, otherwise things can quickly become complicated, particu­larly when it comes to establishing a single source of truth.

Back-office teams, investment teams and marketing teams, for example, may hold different data sets that can often overlap. That data needs to be aggre­gated, normalised and validated until everyone is confident that the data they are accessing is based on the most accu­rate and up-to-date information. Only then can firms consider moving on to the next step of gleaning accurate and meaningful insights from the data and automating processes.

Q To what extent are private equity firms leveraging automation tools and data analytics today and what are the most interesting use cases?

At the highest possible level, there are three areas where private equity is exploring the use of automation: op­erations, portfolio management and investment decision-making. It is in the operational arena that we first saw many of these automation tools come into play. Any time you are dealing with a recurring process, such as an invoice payment, for example, that is a task that can be streamlined through automation.

Communication with portfolio companies, meanwhile, is another tan­gible use case for automation. Manag­ers require businesses to provide reg­ular updates on financial performance that are then fed into a data model up­stream. Automation can really help in processing that information, regardless of the format in which it arrives. There are tools that can be used to standardise the different balance sheet and income statements coming from portfolio com­panies, allowing the firm to compare apples with apples and to feed the data into valuation models. In some cases, this data is coming from hundreds of different portfolio companies and so the ability to process and standardise it without manual inputting is clearly a massive efficiency gain. Teams that would have acted as data aggregators are instead able to spend more time re­viewing and analysing the output.

By contrast, we are still in the ear­liest possible stages when it comes to automating investment decision-mak­ing processes. The focus for GPs right now is very much centred on creating a single source of truth, then employing automation tools to pull the relevant data so that humans can make decisions based on the best possible information.

Q What are the next steps for private equity when it comes to tech adoption?

What is most important is that we have now reached a stage where there is near-universal recognition of the im­portance of tech adoption. Just a few years ago, not everyone was necessar­ily sold on its benefits and tech adop­tion certainly wasn’t always viewed as the priority. That situation has flipped entirely. Of course, different firms are at different stages of that journey, but thanks to the now ubiquitous coverage of the benefits of automation in the mainstream media, we have got over the most significant hurdle, which is the willingness to embrace what tech­nology has to offer.

It is important to recognize that no one is trying to get to a point where automation software is being used to identify an investment target, carry out due diligence and then spit out a yes or no answer as to whether or not the firm should proceed with that deal. No one is looking to go to those extremes. Instead, firms are experimenting with using technology to identify market trends and carry out sensitivity analy­sis, and then build in the human judge­ment that sets them apart. The use of technology in private equity has never been about replacing people. Instead, it has been about maximizing the poten­tial of that human resource.

Overview

Amongst the alternative investment universe, private credit[i], specifically loans to corporate borrowers made by non-bank lenders, has garnered significant media attention – seemingly in the headlines on a daily occurrence.

The growth of the private credit markets has introduced new participants to this asset class while raising capital for new funds, acting as an efficient intermediary between prospective borrowers seeking more efficient funding and investors seeking more favorable risk/return characteristics.

However, the attention the private credit market has attracted has been varied. Many recognize the benefits that the private credit market provides for fueling economic growth while offering borrowers alternatives to greater diversified sources of funding.

On the other hand, some have raised concerns referring to its immense growth as an asset ‘bubble’ and/or potentially introducing systemic risk to the financial markets. They have pointed to, as examples, the opaqueness of the private credit markets and  limited regulatory oversight.

Still, there are aspects of the private credit markets that are transparent and regulated, and there are features of this market that mitigate some of the concerns often cited by market observers.

Furthermore, the notion that ‘bubbles’ are countered with regulation or that ‘bubbles’ follow just ‘opaque markets’ is somewhat inconsistent with what has been historically observed from some of the most transparent and regulated markets in the world (e.g., the various ‘bubbles’ that have occurred in public credit and equity markets and of course some of the stress associated with regulated banks and other regulated institutions such as money market mutual funds).

In this paper we offer some perspective on the private credit market drawing attention to, as examples, certain key elements that market participants could take into consideration during their general risk assessment of the industry. These topics as well as others, including the nature of the individual credits and the lenders’ expertise, are all worthy of their own individual attention.

Private credit as a valuable alternative

Private credit markets have been growing for well over a decade post the Great Recession. That growth has been further highlighted since the US bank crisis in early 2023. The failure of several prominent regional banks that required FDIC intervention has been one of the catalysts that has most recently led to greater regulatory scrutiny across the banking sector.

As a result, banks have tightened their credit standards leading to relatively curbed lending activity. Regulatory pressures will continue to place pressure on banks and their loan portfolios. Recent stress on some regional banks in early 2024 has reinforced this perspective.

Corporate borrowers have in turn increased their reliance on the private credit markets as an alternative source of funding, and non-bank lenders have continued to fill in the void left by banks – a “de-banking” phenomenon, as one market participant put it. What was once an area of the market confined to leveraged loans to small and mid-size corporate borrowers has increasingly financed larger sizes of loan issuances as well as those considered to be investment grade.

We believe that the market evolution has fostered a steadier environment characterized by longer-term oriented investors with fewer liquidity constraints than banks, thus better aligning supply and demand. A good example of which is when the market is faced with too many borrowers looking to rollover (or refinance) their loans (i.e., ‘maturity walls’) and with not enough liquidity available.

The private credit markets satisfy significant investor appetite for its risk/return characteristics as they offer comparably equity-like returns with significant credit spreads versus other fixed income investments.

This generous return profile is especially so since most loans are floating rate where its base rate (e.g., SOFR) has followed the Federal Reserve’s fund rate increases. The enhanced returns aim to not only appropriately compensate the lender (and investors) for the credit risk of the loan (i.e., reflecting degree of leverage, seniority, etc.), but also for the illiquidity of the loan.

Furthermore, investment returns may include incremental premia for the borrower’s prepayment optionality as well as fees associated with the loan facilities. Since the investor base is typically long-term focused, they can realize these additional premiums.

Transparency – Are these markets really “opaque”?

Market participants could access significant amounts of data on the performance of private credit portfolios. These data could be used as reasonable proxies to assess or ‘check’ lender performance in those instances where detailed data may be limited or not readily observable. Here are some key examples:

• Banks and credit unions post quarterly data on the performance of their loan portfolios (e.g., commercial & industrial – ‘C&I’, real estate, consumer). This allows market observers to conduct their own assessment of credit performance (losses and allowances) for almost 10,000 institutions on a quarterly basis with significant historical information. Estimates of the private credit markets, excluding banks, are in the area of $1.7trillion. The three largest US banks alone have about $1.4trillion in C&I loans, a good proxy for private credit performance, whereas all the banks in the US have close to three times this amount.  
• Business Development Companies (BDCs) that are regulated report their financial information generally on a quarterly basis, consistent with SEC reporting requirements. These reports include detailed information across their portfolio holdings, with estimated valuations and income earned on these portfolios. The total BDC market is approaching $300bln where roughly half of the market is publicly traded.
• Leverage loan funds (e.g., open-ended funds, closed-ended funds, ETFs) also report detailed information on a quarterly basis regarding their portfolio holdings, with valuations and income earned on their investments and are consistent with reporting requirements that are guided by SEC rules and regulations.

Reduced Pressure for ‘Fire’ Sale

Bank lending is often financed with deposits, a source of funding that could be volatile depending on human behavior. Several banks in early 2023 experienced a ‘run’ on their deposits which imposed significant pressure on their funding needs while many of their assets were ‘locked’ into longer-term loans.

The private credit markets, on the other hand, are typically funded with more stable and longer-term funding. For example, private credit investment vehicles can have access to a fixed liability profile (e.g., direct lending fund, CLOs, BDCs, closed-end funds) or one that is highly predictable (e.g., life insurance, pension) along with semi-permanent capital.

The better match between funding sources and underlying loans provides a significant cushion to private credit investors and acts as a ballast against a liquidity crunch. Importantly, this longer-term match allows investors to potentially reap the excess returns associated with illiquidity and other premia that are attached to private debt investments.

Active Portfolio Management – ‘Skin-in-the-game’

Banks may have millions of loans across various segments (e.g., Commercial Real Estate – ‘CRE’, C&I, residential real estate, consumer, etc.) whereas private credit lenders will tend to have tens or hundreds (in a few cases maybe more but that is not common) of loan issuers, primarily C&I-related.

Private credit managers will typically invest in fewer companies but will invest significantly in knowing those companies and related industries very well. This active management and expertise allows private credit managers to be more focused and proactive in preserving value for their investors.

As we have noted earlier, private credit managers tend to have a longer-term investment horizon and a general tendency to invest in companies where they have an in-depth understanding of the borrowers and related industries. Furthermore, in times of distress, private credit managers will often have less pressure to offload investments since these managers are in the business of lending and working through any stress in underlying credits. In many instances, the managers may have significant relationships with the private equity sponsor.

A Diversified Market

Unlike large liquid markets such as BSL, mortgage-backed securities, agency mortgages, and equity markets, the private credit market is characterized by small companies issuing debt to a limited (and often small) number of creditors.

Thus, issuer concentration risk is to some degree mitigated in the private credit markets. We have also shown in previous research that there exists some diversification across industries (and possibly investment strategies) in the private credit market, mitigating some type of ‘systemic’ event.

When these features are combined with the close watchful eye of seasoned asset managers and more stable funding sources, as discussed above, the risk can be further reduced.

However, there are at least two areas of potential systemic risk worth noting – correlation with the broader (potentially global) economy as a whole and any risk related to looser underwriting processes paired with poor risk management applications by the asset managers.

Both risks apply regardless of the asset class in question – whether it is private credit, actively traded high-yield bonds or the most liquid agency mortgage-backed securities. There is no substitute for prudent underwriting processes and disciplined risk management.

Conclusion

The private credit market, senior secured loans in particular, is a significant element within the alternative investment universe, displayed by its immense growth in recent years. This market  has contributed to the overall economy providing corporate borrowers an alternative to banks with more diversified source of funding.

This is especially important in times when it is most needed and is a sign of a dynamic market where supply/demand imbalances are filled with market solutions that may be more efficient by better aligning risk/return characteristics.

As the private credit market has grown, it has attracted significant attention from the media and other market participants across the capital markets. Though many rightfully give credit to the economic benefits the private credit market provides to both borrowers and investors, the rapid growth of this market has also raised concerns from some that are wary of the size and growth of this asset class.

Risk-return tradeoffs are a constant in all financial markets, and it is no different with the private credit markets. The overall benefits that the private credit markets provide may significantly be more than enough to offset any potential risks that may reside.

The private credit markets, which offer relatively high returns, already feature various mitigants to some of the identified risks. For example, certain levels of transparency, various regulatory oversight, asset-management focus and expertise, and more effective asset-liability matching. It is also worth noting that a number of these identified risks also exist in the public capital markets to varying degrees.

[i] Note: that we make a distinction here between the private credit market and the Broadly Syndicated Loan (BSL) market (see our previous research here on key differences between them).