The private credit market in the US is estimated to be valued at $1.5tr. An environment with 15% default rates? “Not possible,” says Ares’ CEO. Even during the 2008 financial crisis, private credit portfolios had a 1-year default rate of 8% to 10%. For perspective, Ares default rate across their entire direct lending business in 20+ years is 0.14%.
Fears of defaults in the private credit industry have intensified over exposure to software firms vulnerable to artificial-intelligence disruption. The software exposure in our recommended PC funds is anchored in resilient companies concentrated in mission critical platforms, embedded workflows, proprietary data, and high switching costs that are more likely to benefit from technological change than be disrupted. Furthermore, AI represents more opportunity than risk for the types of companies within the portfolios. Across both software and non-software sectors, the most immediate impact is improved automation and productivity, with potential cost and margin benefits.
Concerns over private credit, particularly in the retail market, reflect a misunderstanding of retail products that were never meant to be liquid (ex. Blue Owl’s restricted withdrawals from one of its retail-focused PC funds). All redemption requests from the PC funds we utilize have been filled in full. The redemption activity is sentiment driven in reaction to headlines and is not indicative of fundamental deterioration.
As the private credit headlines continue to be published, it’s worth taking a step back and revisiting why we allocate to the asset class in the first place. Private credit has historically been one of the most consistent performers across market cycles. As the Callan chart below illustrates, direct lending has delivered durable returns through the GFC, the Eurozone crisis, COVID, and the recent rate-hiking cycle (periods when many traditional asset classes experienced significant volatility).
Bottom line: Quotes in a vacuum don’t always tell the true story. AI disruption fears create temporary volatility, not systemic risk. The underlying fundamentals of the asset class remain intact. Private credit continues to deliver a meaningful premium relative to traditional fixed income. We believe the long-term role of private credit in portfolios as a consistent income generator and portfolio diversifier remains unchanged.
It’s also important to reiterate that FPLCM does not receive commissions or kickbacks from any fund companies. As a fee only advisor, we have no incentive to keep you in (or steer you toward) any particular investment. Our recommendations are conflict free and based solely on what we believe is in your best interest.