Talk Your Book: What Is Private Credit?

Episode Summary

Executive Summary: The episode introduces private credit through a conversation with Marco Hanig of Alternative Fund Advisors. It explains why the asset class has grown, how it differs from public bonds and bank lending, why investors are drawn to its higher yields and lower volatility, and what risks and due-diligence issues advisors should consider. Much of the discussion centers on sourcing, collateral, liquidity, fees, and the role of regulation in shifting lending from banks to private platforms.

Main Topics: What private credit is (Priority: 5/5): Private credit is defined as direct lending that is neither publicly traded like a bond nor originated by a bank. The discussion frames it as money lent directly to middle-market and smaller borrowers through private lending platforms. Why private credit has grown (Priority: 5/5): The rise of private credit is linked to banks pulling back from certain lending segments due to post-2008 regulations, capital requirements, and balance-sheet constraints. This created space for alternative lenders and private equity firms to step in. How returns are generated (Priority: 5/5): Returns come from both a liquidity premium and an origination/sourcing premium. Investors are compensated for locking up capital and for accessing loans that must be sourced, underwritten, and monitored rather than bought in a liquid public market. Asset-based vs. cash-flow lending (Priority: 4/5): Hanig distinguishes between cash-flow-based loans and asset-based loans, noting his firm focuses on the latter because tangible collateral can improve repayment recovery and reduce dependence on the economic cycle. Liquidity, valuation, and volatility (Priority: 4/5): Private credit is less frequently marked to market than public bonds, which reduces apparent volatility. The conversation addresses whether this is a true economic advantage or simply a smoother accounting experience for investors. Risks, leverage, and due diligence (Priority: 5/5): The episode highlights the importance of manager selection, underwriting quality, loan-to-value coverage, covenant strength, and avoiding hidden leverage. It also warns that not all interval funds marketed as private credit are truly private loans. Fund structure and investor access (Priority: 4/5): Marco explains that interval funds and fund-of-funds structures make private credit more accessible to advisors, family offices, and RIAs while preserving quarterly liquidity and diversification across lending niches.

Key Arguments: Private credit exists because banks have stepped away from parts of the lending market, especially smaller and more specialized loans, due to regulatory and capital constraints. Investors are compensated for both illiquidity and the work of sourcing/underwriting loans; in other words, private credit is not free excess return. Private credit is often an income strategy, not a capital appreciation strategy, and should be sized as a long-term allocation rather than a tactical trade. Asset-based lending can offer stronger downside protection because repayment is supported by tangible collateral such as equipment, real estate, inventory, or receivables. Less competition in smaller or niche lending markets allows lenders to charge higher rates and generate attractive spreads. A smoother return stream does not mean risk has disappeared; it may simply reflect slower valuation marks and less visible volatility. Leverage can amplify losses in downturns, so Hanig prefers unlevered or lightly levered funds. Advisors should verify how much of a product is truly private credit versus public-market credit exposures like high yield, CLOs, or syndicated loans. A fund-of-funds structure can be valuable because many underlying lenders are small, specialized, and difficult for most investors to diligence individually.

Data Points: Typical loan duration: 3 to 5 years - Used to describe private credit assets as shorter duration than traditional private equity lockups. Quarterly redemption limit: 5% - Interval funds in private credit generally limit withdrawals to 5% of fund assets per quarter. Interest rate example: SOFR + 6 to SOFR + 7 - Representative floating-rate pricing for many private credit loans. Coupon/yield range: Low to mid-teens - Described as normal for many loans in the segment Hanig’s firm serves. Net current yield: 9.3% - Reported as of 12-1-2023 for the fund discussed. Distribution rate: About 6% annual rate - The fund distributes roughly 1.5% quarterly, with a year-end catch-up. Quarterly distribution: 1.5% - Each of the first three quarters distributes at this rate before year-end true-up. Management fee: 110 bps - The fund’s stated management fee. All-in fund fee: 145 bps - Includes management fee and operating expenses at the fund level, excluding underlying fund expenses. Acquired fund fees: About 3.5% - Underlying fund expenses, including borrowing costs and performance fees, as described in the discussion. Portfolio size: About 570 positions - The fund is diversified across many underlying loans. Number of lending platforms: 15 - Underlying positions are originated through 15 separate lending platforms. Weighted average leverage: About 9% - Average leverage across the underlying funds in which the firm invests. Potential loan rate example: 12% - Example used to explain how lending platforms and managers get paid. Borrowing cost example: 8% - Example used to illustrate spread capture when leverage is employed.

Pivotal Quotes: "Private credit, in essence, is any kind of loan that is not a bond, so not publicly traded, and not issued by a bank." — Marco Hanig: Defines the asset class early in the interview. "The benefit is to borrowers that can now do things that continue to have access to credit... The people that are hurt are banks." — Marco Hanig: Explains winners and losers from the shift to private lending. "This is without question an income and yield is the motivation to invest in this. It's not a capital appreciation investment." — Marco Hanig: Clarifies how investors should think about the strategy.

Implications: Private credit is becoming a mainstream allocation for advisors seeking yield and diversification, but investors must separate true private lending from public-credit proxies and understand liquidity, leverage, and collateral risk.